Recession or Depression??

I just wanted to clarify what I meant earlier in my post about Obama's stimulus package. I was saying how every 70 or so years we have these huge build-ups of credit/debt and that "normal" Keynesian monetary policy (increasing and decreasing the money supply through the Fed's open market operations) only works during the build-up of that debt. Keynesian's believe that "expansive" monetary policy usually stimulates the economy by reducing interest rates and increasing credit availability so people and businesses can borrow more inexpensively and, thus, spend more freely. This is what the Fed is doing right now, and has been doing since August 2007. Everytime you hear that the Fed has cut its target for the Federal Funds Rate or that it has slashed its discount rate this means that the Fed is expanding the nation's money supply, and using expansionary monetary policy. This usually does work. However, when the economy becomes to saturated with credit and debt, it doesn't work anymore. It actually makes things worse. This is a direct quote from my finance text book, you would think Ben Bernake would have read this:

"In the Keynesian world, monetary policy always works unless the economy is in a liquidity trap, such as during the Great Depression of the 1930s, when Keynes thought people already had so much money relative to their needs that any extra money would be hoarded and would no longer drive down interest rates. However, because liquidity traps are rare and arguably occur only during major depressions, Keynesian theorists believe an expansive monetary policy stimulates the economy by driving down interest rates and increasing credit availability."

So, basically what this says is that when there is to much money, debt, and credit in an economy it can create huge bubbles. When one of those bubbles pops, think housing bubble, the only way for the economy to recover is to fix what caused the problem. What caused the problem was the fact that credit was to easily available. People had to much money relative to their needs, so they percieved themselves as being wealthier than they really were. So people took on more debt, buying houses, remodeling kitchens, buying new cars, and going on vacations. When adjustable rate mortgages started resetting to higher rates people realized they couldn't afford these houses and they started selling. The market collapsed, and all that is left is accumulated debt. So, the fix the problem we need to destroy the debt. However, you can't let debt destruction occur by throwing more debt/credit at the problem. This is why the Fed cutting interest rates has had absolutely no effect on the economy. If anything they are making things worse and turning a quick correction into 30s style deflation.

I hope this helps you understand what I am talking about when I say that the Fed, Obama, the $700 billion bailout, whatever is all useless. It won't work because they are trying to fix the problem with what actually caused the problem. Here is a chart showing the buildup of credit/debt in the economy over the past 100 years. It will help show you the "bubble" that was created (which in turn inflated asset prices to unrealistic levels and created a false sense of wealth in the United States). Enjoy!