Overinvestment

There's a third kind of overinvestment for poorer countries, such as those of East Asia, pursuing an export-oriented growth path. Competing with each other for the same rich-country markets, they overinvest in the sense that if their capacity were fully used, it would mean even lower prices for them (lower exchange rates). Because of the inelastic demand for their products (i.e., for the products of their economies all added together), falling prices or exchange rates don't help them. This is similar to the phenomenon of overinvestment by small farmers (petty capitalists), who regularly invest too much (in the face of inelastic demand) and drive many of their members into bankruptcy. Falling prices (exchange rates) simply make debt service more expensive. Since the investment boom usually corresponds to debt accumulation, this is crucial.

DeLong continues: " after all, enough monetary expansion can push interest rates low enough to make any investment that is at all productive profitable..."

Ricardo Caballero's research (presented at the ASSA convention in January 2000) points to the real phenomenon of the vertical IS curve due to excessively idle capacity (along with excessive corporate debt and pessimistic expectations). This is what I call the Depression IS curve: falling interest rates do not induce much if any investment under these conditions, so that there's little increase in GDP. This situation can be reinforced by excessive consumer debt, consumer pessimism, and overbuilding in the housing market. (This is a situation that Leijonhuvfud would call "outside the corridor.") Real interest rates cannot fall below zero unless expected inflation rises significantly (as Paul Krugman points out). So, absent severe inflation, even a steep (i.e., non-vertical) IS curve may not intersect the LM at full employment. (Note that even before zero, there's a floor on interest rates because of the liquidity value of money as an asset.) This implies that monetary policy is impotent.