I was reading the other day an Argentine columnist that was arguing that there are two (not necessarily invisible) hands in the economy - one that guides individual decisions into collective good (Adam Smith)...But, that sometimes can lead to collective harm (as the excesses we havejust witnessed) and then another (somewhat discredited for the last 20years) visible hand that is required to bring things back into normalcy-> John Maynard Keynes (and The General Theory of Employment, Interestand Money) and his concept of having government spending replaceconsumer spending...
The piece that Krugman wrote today is more or less arguing the samething and providing some background to what we are living... Goldman didan excellent summary of the liquidity trap we might be going into (whichKrugman points in his article)... Which then connects the dots -> insituations with high real interest rates, the fed can be effective bylowering nominal interest rates, but, when real interest rates can onlygo to zero or negative, monetary policy completely loses significance(Japan in the 90's and the situation we might be in today), so you needfiscal stimulus...
It all comes back to policies of this administration and Fed: 1) we will deeply regret driving that budget deficit higher and higher (that ismoney badly needed right now), and 2) Bernanake should have never cutrates the way he did in 2007, he needed them now.
When Consumers Capitulate By PAUL KRUGMAN
Published: October 31, 2008
The long-feared capitulation of American consumers has arrived.According to Thursday's G.D.P. report, real consumer spending fell at an annual rate of 3.1 percent in the third quarter; real spending ondurable goods (stuff like cars and TVs) fell at an annual rate of 14percent. To appreciate the significance of these numbers, you need to know thatAmerican consumers almost never cut spending. Consumer demand kept rising right through the 2001 recession; the last time it fell even fora single quarter was in 1991, and there hasn't been a decline this steepsince 1980, when the economy was suffering from a severe recessioncombined with double-digit inflation. Also, these numbers are from the third quarter - the months of July, August, and September. So these data are basically telling us whathappened before confidence collapsed after the fall of Lehman Brothersin mid-September, not to mention before the Dow plunged below 10,000. Nor do the data show the full effects of the sharp cutback in theavailability of consumer credit, which is still under way.So this looks like the beginning of a very big change in consumerbehavior. And it couldn't have come at a worse time.It's true that American consumers have long been living beyond their means. In the mid-1980s Americans saved about 10 percent of theirincome. Lately, however, the savings rate has generally been below 2percent - sometimes it has even been negative - and consumer debt hasrisen to 98 percent of G.D.P., twice its level a quarter-century ago. Some economists told us not to worry because Americans were offsettingtheir growing debt with the ever-rising values of their homes and stockportfolios. Somehow, though, we're not hearing that argument much lately.Sooner or later, then, consumers were going to have to pull in theirbelts. But the timing of the new sobriety is deeply unfortunate. One istempted to echo St. Augustine's plea: "Grant me chastity and continence,but not yet." For consumers are cutting back just as the U.S. economyhas fallen into a liquidity trap - a situation in which the FederalReserve has lost its grip on the economy.Some background: one of the high points of the semester, if you're ateacher of introductory macroeconomics, comes when you explain how individual virtue can be public vice, how attempts by consumers to dothe right thing by saving more can leave everyone worse off. The pointis that if consumers cut their spending, and nothing else takes theplace of that spending, the economy will slide into a recession,reducing everyone's income.In fact, consumers' income may actually fall more than their spending,so that their attempt to save more backfires - a possibility known asthe paradox of thrift. At this point, however, the instructor hastens to explain that virtueisn't really vice: in practice, if consumers were to cut back, the Fedwould respond by slashing interest rates, which would help the economy avoid recession and lead to a rise in investment. So virtue is virtue after all, unless for some reason the Fed can't offset the fall in consumer spending. I'll bet you can guess what's coming next. For the fact is that we are in a liquidity trap right now: Fed policy has lost most of its traction. It's true that Ben Bernanke hasn't yetreduced interest rates all the way to zero, as the Japanese did in the1990s. But it's hard to believe that cutting the federal funds rate from1 percent to nothing would have much positive effect on the economy. In particular, the financial crisis has made Fed policy largely irrelevant for much of the private sector: The Fed has been steadily cutting away,yet mortgage rates and the interest rates many businesses pay are higher than they were early this year.The capitulation of the American consumer, then, is coming at a particularly bad time. But it's no use whining. What we need is a policy response.The ongoing efforts to bail out the financial system, even if they work,won't do more than slightly mitigate the problem. Maybe some consumers will be able to keep their credit cards, but as we've seen, Americanswere overextended even before banks started cutting them off. No, what the economy needs now is something to take the place ofretrenching consumers. That means a major fiscal stimulus. And this timethe stimulus should take the form of actual government spending rather than rebate checks that consumers probably wouldn't spend. Let's hope, then, that Congress gets to work on a package to rescue the economy as soon as the election is behind us. And let's also hope thatthe lame-duck Bush administration doesn't get in the way.
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