Wednesday, December 1, 2010

I'm in debt, maybe I need to work less

The essential message of what I am now getting used to calling the liquidationists is just that - the world got over-leveraged, and the recession (in other words, the fact we're working and producing less) is the logical result. In other words, the logical result of getting too much into debt is to work and produce less.

This point is brilliantly made by Karl Smith (via Brad DeLong). Sure, it is not so simple: too much debt makes investment problematic and dampens consumption leading to a decline in output, so there is a reason why a burst bubble results in a downturn. But the basic point remains: this downturn amounts to getting people to work less in order to pay off their debts, and government needs to act to get us out of this individually rational but collectively bone-headed scenario.

Having a decent-sized public sector is one way - it didn't stop Sweden posting record growth last quarter. Stimulus is another. And yes, there are fiscal sustainability issues in some countries, but they could in principle be dealt with through international cooperation. After all, markets need some government debt to invest in, and global bond yields are at historically unprecedented lows. This could be done with the right institutions.

Something tells me the ECB, the Fed and the Bank of England aren't the right institutions.