He writes: "when expected yield on holding cash is greater or even close to the expected yield on real capital, there is insufficient incentive for business to invest in real capital and for households to purchase consumer durables. Real interest rates have been consistently negative since early 2008, except in periods of acute financial distress (e.g., October 2008 to March 2009) when real interest rates, reflecting not the yield on capital, but a dearth of liquidity, were abnormally high. Thus, unless expected inflation is high enough to discourage hoarding, holding money becomes more attractive than investing in real capital. That is why ever since 2008, movements in stock prices have been positively correlated with expected inflation, a correlation neither implied by conventional models of stock-market valuation nor evident in the data under normal conditions.
As the euro crisis has worsened, the dollar has been appreciating
relative to the euro, dampening expectations for US inflation, which
have anyway been receding after last year’s temporary supply-driven
uptick, and after the ambiguous signals about monetary policy emanating
from Chairman Bernanke and the FOMC."
As I pointed out a while back when David was talking about the Fisher effect and inflationary expectations, this is the exact same point as the liquidity trap argument. It is a little surprising to see all the schadenfreude over Europe. Trouble there does not bode well for us.
One Last One on Sumner vs. Murphy
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