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The basic problem our economy faces is a lack of effective demand

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As economist Dean Baker recently pointed out, the basic problem our economy faces is a lack of demand. To better understand this problem, let's suppose that we had a super-effective counterfeiter: someone who could make near perfect copies of $50 or $100 bills. Further suppose that this person was in the process of printing up $2 trillion of counterfeit money and had begun spending it on all sorts of items -- houses, cars, boats and planes for him and all his friends, as well as incredibly lavish parties, excursions and trips. Imagine they hire all sorts of servants, groundskeepers and investment advisers and never stop building luxury homes all over America.

What would be the effect of such an immense counterfeiting scam on the economy?

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In the current situation, it would provide an enormous boost to GDP and create millions of jobs. After all, everyone thinks the money is real. And, it makes no difference whether:

a) the counterfeiter and his underlings spend $2 trillion of counterfeit money, or if

b) the big corporations were to suddenly start investing/spending the $2 trillion in hoarded cash that they've accumulated, or if

c) Americans were to find $2 trillion (fresh from government printing presses) that had been dropped from helicopters in the middle of the night in every major city in the U.S.

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Each of these scenarios would have the same effect on the economy, just as long as Americans began to spend again as though the housing bubble had never collapsed -- which is exactly what people would do, in each case.

In normal times, as economist Baker points out, the economy is, at least partially, supply-constrained. This means that collectively we want more goods and services than the economy is capable of producing. Therefore, if our counterfeiter manufactured his $2 trillion in normal times, it likely would cause a serious problem of inflation. Why? Because there would be more demand for cars, houses and other goods than the economy was able to supply. (Too many dollars chasing too few goods.) This would push up prices and wages, leading to a cycle of inflation that would persist until policy measures were taken to slow the economy.

In our demand-constrained economy, however, there is no possible problem of inflation. Why? Because our economy can, could and would produce more of almost anything right now, if only the effective demand for these things were there. In short, the only reason we are not ramping up production is simply for lack of effective demand (i.e. sufficient numbers of consumers who have money in their pockets to spend).


The really interesting part of this counterfeiter story is that his $2 trillion of phony money would not create problems even in the long run -- assuming that he is eventually shut down. Here's why:

Let's suppose that the counterfeiter's lavish spending gets the economy back towards full employment sometime around 2012, at which point he gets nailed by the FBI who finally figure out how to recognize his virtually perfect but fake $50 bills.

At that point, the $2 trillion will gradually be sifted out of circulation and destroyed -- assuming that the economy is strong enough at this point to remain near full employment even as this counterfeit wealth gradually disappears. So, there would be no lasting damage from the episode. So, the fictional wealth would have served its purpose: it generated demand when the economy needed it, but was then pulled out of circulation at the point when it could have begun generating inflation.

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And here's the key point to be made from all this: while it is of course unlikely we will see a successful counterfeiter on this scale, the government and the Federal Reserve Board could safely (and very beneficially to all of us) imitate the counterfeiter's actions. However, instead of putting people to work catering to the frivolous whims of the counterfeiter, his friends and all of their extended families, we could have these millions of newly employed workers build up the entire economy by meeting important societal needs. (The list of necessary tasks is long and well-known.)

As is the case with the counterfeiter's illicit stash, this stimulus spending need not even create any long-term debt burden. As economist Baker explains, the Fed could simply buy and hold the bonds issued to finance all this spending. Then, when the economy returns to more normal levels of employment, the Fed would raise interest rates, as it always does, to prevent inflation from posing a serious risk.

It's all very simple. Unfortunately, our Washington politicians lack the courage and imagination that would be required to take the necessary steps to get the economy back on its feet in this way. But never let it be said that there is no practical way to save this economy and put millions of people back to work at decent wages!

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Several years after receiving my M.A. in social science (interdisciplinary studies) I was an instructor at S.F. State University for a year, but then went back to designing automated machinery, and then tech writing, in Silicon Valley. I've (more...)

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