The Kroog Versus Plan C

At this point, Paul Krugman argues, the best we can hope for out of the Obama administration is that they don't cave to the GOP on Plan C.

The first-best answer — that is, the answer that economic models, like my old Japan’s trap analysis, suggest would be optimal — would be to credibly commit to higher inflation, so as to reduce real interest rates.

But the key thing to recognize about this answer is that it’s all about expectations — the central bank only has traction over expected inflation to the extent that it can convince people that it will deliver that inflation after the liquidity trap is over. So to make this policy work you have to (i) convince current policymakers that it’s the right answer (ii) Make that argument persuasive enough that it will guide the actions of future policymakers (iii) Convince investors, consumers, and firms that you have in fact achieved (i) and (ii).

In reality, we haven’t even gotten anywhere near (i): the conventional wisdom is still that any rise in expected inflation above 2 percent is a bad thing, when it’s actually good.

And the reason why that's good is because of the massive, massive loss in real estate prices in both residential and commercial sectors amounts to deflation.  We've lost trillions nationally because the first the housing market collapsed, and now the CRE market is following.  That value is literally vanishing into thin air, it's leaving the economy, period.  Combine that with the fact that rates have been kept artificially low for most of the last decade, and wages have been stagnant, and you have a classic liquidity trap.
(More after the jump...)

Krugman continues:

So some readers have asked why I’m not making the same arguments for America now that I was making for Japan a decade ago. The answer is that I don’t think I’ll get anywhere, at least not until or unless the slump goes on for a long time.

OK, so what’s next? The second-best answer would be a really big fiscal expansion, sufficient to mostly close the output gap. The economic case for doing that is really clear. But Washington is caught up in deficit phobia, and there doesn’t seem to be any chance of getting a big enough push.

That’s why, at this point, I’m turning to what I understand perfectly well to be a third-best solution: subsidizing jobs and promoting work-sharing.

Call it constrained optimization, where the constraint comes from the power of bad ideas.

Inflation is out.  Deficit spending is out.  That leaves...what?  Yes, a real jobs program would be helpful, but the Teabaggers refuse to do even that much.  Quite literally to them, the only thing the government should be spending anything on is the military, and that spending should be absolutely unlimited.  It's nonsense.
So we're at the point now instead of doing what we should be doing (major surgery on the economy), and instead of doing what we could be doing (triage medicine), we're hoping that the idiots on the right will stop screaming long enough to let us apply a tourniquet.  The tourniquet is too expensive, and should really be left to the body's natural clotting system, they argue.

The great part?  They're not even in charge.  So why are we listening to them?