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Selling the Deficits

We can only cut debt by borrowing

“Let us approach the issue of de-leveraging – or debt reduction – analytically”, argues The Financial Times’ columnist Martin Wolf:

Between 1994 and 2007, total US non-financial private debt rose from 118 per cent of gross domestic product to 173 per cent, the highest level in US history. Over the same period, US financial sector debt rose from 54 per cent of GDP to 115 per cent. A great deal of this leveraging up of the economy (matched elsewhere, notably in the UK) was based on false premises: borrowers and lenders thought that the assets against which they had borrowed would be worth more than turned out to be the case.

Outside of increasing one’s income or revenue, Wolf argues that “the least bad way to deal with a huge debt overhang has three elements: facilitate mass bankruptcy of the hopelessly over-indebted; lower interest rates, so making it easier for the indebted to carry and pay down their debt; and accept large fiscal deficits as a way of sustaining the incomes of those trying to pay down debts”.

Government is the only recourse, insists Wolf, and CEPR (see below), unless you wanna take down the house (which I think is politically and socially unpalatable, even if you’re conservative). Thus, I assume this is the current game plan. Individually, it’s foolish to get angry or upset, won’t do any good. Best tact is to use their game plan to your own advantage.

http://blogs.ft.com/martin-wolf-exchange/2010/09/26/we-can-only-cut-debt-by-borrowing/
#more-786

Why a Deficit In Times of High Unemployment Is Not a Burden

The combined impact of the drop in house prices to date and the loss of stock wealth should be a falloff in annual consumption of between $480 billion and $660 billion. The mid-point of this range would imply a drop in annual consumption of $570 billion. Adding this to the $600 billion drop in construction spending implies a falloff in annual demand of $1,170 billion. This dropoff is shown in Figure 1, which shows the components of GDP before and after the collapse of the housing bubble. (Net exports are excluded for simplicity.)
Graph

: A fig one.PNG

As can be seen, GDP is much lower post-crash since there is nothing to replace the demand lost as a result of the collapse of the housing bubble. In response to a modest downturn, it is possible for the Federal Reserve Board to lower interest rates, which in turn boosts investment and consumption, and also housing construction. In this downturn, the Fed has lowered interest rates as far as it can – all the way to zero – but it has had relatively little effect. The reason that this drop in rates has had a limited impact is that it cannot make up for the huge amount of lost housing equity. Also, low interest rates are not likely to spur much construction in an economy where there is already a glut of housing, retail stores, office space, and hotels.

The drop in interest rates has benefited the economy, but not nearly enough to offset the huge loss in demand from the collapse of the housing bubble. This is the reason that stimulus is needed.

http://www.cepr.net/documents/publications/deficits-2010-9.pdf

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