It occurred to me that the arguments for Supply Side improvements as demand stimulus in a liquidity trap are stronger than I had originally thought.
Why?
Well as long as we are in the liquidity trap then the real interest rate is zero. This means that the value of Supply Side improvements after the liquidity trap are necessarily not discounted.
The liquidity trap is like a time warp in which in Discounted Present Value Terms, the end is always tomorrow. Even massively long dated supply improvement should affect demand now.
It means also that the carrying cost of real capital is simply depreciation.
What makes this doubly interesting is that among the slowest depreciating capital goods are structures.
Yet, it is precisely investment in structures that are in the dumps right now.
This wraps around in almost an obvious way, but it suggests that Minsky type moments of the kind Eggerston and Krugman model generally do not persist because if they occurred they would simply induce a boom in the building of structures.
Indeed, that is of course how the business cycle generally operates.
However, that makes bubbles in the price of structures very dangerous. Once the price of structures begins to fall this impedes their use as collateral. This in turn makes borrowing for the purpose of building structures risky and so raises the actual financing cost of structures well above zero even in a liquidity trap.
The key to a liquidity trap then is not that savers cannot be induced to spend, it is that builders cannot post collateral. If they could the slow depreciation of structures and the perpetual tomorrowness of the liquidity trap would induce more building.
This also shows why a currency zone with very slow or negative population growth can so much more easily get stuck in the trap. The demand for structures may actually be falling over time. This means that the distance until the end of the trap matters and you can’t necessarily produce the backwards cascading that would always call for an increase in construction.
What would be interesting is if historically there is a link between the length of a recessions and the speed of population growth/urbanization.
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Monday ~ November 14th, 2011 at 11:06 pm
Lord
There probably is such a relation but it would go in the wrong direction with depression lowering the birth rate. Values are likely already below replacement cost in the worst hit areas making new construction uneconomic there and land owners would prefer to bide their time than sell anytime soon elsewhere.
Tuesday ~ November 15th, 2011 at 9:45 am
engineer27 (@engineer27)
“…as long as we are in the liquidity trap then the real interest rate is zero.”
No, the nominal interest rate is zero. The real interest rate is negative (in our case, although with deflation it could be positive).
Tuesday ~ November 15th, 2011 at 11:39 am
Becky Hargrove
On the little main street where I live, new (never used) commercial structures sit side by side with older commercial structures with faded real estate signs – both caught in the time warp of what the world was supposed to be and what it actually is.
The best lever we have to stabilize credit and current investment at the zero bound is something few expected: non-credit forms of current time mobile building components. Such forms of asset creation are always needed to stabilize economies but even more so when demographics “work against us” as they do in the present. Civilizations can thrive if they realize markets can no longer remain sticky as populations grow older.
In order to supply a good, more demand is needed but sometimes we look at this wrong. For instance, consider the local level where people want to open a business but existing businesses are threatened by that happening. They might see food trucks, market stands and modular building components in varying uses as only taking away their customers. So they convince the public that such informal activity is not “safe” for the public. But as a result, many among the public can not participate economically at all. And so the remaining businesses have even fewer customers with time. The solution is to break the spiral of fear, so that not only can new businesses thrive, but people see the new potential customers, which in turn gives them the confidence to lease or buy the existing empty large structures. When the little player is let back in, the larger players do not have to see their capital disappear into the ether.
Tuesday ~ November 15th, 2011 at 7:36 pm
Bob Murphy
Extremely interesting post, Karl.
Wednesday ~ November 16th, 2011 at 3:00 am
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