It seems ridiculous for you to talk about the effectiveness of fiscal policy without mentioning the liquidity trap a single time in your entire article.

Those estimates are produced from 1960 to 2007. How many countries were in a liquidity trap from 1960 to 2007? By my count only one. Those estimates cannot be used to determine the impact of fiscal stimulus in times like these. They provide good caution against using fiscal stimulus in normal times, which is exactly what any New Keynesian would have told you anyway!

EIS – Yes, there are Wicksellian roots. I’m aware and comfortable with that, but I’m not sure what your point is.

He presents empirical evidence from non-liquidity trap periods and treats it like it’s empirical evidence that is relevant to our current situation.

He discusses fiscal stimulus as if it were financed by current taxation rather than by borrowing, which is also completely irrelevant to the current situation and which has nothing to do with the Keynesian position, which relies on borrowing rather than current taxation.

It’s a sloppy piece that doesn’t even address the counter-argument. And your reply is just an assertion, no an argument

Daniel Kuehn,

Okay, so your position is that liquidity traps are bad, as opposed to a self-correcting market mechanism attempting to free the original means of production from unwarranted activities. Thus, the government must engage in deficit spending on unwarranted economic activities, further disturbing the necessary liquidation when faced with a liquidity trap. Am I getting it so far? From this, you reach the conclusion that Terrell’s position against fiscal spending is invalid because he doesn’t accept or even acknowledge Keynesian confusion (the liquidity trap).

EIS: “…..the dialectical tension between the forces and relations of production”

Q: Is this a Marxist concept?

Is the (apparent) benefit of the supposed fiscal multiplier for “fixed exchange rate” and “closed” economies likely to be a result of the fact that given their heightened control over their economies, the governments who inject stimulus can therefore get almost any statistical result they want?

Daniel Kuehn,

“EIS – The point is the market CAN’T correct in a liquidity trap. If it could there would be no point in bringing it up, and we could proceed with liquidation, like we did in the early 80s when a liquidity trap did not apply.”

Says the Keynesian who believes that Say’s tautology has been refuted. Your notion of “correction” is different from our notion of correction, the actual notion–where malinvestments are liquidated and the original means of production are freed for warranted economic activities. Austrians don’t believe in 30% unemployment equilibrium’s (and neither should any serious economist).

Defending Keynes with Keynesian posits is absurd. If you want to show how fiscal stimulus is effective, then by all means, go ahead. But don’t presuppose your conclusion in the argument.

The point is, to characterize the current environment as a “liquidity trap” requires that you already subscribe to Keynesian presuppositions, hence accusing this author of neglecting this point is off the mark.

Spending OPM (sounds like opium, is equally addicting, stands for other people’s money) is not only bad because of its negative financial impact on those other people (As Mr. Terrell explains,”Taxing away a person’s ability to fulfill his own wants and then providing him with things he may not care about makes him worse off.”), I contend its effects are even worse on the recipients of the spending–those who receive the stimulus money.

“What?” says Nedib, “Are you crazy? When it comes to tax revenues, it is always better to receive than give. All the congresscritter and their constituents know that.” Why do you think people hire lobbyists?”

“Nobody GIVES taxes,” says I. “Tax revenues are TAKEN by force or coercion. So the money is tainted, and those who share it are tainted by it. If you saw a man accidentally drop his wallet with a lot of money in it, would you pick it up and keep it? If so, the man is out the money and poorer for it, and you are apparently richer for it. But the man who lost his wallet remains the man he was before, while you are a thief. Will you ever be prosecuted for stealing? No. Are you nevertheless a thief? Yes. Are you better off? I am confident that in due course you will find yourself–a common thief–declining physically, emotionally, mentally, spiritually and, yes, even financially. Don’t believe it? Stay tuned.”

If I am right, this then is the truly egregious consequence of Bush’s and Obama’s tax giveaways to “stimulate” the economy. Those who accepted a Bush stimulus check or Obama’s cash for clunkers, and their numbers are legion, have been blissfully sucked into the shameful role of welfare kings and queens, government dependents, irresponsible leaches on the body politic slurping at the government trough, sharing in the tainted revenue, accessories after the fact. I quake to think what will become of them. Of course if they repent and send the money back, chances aree good that they will recover.

Jonathan –
How would you debate it? How would you argue that we’re not in a liquidity trap. I agree with your point on asset bubbles. But this is because policymakers have taken the wrong response. The last thing you need in a liquidity trap is liquidity. When the Fed loans out more money when the market for loanable funds isn’t clearing, it’s definitely going to make things worse – they shouldn’t be doing that. What they need is to boost the demand for savings. You do that by running deficits, not by monetary policy. So I agree – we are looking at asset bubbles because of bungled policy.

Re: “Furthermore, while the volume of loans has been decreasing, in no way has borrowing and investment ceased.”

I’m not sure anybody has suggested that it has ceased, have they????

RE: “This conclusion should only be made after a period of logical deduction.”

Or empirical induction. Or better yet – both.

Re: “Given this, I am not sure how you can justify your belief in the Keynesian concept of the liquidity trap as a market failure.”

Did I ever say it was? The market is prone to instabilities – I believe that. But I don’t think I’ve ever promoted the view that this crisis was primarily caused by a failure of the market. Have I? You seem to assume you know a lot about what I think.

RE: “That is, whether or not government spending can stimulate an economy. There can very well be a liquidity trap, but you have failed to explain why in the event of such a liquidity trap government spending will help to lift the country out of this liquidity trap. Not only is your argument wrong, but it is even incomplete.”

I’m sorry – I thought that was implicit. The article is inadequate because it takes empirical estimates from periods when we weren’t in a liquidity trap. When we aren’t in a liquidity trap, government borrowing crowds out private borrowing and distorts credit markets because the loanable funds market clears. In a liquidity trap, when savings considerably exceed investment and nominal rates can’t adjust, there is no crowding out of private investment because savings are available in excess of private demand for savings. Government borrowing therefore (1.) doesn’t crowd out private borrowing under these circumstances, (2.) increases output, and (3.) helps loanable fund markets clear – all of these conditions are going to encourage private demand, rather than discourage it. Therefore, in a liquidity trap and a liquitidy trap alone fiscal stimulus can get traction.

Daniel Kuehn,

“Weren’t you just telling me that who I’m really talking about is Wicksell? Forget who said it. I’m saying that the article’s analysis doesn’t make sense when the nominal interest rate is zero at a time when savings exceed investment. YOU attached a name and a label to that, not me. I’m asking the author to engage those specific conditions: the conditions that we find ourselves in right now. Forget Keynes. Attribute it to me. I’m asking, you’re dodging.”

Savings is greater than investment? Are you insane? This is where the Wicksellian framework comes in. Savings is greater than investment when the market rate of interest is above the natural rate. The natural rate of interest cannot be below 0%–it’s quite literally impossible. How can the natural rate of interest be anywhere near 0% when there’s a 3% savings rate!?!

This is the confusion I was talking about. This is why the Keynesians never saw this coming; they saw -3% savings rate and went, “great huge aggregate demand!” Consumption is the destruction of wealth.

“Command over a sum of present consumption goods provides us with the means of subsistence during the current economic period. This leaves the means of production, which we have at our disposal during this period, free for the technically more productive service of the future, and gives us the more abundant product attainable by them in longer methods of production….Possibly I have wasted too many words in proving a truth so obvious that no thinking man unskilled in science would ever doubt it.”

Daniel Kuehn,

Regarding the concept of the liquidity trap, one could certainly make the case that further monetary expansion is having an adverse effect on the structure of production. The Keynesian liquidity trap theory explicitly suggests that before short-term interest rates are at zero, increased liquidity will (positively) effect output and prices. At zero percent, this can no longer be the case (there must be a number of Keynesian economists who have molded the theory to fit the fact that there can be “negative rates of interest”, thanks to price inflation). The liquidity trap theory must be inherently wrong if you agree that further monetary expansion will change the relative prices of different order capital-goods, even if short-term interest “remains” at zero-percent (and, as considered above, the rate of interest does not remain at zero).

So, yes, the use of “liquidity trap” to describe our current condition is certainly debatable! But, as I alluded to in my response above, this was hardly at the center of the rebuttal. I do not think that we need to delve deeper into the idea of the liquidity trap, especially in this post.

If you’d like, you can certainly continue the debate on the Mises forums, or even on my blog. I reproduced my first reponse, here:

http://www.economicthought.net/2009/12/note-on-liquidity-trap/

(I will probably reproduce this comment, as well, eliminating the above link and whatever is not really relevant to your last post.)

That said, however, it follows that if further monetary expansion is having no effect upon the economy, then this new money is not being used to invest. To be sure, this case is false as I have already argued, and you seem to agree with. As a result, we can conclude that further monetary expansion does play a role in future output and prices. So, at least a portion of the liquidity trap theory suddenly flies out the window!

As an aside, I apologize if I misrepresented your original argument by relating your agreement with the liquidity trap, and the idea that government stimulus can truly stimulate an economy, with the theory that the current economic crisis is the product of an inherently unstable economy. It just seems to follow that if you agree that government spending and intervention can pick the economy up out of recession, then it did not have anything to do with the reasons why the crisis occurred in the first place. In any case, in my defense, you just wrote the following:

But I don’t think I’ve ever promoted the view that this crisis was primarily caused by a failure of the market.

Primarily or secondarily, there is hardly a difference when judged within the context of my former argument.

In any case, back to more pertinent matters. You note that investment is low (well, you suggest lower than savings; I’m not so sure that that is completely true), but you fail to address the issue of regime uncertainty. That is, the secondary and destabilizing effects of government spending, taxation and borrowing on private production. I am also not sure how the general idea of government spending a priori equates with the idea of positive government spending, or investment in areas in which the consumer is actually demanding the higher-order products. Does government spending take into consideration time preference?

Your point on increasing output is interesting. Surely, the bubble we experienced also increased output. The effects of this increase in output, however, as we have seen, was not as positive as one could possibly infer by reading your post! Surely, there must be more to your argument, than that. Apart from the above stated question, you also need to address the following: how does government spending encourage private demand, and how does government spending help the loanable funds market clear.

Good article overall…

I agree – the fiscal policy can never efficiently stimulate economy. It is just another instrument of re-distribution…

However, some policies could mitigate extreme polarization of the society by discouraging hoarding and providing minimum subsistence to the very poor, so that they do not become even greater burden on the shoulders of the society…