Hi tkc,

You are right about the complexity. So please don't take me as the font of Neo-Keynesian wisdom. I do the best I can looking at a machine with many moving parts.

A few points.

1. I think it is important to distinguish between existing conditions and attempts to influence them. We all know that house prices have been under sustained pressure for a few years and that consumption has taken a hit in consequence. Instead of buying goods, people are trying to repair their personal balance sheets. So there's a paradox of thrift issue here. That's a large part of the problem. Unemployment flows naturally from that.

2. I think you may be flipping between the supply and demand side in your post. We want producers to produce and consumers to consume. When I was talking about the issue of getting folks to invest the money they have, I was focusing on the supply side. Companies (ie as producers) have strong balance sheets but they are not investing their money in hiring staff. Why? I think that is because there isn't so much demand in the marketplace.

3. Home-owners as consumers are on the demand side of the transaction. They are currently heavily indebted and many are underwater, so of course consumption figures are generally weak (although I'd be interested to know how luxury goods makers are faring). Home-owners also might want to see some inflation (especially if their mortgage rate is fixed) so that the cost of the principal on their mortgage diminishes relative to the value of their homes. But right now, in sum, home-owners are not sitting on a hoard of cash. And they cannot be induced to release what they don't have by government incentives. The primary means to increase consumption is through the creation of more, well-paid jobs - jobs of the sort that yield surplus cash flows.

4. But as we have seen, producers are not investing in staff, because the demand side isn't happening. There's a kind of circular, chicken and egg issue here which the market cannot easily resolve. I don't think this analysis is controversial. It is a simple statement of the current situation. I think this is what you were saying as well.

5. So the big question is, how do we stimulate demand? How do we get the economy going? And this, of course, is where the argument occurs.

6. The Republicans suggest growth eventually will emerge from public sector austerity and private sector investment. If we get public finances in order, cut costs and act responsibly, businesses will begin to invest again at some point in the future. The economy will find its way, by the methods of creative destruction and market action, towards the sunlight. I think this would likely be the right medicine in an inflationary environment in which the demand issue wasn't the key one. But in a deflationary environment, in which the house price slump has resulted in crushing debts and unemployment is already high, I think it will have the opposite effect: demand will suffer; the sustainable value of existing money will increase; companies will not invest. House prices will continue to reduce. Unemployment will increase. etc. We end up in a spiral of misery that feeds on itself. Indeed, as you pointed out earlier, companies are already rich in assets but they are not investing or creating jobs. And in the long run, as Keynes pointed out, "we are all dead".

7. The neo-Keynesian idea - as I understand it - is that ideally the government uses monetary and fiscal tools to prime the pump, take advantage of spare employment capacity to build infrastructure (ie assets that will be useful over the long run, like the Hoover Dam), and - as a result of the fact that folks would now be working again - stimulate consumption. In an inflationary environment, I am not sure this is the correct medicine and I don't think this would be proposed by neo-Keynesian economists. In a deflationary (or weak inflationary) environment in which consumption is moribund and private industry is not investing its surplus capital in jobs, I think that government is the variable - the tool - which works best. In fact, I think it is the only tool available. The cost of doing so is that you run up government debt. But in a low inflation/deflation environment, borrowing costs are low: so as a nation, the US can afford to pay the interest on its long term borrowings. Unemployment is a cost the government bears in part anyway, so you might as well put the unemployed to use making things like bridges and railroads, or upgrading the security of the information network. Knowing the government is committed to long term projects, businesses will be willing to invest in them. In future and fatter times, once inflation has had a chance to act gradually on the value of old money, the principal might either be repaid or rolled over.

8. Obviously, a person who believes this view is disrespecting Republican sacred cows, such as "government is intrinsically a bad idea", "taxes must always be lower than they were" and "governments can't create jobs" etc. Not being a Hindoo, I don't see any factual support for the sacred nature of them thar cows and thus I am perfectly content to send them off to slaughter.

9. Onwards to the discussion of inflation, in which we have a major discrepancy in our understanding of the facts.

I appreciate your personal experiences and they seem to be informing your broad view, but for the sake of discussion I think it is best to use the bureau of labor stats, no? The broad statistics are showing very little inflation. The CPI over 12 months is 3.6%. Ex energy and food costs, the rate is less than 2%. http://www.bls.gov/news.release/cpi.nr0.htm

I agree that commodities have been volatile, but as they trade in real time in global markets I think they are only to a minor extent dependent on local market conditions, and thus are not easily susceptible to local policy solutions. Food and labour costs, for instance, affect the CPI, so they have an impact on simple/general numbers and, of course, on the cost of living. Even including fluctuating commodity prices, however, the CPI is historically low. And even so, the oil markets seem to respond to things like Chinese demand and speculators' price manipulation, so, absent global regulation and Chinese action, there's not so much to be done about that. And food costs reflect to a great extent the same kind of factors, and actually they are also highly dependent on energy costs. So US policy makers are not going to have much of an impact on that kind of inflation via interest rates etc.

Now that is not to say the prices of those kinds of goods don't affect you. But we are talking about the broad US economy here and what appears to be going on within it based on the numbers at our disposal and what to do about it. And policy makers can't manage things they don't really control and commodity market prices are one such thing.

One thing that does matter greatly is what folks expect - inflation measures current price changes but built into decisions about prices are expectations about the future. And when you look at core inflation (ie inflation ex food and energy), which is mostly based on goods and services with longer term underlying contracts, there is a pattern of very low inflation since 2008. The limitation of core inflation is that it doesn't reflect cost of living adjustments - which you point to properly as being relevant to your own experience. But the reason core inflation is interesting is it tends to reflect expectations - and these expectations are the thing which drives many kinds of controllable decisions about prices.

There's also another economic factor which I believe is excluded from inflation calculations and which is somewhat relevant in spite of it. In dynamic markets like the PC and information industries, costs have been persistently lowering for years. Moore's law expresses the rate of growth of efficiency in microchips. In a market environment in which microchip prices stay roughly similar, the increase in the power of processors expresses the lowering of the raw processing cost. So processing costs are diminishing. The same kind of deflation is present in the cost of bandwidth and of memory. So there's another deflationary effect, which is actually invisible.

10. Okay. So this is where we differ. You are imputing your personal experience to the broad economy and saying inflation is everywhere. I am looking at the labor department statistics and they are saying the opposite. I don't know how to bridge that gap. But the problems I see are the ones I wish could be fixed.

11. On the other hand, I absolutely agree that this is a demand-side issue (the neo-Keynesian analysis), that the Fed is trying to use monetary tools to stimulate the economy and encourage investment, and that the Fed hopes to cause inflation to appear, which would actually help in the circumstances that deflation is the problem. I think the failure of government to employ fiscal tools is a disaster (and where are those high speed trains, by the way?).

12. Re the zero lower bound. So usually, when you have some level of inflation, you set interest rates above zero and look to achieve an inflation rate about the same rate as GDP growth. But in a deflationary environment, you cannot create negative interest rates. So when you have a deflationary environment, the zero bound - where interest rates cannot get any lower - decouples the influence of interest rates from the change in value of the currency relative to the value of assets. The Fed cannot use changes in interest rates - the main tool they use to influence the economy - to do anything. Instead, they have to use alternative tools, such as printing money, to lower the value of outstanding dollars relative to the goods and services they are used to purchase. Otherwise, we will end up stuck in a situation in which hoarding is rational for potential employers and investment is a bad idea.

13 Unfortunate situation.