Deficit spending during recessions has great consequences on inflation rates, and whilst it may provide short term relief, it all has to be paid back which inhibits the long run performance of an economy.

The Fed has no money on hand... all it does is print, and exchange for T-Bills. The Federal government? If you're asking the Fed to always balance the budget, like the EU wants to, then you completely neuter its abilty to do any fiscal policy.

What do we do, when we are at or near 0% interest rates? Cut the rate to -1%? O.o

If there is a aggregate demand shock, there should be disinflation, so inflation shouldn't be a problem. Theoretically, all we're doing is putting back inflation where it was pre-inflation rates.

But, inflation will still be a problem. Increased deficit spending, for example, will result in an increase in money supply. Increasing the money supply in itself is inflationary as it will almost certainly result in a fall in the value of money.

Did you take a look at the graph? The aggregate price level goes down, and as long as our government doesn't engage in excessive inflationary policies, then it should be back at its pre-recession levels.

Increased defeceit spending doesn't increase money supply... the Fed doesn't provide the government money, the government engages in extremely little seniorage. Expansionary monetary policy (lowering the rate) increases the money supply.

@Akvod -

That makes absolutely no sense. If the government is running a deficit, and spending the money, then it is inflating the economy - it is running a major deficit, and creating money to use in the market place (after all, if the government is down $13 trillion in money, I must think that the money is out there in the supply, at some point).

Although the government doesn't engage in a significant amount of seigniorage, it still is there. If it were not, then quantitative easing wouldn't be a possibility for dealing with our deficit.

I've studied the graphs for hours on end, Akvod, and, frankly, all real world data points towards Government deficits being inflationary. Hell, inflation didn't really even exist in the USA before the 1900s, indicating that, actually, Government deficits are the sole cause of inflation.

Now, of course, you can argue that it's because the deficit has been sustained during periods of growth. Which I agree with, and, in fact, the data also shows that if the deficit is quickly reduced, inflation will quickly fall with it. However, this is only when the deficit has come from the Government spending money on projects that have a greater long-term gain. If the Government borrows a tonne of money, for example, to improve the infrastructure, inflation will fall as the benefit derived from the infrastructure increases - in essence, as the projects pay for themselves.

The problem is that during recession, and the kind of policies that Keynesian politicians usually go for - generating bulking deficits to increase consumption - are policies that not only don't generate as much long term benefit for an economy (£20 billion spent on subsidising cars will not generate as much long term benefit as £20 billion spent on roads, for example).

It all just boils down to the fact that Keynesian economics are all ridiculously short-term. Unfortunately, the only terms shorter are terms of mandate for a Government, and they only really ever focus on the next 5 years, not the next 50.

To quote Keynes, "in the long run, we're all dead".

And, yes, I forgot, deficit spending, indeed, all debt spending, requires an increase in the money supply to actually happen.

The Federal Reserve isn't the only body in the USA which can create money, you know. Every single bank in the USA has the ability to create money. When you take out a loan of, say, $20,000 the bank will "create" a large chunk of that money. The difference is that when you take out your loan, or a mortgage for $200,000 the amount of money created is infinitesimal, especially when compared to the amount of money created to fund the trillions required for the Government's debt.

Gonna have to call you on this, not because i have any inkling one way or another, but that sounds extremely like correlation != causation sort of thing. To say something this radical is going to need at least a modicum of proof.

Here's a lovely little video for you :P

http://www.youtube.com/watch?v=afWqKcqntfs