By John Muellbauer

The world economy is suffering from a Keynesian shortage of demand. Worse, it is trapped in a dangerous downward spiral of falling asset prices, rising bankruptcies, foreclosures and unemployment feeding into more of the same, along with falling commodity and now goods prices. Since no country is exempt, international co-ordination is needed and made easier because of the obvious common interest. The rapidity of the current contraction also means that fiscal solutions, though helpful, are not timely enough and create obvious free rider problems.

That is why monetary policy should be the first line of action. But conventional monetary policy has gone almost as far as it can in the US and Japan. The failure of the European Central Bank and the Bank of England decisively to respond in October was very damaging, but that is now history*. Policy rates will fall further in December, but may make only a modest contribution to stabilising demand, given the further decline in bank balance sheets and rising levels of fear. It is therefore time for unorthodox policy, but one that is far better than Milton Friedman’s helicopter drops of money, because it is reversible.

Continue reading “The world’s central banks must buy assets”

November 25, 2008 12:52am in Central banks, Keynesianism | Comment