Friday, October 29, 2010

Wall of liquidity versus wall of worry

The problem with a financial crisis is that the wall of worry is very high. Keynes view is that the economy needs animal spirits to create a sense of optimism to gee over the wall of worry and continued uncertainty. The worry all can be offset by a wall of liquidity. This is the premise for QE2. A wall of liquidity will offset the worry. Excessive liquidity will allow borrowing to continue or actually overshoot the current worries in the economy. The problem may be that the wall or wave of liquidity may not be high enough to offset the worry. Or, liquidity at the other extreme could be too great.

Ultimately these walls are associated with expectations. Changing expectations is critical to increasing growth. The expectations that liquidity will be cheap is supposed to offset market worry. Unfortunately, it is difficult to control expectations. Policy markets and economists have not been able to control the thoughts of businesses and consumers.

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