Article;
The economy is not like a household.
Comment;
Nominal interest-rates are zero and the Fed is trying to
push inflation because it wants to ward-off deflation, without policy the
pressure on the prices is to go down, but real-interest rates are negative. Krugman
is suggesting that fall in the prices will not reduce the burden of debt,
because interest rates are already zero, but not on home-loans. Interest rates
on home-loans are around 3-4% and since there is pressure on prices to go down
(without policy), means low-inflation; the Fed should try to compensate for the
rise in the value of debt by reducing interest-rates. But, the Fed does not
regulate home-loans directly; it manages base-rates, repo-rates. Nevertheless
the Fed manipulates the value, of any debt, by manipulating the rate of
inflation and real interest rates. Home loans have constrained the economy’s
demand and a lower real interest rate will reduce the burden of debt and will
generate demand for other products. Therefore, if inflation in the economy is
around 2% (which is not), it is only our target, and home loans are 3-4% we
need to increase inflation by 1-2% to reduce the value of debt to zero, means
real-interest rates at zero, but we need negative real interest-rates to push
the demand more. The more the Fed would push inflation the more the value of
debt will go down. Inflation reduces the value of debt. Repo-rates are already
zero, but home-loans are not. But what if the Fed does not use inflation
targeting and let the prices fall… falling prices with constant wages and
income, because of nominal-wage-rigidity, and income is certainly likely to
increase demand and more resources for debt repayment but we are limited by the
nominal interest rate, they can not go below zero but we can reduce the burden
of debt by inflating the economy and reducing real interest rates… I think this
is precisely what Krugman wants…
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