What should we make of these claims that a balanced budget amendment would:
a. lead to a liquidity trap when a large portion of the GDP is removed
b. undermine economic stability by removing safe havens in Treasuries
What is the MMT theory that a balanced budget would lead to the private sector having to go into a deficit? I’ve tried for about an hr to understand their theory, but it seems like a convoluted strand of assertions that I can’t ascertain the meaning of..
Further, do you think they are a viable answer to the fiscal problems we have?
A liquidity trap is the Keynesian notion that when interest rates are very low monetary policy is ineffective. With interest rates so low, Keynes argued, investors all expect interest rates to rise, and therefore when the Fed inflates the money stock investors will not invest but instead hold cash. In other words, Keynes thought the demand for money would be indefinitely large.
The reduced demand that the Federal government would have for debt it it balanced its budget is far to small to push interest rates so low that a liquidity trap would ensue. The Federal deficit is around $1 trillion but global credit markets are well over $150 trillion in 2011.
Moreover, as interest rates fell private borrowing and investment would increase. The world in not in a liquidity trap now and so credit markets would work normally. Keynes invented the notion of a liquidity trap to explain why expansionary monetary policy could not stimulate an economy that was in depression. Keynes did not think it was a normal condition of credit markets.
The $20 trillion Federal debt did not prevent economic instability in 2008. It seem apparent, then, that preventing the Federal debt from increasing from $20 trillion to $21 trillion will have no ill effect on economic stability.