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Originally Posted by Sexxxy Sites
So how can anyone think that the government loaning/borrowing/printing money to provide these institutions the ability to resume the very thing that created the problems in the first place can solve the problem other than on a very short term basis.
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These are not just the solutions in the US but the solutions in nearly every country in the world. A central banks that acts as the lender of last resort and deficit spending in order to stimulate aggregate demand according to the principles laid out by Keynes.
Before the government acted as a lender of last resort to banks private banks did. Go back to 1907 and JP Morgan put together the rescue that provided liquidity to banks. It is easier and more reliable for the government to do it - and it is the system that pretty much every country in the world uses.
Consider the situation in which the central bank does not act as a lender of last resort. With the failure of just a few institutions the entire credit system came to a halt in September of 2007. Banks stopped lending to each other because the counter-party risk was judged to be too great, the commercial paper market completely froze and left institutions with no short term funding. The TED spread, which is one credit market indicator jumped from .5 to 4.0. It has since retreated to under 1.0 again. Still elevated but at least not scary.
Consider the situation in which government doesn't stimulate aggregate demand through deficit spending. Aggregate Demand is C+I+G+(X-I) where :
C = consumption
I = Investment
G = Government spending
X-I - exports -imports
Consider Consumption. Obviously the consumer isn't spending. That is the problem. The consumer's confidence is low and thus he is saving and paying down debt. The savings rate has jumped from about 0% to 4%. The less he spends, the smaller the economy the more unemployment. How to stimulate that? Give him some money. Back to that in a minute.
How about Investment? Businesses won't invest in this environment. Just the opposite. They are hoarding cash and laying off people in order to survive.
X-I = a wash for all intents and purposes.
G is our only choice. So the government spends money and increases aggregate demand which typically gets the economy moving. Eventually the increased demand translates into higher GDP, wages, employment and so forth leading to greater consumer confidence. On the tax side, when taxes are lowered there is a marginal propensity to consume. Say it is 2/3. That means that 2/3 of money given back in the form of tax rebates will be spent in the economy. That increases the "C" (consumer spending) above. The other 1/3 goes into savings which becomes investment as total savings in the economy = investment. Eventually the pent-up demand and savings are translated into purchases and investment. The savings in the banks get loaned out to business that expand. People who are putting off purchases such as new cars will eventually come and purchase them once confidence resumes. The current rate of car purchases indicates the consumer will keep his car for 23 years before replacing it. Obviously that won't stick. Let's call that "pent-up demand".
On top of that the FED purchases treasuries in the open market increasing the money supply. The purchase of treasuries increases the demand for them and thus increases their price. As a result interest rates are lowered increasing the demand for loans.
Consider the opposite case which happened during the Great Depression. Instead of increasing the money supply the FED decreased the money supply. It fell 33% from 1929 to 1933. In Friedman and Schwarz' Monetary History of the United States it is precisely this error that blew a recession up into a depression. Everywhere the money supply was shrinking, held up by the gold standard. Almost immediately after relaxing the gold standard and increasing the money supply the US economy started to grow. 12 months after that day GDP was up 17%. 11% the next year. 14% the next year. In one of Bernanke's papers he shows that the earlier a country came off the gold standard and inflated their money supply the faster they recovered from the recession. Also, the government tried to balance the budget, increased taxes and increased tariffs. No wonder we do the opposite now.
Why do we inflate the money supply and deficit spend in order to get the economy going? Why is that 90% of economists think that is the best options? Because the alternative is too painful.