Hamilton Scoffs at Deflation and the Liquidity Trap
By Bryan Caplan
Here‘s James Hamilton at his most dismissive:
Some of my colleagues still talk of the possibility of a liquidity trap,
in which the central bank supposedly has no power even to cause
inflation. Their theory is that interest rates fall so low that when
the Fed buys more T-bills, it has no effect on interest rates, and the cash the Fed creates with those T-bill purchases just sits idle in banks.
To which I say, pshaw! If the U.S. were ever to arrive at such a
situation, here’s what I’d recommend. First, have the Federal Reserve
buy up the entire outstanding debt of the U.S. Treasury, which it can
do easily enough by just creating new dollars to pay for the Treasury
securities. No need to worry about those burdens on future taxpayers
now! Then buy up all the commercial paper anybody cares to issue.
Bye-bye credit crunch! … Print an arbitrarily large quantity of money with
which you’re allowed to buy whatever you like at fixed nominal prices,
and the sky’s the limit on what you might set out to do.
Of course, the reason I don’t advocate such policies is that they
would cause a wee bit of inflation. It’s ridiculous to think that
people would continue to sell these claims against real assets at a
fixed exchange rate against dollar bills when we’re flooding the market
with a tsunami of newly created dollars. But if inflation is what you
want, put me in charge of the Federal Reserve and believe me, I can
give you some inflation.
Think about it this way: Even the most incompetent governments on earth are able to create inflation. But liquidity trap alarmists doubt that we can prevent inflation from going negative. That’s crazy talk.