Do deficits matter during a Depression?

In a word: No.

Deficits are a handy way of printing money during a depression. Normal monetary policy fails during a depression because the freshly printed money (printed to offset money lost due to the contraction of bank lending activity and loss of money to reserves and to under mattresses) is increasing in value (due to the deflation of the circulating money supply as a whole) and thus, rather than getting spent or loaned out and fostering commercial transactions, simply disappears into bank reserves or under mattresses. This leads prices and wages to continue their downward spiral until, at the end, all money has fled into reserves or under mattresses and the economy as a whole has devolved to a very inefficient and misery-filled barter economy. As I previously pointed out, the whole point of money is to serve as the lubricant of commercial transactions in a capitalist economy. No money, no capitalism. Meaning you need money to keep a capitalist economy economy going. Meaning, if you don't have enough money to lubricate commercial transactions, things go to hell in a handbasket.

As previously noted, monetary policy -- simply printing money -- fails during deflation. The only way to effectively print money during deflation is to hand it out with strings attached that require it to be spent -- such as food stamps (where the money must be spent on food and can't be saved), or contracts to build stuff, where the money has to be spent on wages (to the workers building stuff) and materials (the steel and concrete and etc. needed to build stuff). And the spending on materials ends up being spent on on the workers who make the materials, the workers who mine the substances needed to create the materials, and so forth. In short, fiscal policy -- running deficits financed by printing money that is handing out money with strings attached that require it to be spent on *stuff* -- ripples through the economy and gets economic activity jumpstarted again, because the money has to actually do something before it can disappear back under mattresses or into bank reserves. Indeed, any other way of printing money during a depression fails, because the freshly-printed dough simply disappears under mattresses or into bank reserves.

At which point morons chant, “where are you going to get the money?” The printing press was invented in 1440, for cryin’ out loud! Apparently these people live in some alternate universe where unicorns are real, the sky is a fine shade of puce, and the printing press was never invented, because the concept of just printing money to replace the money lost in the collapse of bank lending and the collapse of asset values eludes them. We can print money to pay for all this as long as inflation is below the 2%-4% target rate. At that point the economy will be bubbling along again and we can quit printing and start taxing in order to keep inflation from getting out of control. In our universe, at least. Not in the alternate universe these other people live in, where the printing press was never invented, but why does anybody listen to people whose mindset is so medieval that the printing press is a novel concept to them, anyhow?!

-- Badtux the Economics Penguin