The Problem, by Paul Krugman, in NY Times: Richard Koo has another paper on balance sheet recession out (pdf), with good charts for a number of countries. I still have some differences with him over monetary policy — I still don’t understand why he doesn’t see debt-eroding inflation as something helpful in dealing with debt overhang — but his view of the sources of our Lesser Depression is completely right.
Let me just focus on the United States. Here’s gross private saving minus gross private investment — the private-sector financial surplus:
This huge move into surplus reflects the end of the housing bubble, a sharp rise in household saving, and a slump in business investment due to lack of customers.
Given this reality, it’s not hard to see why massive government borrowing hasn’t led to soaring interest rates; we’re awash in saving with no place to go. And that’s also why we’re in a liquidity trap, in which large increases in the monetary base don’t lead to inflation.
And the question is, how do people who want us to slash the budget deficit now now now think this is going to work? Unless the confidence fairy arrives, causing households and businesses to suddenly ramp up their saving despite high unemployment and weak sales, deficit reduction will only intensify the problem of excessive savings relative to perceived investment opportunities — and make the slump much, much worse.
I know, I know — families are having to tighten their belts, so the government should tighten its belt too; and we’ll tighten our belt all the way to a full-on depression.