At the Birth of Central Banking: The Lender of Last Resort: Bank of England Court Member Jeremiah Harman's Evidence on the Panic and Recession of 1825-6 Before the Committee of Secrecy on the Bank of England Charter, 1832
Paul Krugman Sends Us to Martin Wolf on Death By Accounting Identity

We Could Put the Global Economy on the Road to Recovery Tomorrow...

Either Paul Krugman needs to stop being so depressed or he needs to stop being so right.

I would be happy with either eventuality:

John Stuart Mill, 1829:

There can never, it is said, be a want of buyers for all commodities; because whoever offers a commodity for sale, desires to obtain a commodity in exchange for it, and is therefore a buyer by the mere fact of his being a seller. The sellers and the buyers, for all commodities taken together, must, by the metaphysical necessity of the case, be an exact equipoise…. If, however, we suppose that money is used, these propositions cease to be exactly true…. What they called a general superabundance, was not a superabundance of commodities relatively to commodities, but a superabundance of all commodities relatively to money…. Money… was in request, and all other commodities were in comparative disrepute… all commodities fall in price, or become unsaleable…

And the solution is obvious: when the market wants money--liquid, safe savings vehicles--to hold, it is the business of the central bank to give the market the money it needs under those circumstances--like right now--when private entities cannot.

To quote Jeremiah Harman's evidence before the Committee of Secrecy on the Bank of England Charter in 1832, in the 1825-6 financial crisis the Bank of England flooded the zone with safe, liquid savings vehicles:

lent…by every possible means and in modes we had never adopted before; we took in stock on security, we purchased exchequer bills, we made advances on exchequer bills, we not only discounted outright, but we made advances on the deposit of bills of exchange to an immense amount, in short, by every possible means consistent with the safety of the Bank, and we were not on some cases over-nice. Seeing the dreadful state in which the public were, we rendered every assistance in our power…

A lesson that applies to today. Paul Krugman:

Death By Hawkery: What the world needed in this global deleveraging crisis was deficit spending and higher inflation targets. What it got was fiscal austerity and obsessive concern with inflation risks that weren’t real. Hence the catastrophe now unfolding. Judging from recent comments, many readers missed my earlier analyses on these issues — I’m still getting the “You idiot, debt got us into this mess, how can debt get us out?” type of comment. So let me re-repost my discussion of this whole issue in full, followed by a couple of brief notes on the European situation:

Sam, Janet, and Fiscal Policy

One of the common arguments against fiscal policy in the current situation – one that sounds sensible – is that debt is the problem, so how can debt be the solution? Households borrowed too much; now you want the government to borrow even more?… [T]hat argument… assumes… debt is debt – that it doesn’t matter who owes the money. Yet that can’t be right; if it were, we wouldn’t have a problem in the first place…. [T]he level of debt matters only if the distribution of net worth matters, if highly indebted players face different constraints from players with low debt. And this means that all debt isn’t created equal – which is why borrowing by some actors now can help cure problems created by excess borrowing by other actors in the past.

To see my point, imagine first a world in which there are only two kinds of people: Spendthrift Sams and Judicious Janets…. Sams have borrowed from the Janets to pay for consumption. But now something has happened – say, the collapse of a land bubble – that has forced the Sams to stop borrowing, and indeed to pay down their debt. For the Sams to do this, of course, the Janets must be prepared to dissave, to run down their assets. What would give them an incentive to do this? The answer is a fall in interest rates…. But… what if even a zero rate isn’t low enough; that is, low enough to induce enough dissaving on the part of the Janets?… Then we have a problem…. [W]e’d be looking at a depressed real economy and deflationary pressures. And this will be destructive; not only will output be below potential, but depressed incomes and deflation will make it harder for the Sams to pay down their debt.

What can be done?… [I]nflation… will make it possible to have a negative real interest rate, and it will in itself erode the debt of the Sams. Yes, that will in a way be rewarding their past excesses – but economics is not a morality play…. [Y]es, inflation erodes the assets of the Janets at the same time, and by the same amount, as it erodes the debt of the Sams. But the Sams are balance-sheet constrained, while the Janets aren’t, so this is a net positive for aggregate demand. But what if inflation can’t or won’t be delivered?… Government Gus… can borrow for a while, using the borrowed money to buy useful things like rail tunnels under the Hudson. The true social cost of these things will be very low, because he’ll be putting resources that would otherwise be unemployed to work. And he’ll also make it easier for the Sams to pay down their debt; if he keeps it up long enough, he can bring them to the point where they’re no longer so severely balance-sheet constrained, and further deficit spending is no longer required to achieve full employment.

Yes, private debt will in part have been replaced by public debt – but the point is that debt will have been shifted away from severely balance-sheet-constrained players, so that the economy’s problems will have been reduced even if the overall level of debt hasn’t fallen….

The European mess is pretty well described by the story above, with the Sams mainly in the periphery and the Janets in the core; what we’re getting is forced austerity in the periphery with no offsetting expansion in the core, and now everyone is shocked, shocked that the whole continent seems headed for recession.

In Europe’s case, however, higher inflation is even more crucial than for the United States — because Europe also needs a large adjustment of relative prices that will be very hard if not impossible to achieve with low overall inflation.

So as of this morning, the 5-year German breakeven — an implicit forecast of inflation — is only 0.9%.

This is not going to work.