Fundamentally I think central banks have full control of nominal spending and therefore also inflation. Therefore, to me there is no liquidity trap.
However, there can be a mental or an institutional liquidity trap if for example a central bank refuses to take the necessary steps to permanently increase the money base.
I believe we are now in such a situation in the euro zone and therefore I think it is now time to suggest something I never thought I would have suggested – significant keynesian style (with quite a bit of market monetarist influence) fiscal “stimulus”.
So have a look at what I wrote on Twitter earlier today:
I know this is radical and maybe not expected from me, but the seriousness of the global ‘corona shock’ and the ECB’s refusal to act appropriately necessitate policy proposals like this.
Furthermore, proposals like this will not permanently expand the role of government in the economy and it will have an imitate and transparent impact.
Some might argue that this will not work as the Germans would just increase savings. This, however, really doesn’t matter. What is important is that this would decrease net savings in the euro area – through “weaker” public finances in German. This in turn would push up the “real natural interest rate” in the euro area. In line with what we have seen with the Trump tax cuts.
My “guesstimate” is that such measures likely would increase the real natural interest by at least 100bp in the euro zone and hence if the ECB keeps its key policy rate unchanged this would cause an “automatic” easing of monetary conditions in the euro zone. Hence, this proposal is really away to get monetary easing without the ECB actually doing anything (directly and on its own).
It is highly imperfect and not something I am happy about suggesting, but it is certainly better than the deepening of the deflationary pressures in the euro area and potential re-ignition of the euro crisis that we now might be facing.
Remember to have a look at my speaker agency’s web site here and follow me on Twitter here.
Matthias
/ March 5, 2020If you want to weaken the German public finances, wouldn’t a cut of some marginal tax rates, like eg of GST, be better?
Also: the Germans can’t just willy nilly weaken their public finances any more. They have a constitutional debt brake. And their unemployment rate at 3.1% is at historical laws last seen since the Wirtschaftswunder. So even if the politicians were willing to bend the law, their supreme court might strike down any deficit spending.
If the German unemployment rate goes up, things might change. But government finances would weaken on their own already.