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"Since we don't know much about how an economy can escape a deflationary spiral by itself"

Either we have never had a deflationary spiral, or we are not here.

There was a deflationary spiral in the 1930's, but I don't think it was the same. The big difference was that the 1930's had the gold standard. When you have a fixed stock of international reserves (gold), deflation has one beneficial effect: it increases the real quantity of international reserves, and so allows the global real money supply to increase. (I am NOT saying that deflation doesn't have bad consequences, but in the 1930's there was one good consequence to at least partially offset them). Currency devaluations against gold had the same effect. Fortunately, we don't seem to have to worry about shortage of international reserves and global money supply this time. But it also means that lessons from the 1930's are always helpful. Or you could say that WW2 was the deus ex machina.

Correction: should be: "But it also means that lessons from the 1930's are NOT always helpful."

Say we accept that the mess is not too far from current reality. It might explain all the flailing going on. Since the mess is unstable and must resolve somehow maybe policy makers get to choose?

Coming from a math/physical sciences background, unstable dynamic systems scare me. When you poke them, they have a tendency to reconfigure themselves in a unexpected ways - sometimes tearing themselves to pieces in the process.

Atleast in the early phase, the power structure resisting the forces that eventually shift this framework are successful in denying that there is any threatening force.
Holding onto the microphone in these modern times is a significant advantage to the modern power structure with a few voices speaking somewhat authoritatively to many --as opposed to many unorchestrated voices speaking somewhat more interactively to smaller audiences yesterday. (The "on message" scripts of the Bush administrations from various principals in the WH should make this abundantly clear, yes? These people were delivering...not receiving feedback.)
Or so I would argue against Nick's "gold standard": the reliance on this precious metal having everything to do with custom and tradition (as Hume might argue)[as calmo gathers respectable figures seein how small his mike is...how small his gold pile is too...] --confidence not reinforced (and somewhat undermined by the very process) by a central banking authority "guaranteeing" your deposits in the bank.
But characterizing the "sameness" or "the difference" between now and 1930s, important given the outcome (WWII).
We are beyond just handing over our confidence to prominent figures who have recently demonstrated their incompetence...and we are listening to many other smaller voices --not for direction(s) especially, but to find out if they are listening or...just directing. Sorta.
We have become "difficult"....a jazzy version of "We are all subprime now."

But, but, but: what about expectations of exchange rates? How do they get determined? It matters.

Nick, I might ask something else, but this puzzles me:

"because the domestic and foreign central banks want to push interest rates lower, but can't.'

I don't understand why the Fed couldn't"
1) Add a fee to these bonds
2) Discount them over time

In other words, add a disincentive to buy and hold them.

Hi Don: it's technically possible. But people would just hold cash under the mattress, or in safety deposit boxes, and get zero interest rates that way. (There are various schemes always floated to tax cash, or make it expire, etc., but they always come across as a bit sci-fi.)

OK. Wait. The importance of the Flight to Safety is the guarantees. The fact that the government will insure these bonds can be redeemed.I can understand people actually going and withdrawing cash in waves at, say, -5%. But at -1 to -3 % I'm not so sure. Also, mightn't it be better to force people to cash? I'm not even saying that you'd have to actually do it. The other thing that I'm suggesting is using this for exchange rates. What exactly is China going to do with their money if they don't put it in US Treasuries? They're obviously willing to receive nothing for explicit guarantees.

"In a liquidity trap, domestic and foreign interest rates are exogenous, both stuck at zero. They don't adjust to changes in the current exchange rate (as they normally would), because the domestic and foreign central banks want to push interest rates lower, but can't."

I'm suggesting that, in the case of China, you could. Am I wrong?

The government guarantee only means the government guarantees they will be converted into cash. Ten $100 US banknotes is the same as a $1,000 US T-bill, except the former can be used as a medium of exchange, if needed.
At below 0% interest, China would just hold US$ banknotes instead.

We don't want to force people into cash (that usually works, but has stopped working). We want to force people out of cash, and out of bonds, and into newly-produced goods and services. There are 2 ways to do this: flood the market with bonds+cash (so they've got so much they decide to spend some); create expectations of inflation, which is a way to tax cash+bonds, create a negative real (inflation-adjusted) interest rate on cash+bonds.

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