Wednesday, December 17, 2008

Traps and consequences

From the Master of Disaster (Roubini):

"A severe global recession will lead to deflationary pressures. Falling demand will lead to lower inflation as companies cut prices to reduce excess inventory. Slack in labour markets from rising unemployment will control labor costs and wage growth. Further slack in commodity markets as prices fall will lead to sharply lower inflation. Thus inflation in advanced economies will fall towards the 1 per cent level that leads to concerns about deflation."

"Deflation is dangerous as it leads to a liquidity trap, a deflation trap and a debt deflation trap: nominal policy rates cannot fall below zero and thus monetary policy becomes ineffective. We are already in this liquidity trap since the Fed funds target rate is still 1 per cent but the effective one is close to zero as the Federal Reserve has flooded the financial system with liquidity; and by early 2009 the target Fed funds rate will formally hit 0 per cent. Also, in deflation the fall in prices means the real cost of capital is high - despite policy rates close to zero - leading to further falls in consumption and investment. This fall in demand and prices leads to a vicious circle: incomes and jobs are cut, leading to further falls in demand and prices (a deflation trap); and the real value of nominal debts rises (a debt deflation trap) making debtors' problems more severe and leading to a rising risk of corporate and household defaults that will exacerbate credit losses of financial institutions."

1 comment:

Adam Smith said...

The Economy? It Is Stupid.

Now, That I Have Your Attention:

The Economy? They Paint It Black.
Let's Paint it Green, Will You?

What Are They Offering Except to Wait, Suffer and Be Patient Till, On the Long Run, The Crisis is Over?

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Economists set themselves too easy, too useless a task if in tempestuous seasons they can only tell us that when the storm is past the ocean is flat again."

Sir John Maynard "Invisible Hand" Keynes
A Tract on Monetary Reform (1923) Ch. 3

We Can't Afford to Wait That Long.
Or Can You?

"The decadent international but individualistic capitalism, in the hands of which we found ourselves after the war, is not a success. It is not intelligent, it is not beautiful, it is not just, it is not virtuous—and it doesn’t deliver the goods.

In short we dislike it and are beginning to despise it. But when we wonder what to put in its place, we are perplexed.”

John Maynard "Invisble Hand" Keynes

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"Education is the inculcation of the incomprehensible into the indifferent by the incompetent."

"At the present moment people are unusually expectant of a more fundamental diagnosis; more particularly ready to receive it; eager to try it out, if it should be even plausible.

But apart from this contemporary mood, the ideas of economists and political philosophers, both when they are right and when they are wrong, are more powerful than is commonly understood.

Indeed the world is ruled by little else. Practical men, who believe themselves to be quite exempt from any intellectual influences, are usually the slaves of some defunct economist.

Madmen in authority, who hear voices in the air, are distilling their frenzy from some academic scribbler of a few years back. Emperors and armies come and go; but unless they leave new ideas in their wake, they are of passing historic consequence.

I am sure that the power of vested interests is vastly exaggerated compared with the gradual encroachment of ideas. Not, indeed, immediately, but after a certain interval;

for in the field of economic and political philosophy there are not many who are influenced by new theories after they are twenty-five or thirty years of age, so that the ideas which civil servants and politicians and even agitators apply to current events are not likely to be the newest.

But, soon or late, it is ideas, not vested interests, which are dangerous for good or evil."

John Maynard 'Invisble Hand' Keynes,
The General Theory of Employment, Interest, and Money,
13 December 1935, p. 383.

Quoted by Chairman Sir Alan 'El Maestro' Greenspan
Adam 'Defunct Economist' Smith
At the Adam Smith Memorial Lecture, Kirkcaldy, Scotland
February 6, 2005

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✔ A Specific Application of Employment, Interest and Money:
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