DeLong's Keynesian Cure

Brad DeLong explains the situation in a way my students and me can understand:

The world economy, as John Maynard Keynes put it 75 years ago, is developing magneto trouble. What it needs is a push – more aggregate demand. In the US, the weak dollar will be a powerful boost to net exports, and thus to aggregate demand. But, from the perspective of the world as a whole, net exports are a zero-sum game. So we will have to rely on other sources of aggregate demand.

The first source is the government. Fiscal prudence is as important as ever over the medium and long term. But for the next three years, governments should lower taxes – especially for the poor, who are most likely to spend – and spend more.

The second source is private investment. The world’s central banks are already cutting interest rates on safe assets, and will cut them more as the proximity and magnitude of the likely global slump becomes clear.

But low interest rates are entirely compatible with stagnation or depression if risk premia remain large – as the world learned in the 1930’s, and as Japan relearned in the 1990’s. The most challenging task for governments is to boost the private sector’s effective risk-bearing capacity so that businesses have access to capital on terms that tempt them to expand.