The Kroog Versus The Liquidity Trap

Paul Krugman runs the numbers on the Fed's projections for the next three years and comes up with some very grim news.

Which raises the question, why is anyone talking about an “exit strategy”? On the Fed’s own forecasts, the economy will remain seriously depressed three years from now.

If we apply the Rudebusch version of the Taylor rule to the mean Fed forecasts, I get the following for what the Fed funds rate should be:

End 2009: -6.3%
End 2010: -5.4%
End 2011: -3.3%
End 2012: -0.6%

Yep: three years from now, we’re still in a liquidity trap, with no reason to raise rates above zero and a continuing need for quantitative easing and fiscal expansion.

So we're stuck in a liquidity trap until 2012 or later.  We need a serious stimulus to get the economy going, because it's going to be dead for another three years at least.

There's a cheery thought, eh?  Now imagine if Obama decides the trick to fixing all of this is to balance the budget, cutting spending when we're already in a deflationary spiral?

Can you say Great Depression 2?