Thought for the day: a rotten trap in Denmark

from Merijn Knibbe

The regular reader of my posts (if any) will have noticed that I see Denmark as one of the ‘GIPSD’ countries: at par with Greece, Portugal, Spain and Ireland. And indeed, the Danish economy is doing worse and worse. Contrary to all economies in the neighbourhood, the Danish economy is contracting (GDP, fourth quarter 2010) and unemployment is rising.  Why? The reason for this seems to be that the economy is in a liquidity trap while the government pursues delfationary policies to maintain the Europeg (a liquidity trap is the situation where even a roughly 0% interest rate does not kindle the ‘animal spirits’ of consumers and entrepreneurs – they still keep their money at the bank). Look at the graph from J.P. Irving: 

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http://econsophism.wordpress.com/2011/03/21/denmark-should-let-the-krone-float/

The economic consequences are, to me, clear. Sweden is, in this case, the ‘counterfactual’: this non-euro country did devaluate post Lehman (albeit only for some time) – and is at the moment not just doing fine but doing good. But read Irving about this, his insights are much deeper.  With regard to economic thinking it is remarkable that ‘conservatives’  like Scott Sumner (who in his ‘the money illusion’ blog is also very enthousiastic about this ‘Keynesian world’  graph) and liberals like Paul Krugman are, at the moment, marching to the beat of the same drummer: macro economic policies do matter, as money does matter.  Money is a number too, contrary to ideas of people like Lucas and other ‘new classicals’.  It’s a real thing. And in some cases, the numeraire does matter .  After all, the whole point why monetary prices exist and are used and quoted myriads time a day is of course stickyness – if that wasn’t the case we could as well return to barter.

Beware: increasing the money supply does not always have to have the exact opposite consequences as decreasing the supply and during a financial drought the consequences of a mild money rain might not be the same as the consequences of a torrential downpour.

P.S. – on wikipedia a very concise and interesting ‘neutrality of money’ post:

“The term “neutral money” was coined by Friedrich Hayek, and was originally defined as a market coordinating money rate of interest, which did not create a boom and bust cycle by falsely misdirecting investment through the time structure of production goods.^[1]

Later Keynesian economists took up the notion and redefined it in terms that ignored the microeconomic time structure of production. On this later definition, neutrality of money is the idea that a change in the stock of money affects only nominal variables in the economy such as prices, wages and exchange rates but no effect on real (inflation-adjusted) variables, like employment, real GDP, and real consumption. It is an important idea in classical economics and is related to the classical dichotomy. Money neutrality holds that the central bank does not affect the real economy (e.g., the number of jobs, the size of real GDP, the amount of real investment) by printing money. Any increase in the supply of money would be offset by an equal rise in prices and wages. This is the underlying assumption behind all mainstream macroeconomic models, but as the NBER member and IMF chief economist Olivier Blanchard has said, there is no real evidence: “All the models we have seen impose the neutrality of money as a maintained assumption. This is very much a matter of faith, based on theoretical considerations rather than on empirical evidence.”^“

http://en.wikipedia.org/wiki/Neutrality_of_money, March 26, 2011