Lilly Allen and Macroeconomic Stabilization

Rather than trying to understand the current dynamics of monetary policy with a drought management metaphor, perhaps we could turn to the musical stylings of Ms Lily Allen:

Allen, speaking for the American people, is in a conflicted mood. “I want to be rich and I want lots of money,” she says, ignoring the fact that holding her savings as money rather than investing in higher-risk higher-yield assets is undermining the goal of wealth accumulation. Worse, she’s also spurred by instincts toward rapacious consumerism: “I want loads of clothes and fuckloads of diamonds.” Were she to achieve her aspiration of clothes-and-jewelry purchases, the economy would get moving again via employment in the relevant manufacturing and retail sectors. But in the real world, Allen is liquidity-constrained and her desire to stockpile cash prevents her from engaging in stimulative consumption. Once upon a time this wasn’t a big issue, as she sings there’s the debt option: “it doesn’t matter cause I’m packing plastic / and that’s what makes my life so fucking fantastic.”

Today, though, she’s “being taken over by the fear.” Prudent people have become concerned about the future and are attempted to transform as much of their income as possible into safe, highly liquid assets. This is causing a general glut of goods and services. What’s more, “the fear” affecting wealth holders is preventing the less-prudent from securing credit to finance their consumption or investment activities—that kind of lending, after all, is neither safe nor highly liquid. As a knock-on consequences of this, the inflation rate has been dropping and the price level is well below its expected destination. Due to money illusion, this is confusing people who “don’t know what’s right and what’s real anymore” distracted as they are by nominal prices.

The developed world’s population has not, however suddenly become lazy or indolent (“I’m not a saint and I’m not a sinner”), the problem is that elites have betrayed the population by failing to respond adequately to the rise of the fear. The excess desire for money can be met by printing additional money. The excess aversion to risk can be met with guarantees. Unfortunately, both congress and the Federal Reserve are themselves afflicted by the fear. Hence our current predicament.