The Liquidity Trap, I’m a Believer

Paul Krugman, the influential Sith Lord columnist has finally convinced me that America is indeed in a Liquidity Trap. However, I have to add a few tweaks and variables to his thinking.

The traditional “Liquidity Trap” is as follows: Financial meltdown scares the public into saving money and not spending. Aggregate demand then falls, lowering prices. Companies begin to shed workers because of this fall in demand. More unemployed people spend less and discourage other consumers even more. Aggregate demand then falls, lowering prices. The cycle repeats.

Here is my “Liquidity Trap” as follows: Financial meltdown scares the public into saving money and not spending. The government does something reckless and foolish like a bank bailout, hurting future expectations of economic growth and recovery, which kills stock prices. Aggregate demand then falls, lowering prices. Aggregate demand begins to recover, and then the government does something reckless and foolish like a stimulus. Stocks fall, demand drops, inflation retreats. Recovery begins and then the government does something reckless and foolish like announcing a vague new bailout plan. Stocks fall, demand drops, inflation retreats.

Here’s the cycle more clearly in 6 easy steps:

1. Bank panic
2. Stocks crash
3. Government Panics and Screws Things Up
4. Stocks tank again, treasuries surge, inflation falls
5. Stocks begin to recover, treasuries decline, inflation starts to pick up
6. Return to step 3.

I had believed massive inflation was inevitable because the Federal Reserve is cranking out the dough like Pillsbury, but apparently, all the government has to do is slowly but surely destroy the economy to head this off. It's amazing how closely the data fits my new model. Hopefully Obama’s cabinet doesn’t run out of bad ideas anytime soon, or we’re all screwed.