Pushing on the String

Professor DeLong thinks that the Fed is doing the right thing by cutting interest rates. I think that it's a good idea to provide a little liquidity in a tight time and it will certainly help out the financial markets. But this is just more of the same and it's why some people accuse the Fed of creating bubbles in the first place.

After the dot com bubble burst interest rates remained at all time lows. This helped push up the price of housing because what people care about is the size of their payment, not the price they're paying for the house. With long term rates all the way down at 5.0% you can afford a lot more house than you can at 8.1%. Everyone started making money hand over fist - brokers, owners, bankers, furniture salesmen - everyone. Some people started to speculate and flip and others built more houses to sell to people. These people borrowed money for the house and all the stuff in it.

2/3 of the economy is consumer spending. But if consumer debt is at an all time high (as the article states "Household spending grew considerably faster than incomes from the early 1990s to 2006" ) and people's housing ATM has run dry, how are we going to continue spending? If we all already had to borrow to spend previously, where will the money come from now? Sooner or later the party is over and the credit card bills have to get paid, and we all know that Monday morning is not fun. If we're lucky we will escape recession, but the Fed might be powerless to stop it.

I believe the Keynesian solution to a lack of sufficient spending by consumers and businesses is to run deficits. But we've already got huge deficits and we're borrowing the money from foreign central banks. Will we run deficits even bigger?