The private sector will not be responding to the talk of inflation or inflation targeting because it is responding to the fall in asset prices, not consumer prices.In times of deleveraging households are repaying their debt and they do everything to minimize borrowings. But if the value of their debt is too high, it becomes impossible to repay it. So the only choice is default. This chart summarize it nicely. Too bad I don't know the source of it.
The gap between the the value of debt and value of properties is too large and without asset prices inflation it cannot be solved. So the only way for FED is to inflate and print money...
Original article from Koo is worth reading:
Is America facing an increase in structural unemployment? No, America lacks the necessary commitment to stimulus.
THERE is no reason for structural unemployment to increase following an ordinary recession or financial crisis. However, the US today is suffering from a balance sheet recession, a very rare ailment which happens only after the bursting of a nationwide debt-financed asset price bubble. In this type of recession, the private sector is minimising debt instead of maximising profits because the collapse in asset prices left its balance sheets in a serious state of excess liability and in urgent need of repair. When the private sector is deleveraging even with zero interest rates, the economy enters a deflationary spiral as it loses aggregate demand equal to the sum of unborrowed savings and debt-repayments every year. If left unattended, the economy will continue to contract until either private sector balance sheets are repaired, or the private sector has become too poor to save any money (=depression). The last time this deflationary spiral was allowed to materialise was during the Great Depression in the US.
In this type of recession, monetary policy is largely useless because people with balance sheets underwater are not interested in increasing borrowings at any interest rate. There will not be many lenders to those with impaired balance sheets either, especially if the lenders themselves have balance sheet problems. The private sector will not be responding to the talk of inflation or inflation targeting because it is responding to the fall in asset prices, not consumer prices. The money supply also contracts when the private sector de-levers because bank deposits, the largest component of money supply, shrinks when the private sector draws down its deposits to pay back its debt. During the Great Depression, the US money supply contracted 30% mostly for this reason.
Since the government cannot tell the private sector NOT to repair its balance sheets, the only thing the government can do to keep the economy going is for the government to borrow and spend the unborrowed savings in the private sector and put them back into the economy’s income stream. In other words, fiscal stimulus becomes indispensible in a balance sheet recession. Moreover, the stimulus must be maintained until private sector deleveraging is over.
The problem is that in a democracy, it is extremely difficult to maintain fiscal stimulus during peacetime. As can be seen in the US, UK and in so many democracies around the world today, the demand for fiscal consolidation overwhelms the policy debate once the initial fiscal stimulus manages to stabilise the economy. Not realising the critical danger posed by private sector deleveraging at zero interest rates, those who push for fiscal consolidation argue that a big government is a bad government and that the wasteful deficit is jeopardising the future of our children and grand-children.
When the deficit hawks manage to remove the fiscal stimulus while the private sector is still deleveraging, the economy collapses and re-enters the deflationary spiral. That weakness, in turn, prompts another fiscal stimulus, only to see it removed again by the deficit hawks once the economy stabilises. This unfortunate cycle can go on for years if the experience of post-1990 Japan is any guide. The net result is that the economy remains in the doldrums for years, and many unemployed workers will never find jobs in what appears to be structural unemployment even though there is nothing structural about their predicament. Japan took 15 years to come out of its balance sheet recession because of this unfortunate cycle where the necessary medicine was applied only intermittently.
The real impediment to a sustained recovery from a balance sheet recession therefore is the inability of orthodox academics and policy makers to accept the fact that the private sector is minimising debt and that their aversion to fiscal stimulus based on the assumption that the private sector is maximising profits is unwarranted. If Japan had known that it had actually contracted a different disease and kept its fiscal stimulus in place until the private sector balance sheets are repaired, it would have recovered from the recession much faster and at a much lower cost than the 460 trillion yen or $5 trillion it eventually took to cure the disease.
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