Wednesday, July 14, 2010

Liquidity Traps, cont.

Paul Krugman complains that nobody understands liquidity traps.

It's a good post, but he leaves out one potential avenue where printing money helps, and that's with the exchange rate and net exports. Potential J-curvature aside, printing money will reduce the value of the dollar and help exporters and import-competing firms, which should help unemployment and engender inflation simultaneously. Higher inflation makes loans and debt easier to repay for consumers and businesses...

A smaller added benefit of printing money is that it reduces the debt, as the Fed just returns all interest payments it receives to the Treasury. And, yes, this feature has a surprising free-lunch quality to it. (Most of it would likely to be reversed later on, but not all...)

Bottom line, Krugman is waaay too pessimistic about the potential benefits of QE.