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A Time to Spend

The more that governments have worried about enabling future moral hazard by excessive bailouts and sought to stem the rise in public debt, the worse their countries’ economies have performed. And the more that they have focused on policies to put people back to work in the short run, the better their economies have done.

BERKELEY – The central insight of macroeconomics is a fact that was known to John Stuart Mill in the first third of the nineteenth century: there can be a large gap between supply and demand for pretty much all currently produced goods and services and types of labor if there is an equally large excess demand for financial assets. And this fundamental fact is a source of big trouble.

A normal gap between supply and demand for some subset of currently produced commodities is not a serious problem, because it is balanced by excess demand for other currently produced commodities. As industries suffering from insufficient demand shed workers, industries benefiting from surplus demand hire them. The economy rapidly rebalances itself and thus returns to full employment – and does so with a configuration of employment and production that is better adapted to current consumer preferences.

By contrast, a gap between supply and demand when the corresponding excess demand is for financial assets is a recipe for economic meltdown. There is, after all, no easy way that unemployed workers can start producing the assets – money and bonds that not only are rated investment-grade, but really are – that financial markets are not adequately supplying. The flow of workers out of employment exceeds the flow back into employment. And, as employment and incomes drop, spending on currently produced commodities drops further, and the economy spirals down into depression.

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