You’ll probably start to hear the term, liquidity trap, soon. It’s not just for college economic students anymore.
One of the great tools the government has to manage the economy is the interest rate. If the government lowers the interest rate, people spend more money which stimulates the economy.
Unfortunately, as the rate gets lower, the effect of an interest rate cut becomes less. That is, cutting the rate from 2% to 1.5% has much less effect that cutting the rate from 5% to 4.5%.
When interest rates get very low indeed, one of our best economic tools loses it’s ability to stimulate the economy.
In a related matter;
In a move to boost economic growth in the midst of a worsening global financial crisis, the Federal Reserve lowered its fed funds rate by half a percentage point to 1.5%.
Via CNNMoney.com.
{ 7 comments… read them below or add one }
Cbass 10.09.08 at 1:31 pm
I believe the Japanese tried this before and it did not work. Ten years later things got back to “normal.”
Yeah, I know all you economics guys are going to jump in and tell me how this is a different situation again right?
You are the same guys who said the government would just step in and bail us all out and everything would be fine too.
Don’t think so!
Every action has an equal and opposite reaction. This may not be physics but I believe it applies.
Every move the government makes will just cause a problem to pop up somewhere else. Like that game “Whackamole” or whatever.
Why do we try so hard to avoid recessions in the first place, I was always taught they are part of the normal life cycle of an economy. Why can’t we just leave well enough alone and let the free market do it’s thing?
ks 10.11.08 at 2:07 am
Cbass,
I agree 100%.
As far as leaving the market alone: It does not seem to be compatable with human nature. I had hoped that the US would let the markets work through these problems. Now, that the market is not allowed to dole out the punishment through bankruptcy, there must be more regulation to ensure this does not happen again (what a silly statement I just made).
The government will always cause problems through unintended consequences. There is no perfect “targeted” legislation. Our society, and human nature in general, is far too complex for legislation A to have a targeted cause B, without much more of the alphabet getting involved.
There are many who think that this collapse had much help from those trying to prematurely stop the decline of the internet bubble by creating a brand new bubble puffed up by out-of-control credit expansion. It might be best to live with the “normal life cycle of an economy”, as you put it.
The “economic guys”, for the most part, have been very very wrong. The few economic guys that have been more right than wrong (e.g. Nouriel Roubini, Mike Shedlock) tend to be dismissed by those right thinking optomists that keep getting all the attention.
I remember about 6 months (when I was just lurking around this site) that you brought up the idea that we could be facing a Japan type situation. At that time, your view point was dismissed as far too pessimistic. At this point in time, your thoughts seem prescient.
One thing to remember: Do not worry about what someone thinks of your ideas if that person has a track record of being very very wrong.
Brian 10.11.08 at 6:24 am
CBass / KS, the reason we try to modify recessions and soften their blow is that as human beings, we always (or should always) try to help our fellow human. This is codified in the Golden Rule: “Do unto others as you would do unto yourself”.
Doing nothing to stop a severe economic downturn is equivalent to accepting anarchy as the best form of (non)government. Some people say no government IS the best government. I say that no government makes all of us just animals where survival of the fittest rules.
But, I do agree with both of you that managing the economy is always a work in progress and that there always seem to be “unintended consequences”. This is true because the economy is always evolving. No cycle is like the last. What has happened in this latest cycle is that the Internet, has “flattened the planet” in Tom Friedman’s words. We have never had such an interlinked global economic system as we have right now. For this reason, it is reassuring that the G7 Central Bankers are working together this weekend to figure out a global solution.
Will their solution be the Final Answer? No, of course not. There will continue to be adverse reactions to whatever actions are taken. Learning will continue. But to do nothing, is inhuman and causes unnecessary pain and suffering. A stock market decline to DJI 1000 may be ideologically “pure”, but is it right? Should everyone’s financial future be wiped out for the sake of leaving the market to do what it will?
The Market is a harsh master if left to its own.
Cbass 10.11.08 at 11:36 am
KS,
Yeah I know I should not worry about it but it is frustrating when I have been trying to tell friends and family that something is wrong with our system for a long time and they are dismissive as well. Most of them were still telling me to buy a house 2 years ago and some of say still say now is the time to buy?
I think most of our financial problems stem directly from quarterly reporting and earnings expectations. Every quarter if a company does not meet or exceed its estimated earnings the stock gets pummeled. The flip side to that is that big business will do whatever it takes to meet expectations instead of building a sound business model/practice. When I worked at HD back in the early 90s they were known for their customer service. Today they are known for their poor customer service because they have chopped staffing at their stores among other things to meet W$s expectations. This is one of the things I believe that is at the root of our mess right now. Every company out there is doing whatever it takes to meet earnings without regard to future consequences. Many of the big companies have totally done a 180 on the things that made them great in the first place.
Brian,
I do agree with the “Golden Rule,” I just disagree with it’s implementation in our society. I am not for “socialism” which would, idealogiacally speaking, be the ultimate form of the Golden Rule. People who work hard and/or make smart decisions should be rewarded and people who are lazy and/or make poor decisions should not. So when housing prices were flying high and I choose to sit it out and try to save up a down payment for a home why now am Igoing to be responsible for bad decisions of others while I was making the right decision? I have student loans, are we going to nationalize them, as well as my car payment and my wifes student loans? I don’t get it.
I think the things you think of as being helpful (gov and g7 intervention) are in reality actually hurtful in the long run just like big business focusing on the upcoming quarterly results instead of long term growth and prosperity of the business or country.
I don’t know how the G7 will be able to help this anyway. Banks are not going to lend money like they were, for fear of ending up in the same situation. Consumers are already scared and they are gonna save instead of taking out a loan for some new “Dubs.” So the cycle is already in motion and I believe any action they take will be fruitless.
So I guess to answer your question, I say yes they should leave the market to sort things out. And instead of Big Brother we should look to our families and friends for help. The Gov is already to involved in our lives.
I was in downtown Phx the other day and crossed the street while the light was still green to cross traffic. I did not notice but there was a cop on the other side and he said something smart like “Getting an early start huh?” He was real condecending and I thought to myself, he was seriously thinking about writing me a ticket. I don’t need the Gov to tell me when I can cross the street! We need less Gov in this country not more is my point.
Brian 10.11.08 at 2:18 pm
CBass, but we do NEED government, right? This is the problem with saying that the government should stay out of the economy and let the market sort itself out. That is an ideological extreme that is as dangerous as the idea of government doing everything for us.
The practical reality is somewhere in between. I don’t know where that middle is, but that is why we have a democracy. By getting push back from both ends of the ideological spectrum, we get something reasonable and workable in between.
I don’t want government interfering in my life, until they have to, like right now. How much interference is appropriate? I don’t know the answer, but I guess we are finding out.
The Market would have no problem putting 30% of the population out of work and causing 50% of houses in the nation to be foreclosed. This has happened in the past when we had less control over the economy and it was more the Wild West. 30% unemployment? That is where I think this economic panic would take us without any influence from government. Extreme panic / fear is just as bad as extreme greed.
And if the worst case scenario continues unabated and we get those numbers above, wouldn’t it be cheaper for the country in the long run to just solve the problem by intervention? I think $1 Trillion of aid is cheap compared to the alternative. What are the costs in lost tax and social security receipts, increased expense for social welfare programs and long term lost productivity, if we leave our economy to the whims of the Market?
Cbass 10.12.08 at 9:48 pm
When will we ever pay it back?
Will my son be responsible or will we stand up today and say enough is enough.
Adam Smith 11.06.08 at 3:32 am
Prepare for the New World Economic Order
Interest Rates [Credit] are the Cause and Consequence of the Explosion of Income/Wealth Disparities and, Hence, of the Inherent Instability of this Economy:
The Ominous Keynes’ Liquidity Trap.
Origin of Economic Chaos.
Everyone Need an Economy, Don’t They?
There Is One Solution That Works:
A Credit Free, Free Market Economy:
The New World Economic Order.
The Only Goal of 1776 - Annuit Cœptis is to Implement It.
They Can Transfer Their Assets & Forget Their Liabilities.
Anyone Can Join But Still Needs to Ask for It.
http://www.17-76.net/
The Purpose Is to Provide Both a New Deal and a New Game.
It is NOT to Fix This Economy Which is Already Beyond Repair.
The Intention Is to Create a New Economy
With the Assets of the Old One Without its Liabilities.
Why Not Insure Against the Worst Case Scenario?