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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

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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.

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).

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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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