A loss in wealth should boost economic growth

If you woke up one morning and found that your investment adviser had absconded with your pension, how would you react?  Suppose your house burned down; how would you react?  Wouldn’t it be rational to respond to a big loss in wealth by buckling down and working harder?  Would you consider it a good time to take a long vacation?

Here’s David Andolfatto discussing a recent paper by Jim Bullard, of the St. Louis Fed:

I think that Bullard makes a persuasive case that the amount of household wealth evaporated along with the crash in house prices should likely be viewed as a “permanent” (highly persistent) negative wealth shock. Standard theory (and common sense) suggests a corresponding permanent decline in consumer spending (with consumption growing along its original growth path). The implication is that the so-called “output gap” (the difference between actual and “trend” GDP) may be greatly overstated by conventional measures.

Maybe I’m missing something, but I completely fail to see any connection between the final paragraph of that sentence and the previous two sentences.  Yes, you’d want to reduce consumption, although for ”PSST” reasons you’d want to do so quite gradually.  And you’d want to produce more investment goods and exports, as consumption gradually declined.  And you’d want to work longer hours.  And the extra labor and investment would raise the growth rate of the economy.  But why would you want to produce less output just because wealth fell?  That makes no sense to me.

Don’t get me wrong, I’m sure I’m missing something blindingly obvious, as Jim Bullard, David Andolfatto and Tyler Cowen (who also links to this argument) are very bright people.  It’s just that I don’t see the argument.  And the argument is stated in such a way that it seems like one of those “needs no explanation” points.  As if the fall in wealth would obviously reduce consumption (I agree) and obviously that fall in consumption would reduce output.  But why?

I’ll look for an explanation in the comment section.  But don’t tell me “it reduces AD, stupid,” because they are explicitly arguing that it reduces the potential level of output.  I could sort of buy the AD argument, although I’d ask why monetary stimulus couldn’t fix the problem.  Andolfatto continues:

The view that one takes here is likely to influence what one thinks about monetary policy. The conventional view seems to support the Fed’s current policy of keeping its policy rate close to zero far into the future. In his speech, Bullard worries that this may not be the appropriate policy if, in fact, potential GDP has experienced a level shift down (or, what amounts to the same thing, if conventional measures treat the “bubble period” as the economy being at, and not above, potential). Among other things, he [Bullard] says:

But the near-zero rate policy has its own costs.  If we were proposing to remain near-zero for a few quarters, or even a year or two, one might argue that such a policy matches up well with the short-term business cycle dynamics of the U.S. economy.  But a near-zero rate policy stretching over many years can begin to distort fundamental decision-making in the economy in ways that may be destructive to longer-run economic growth.

Precisely how such a policy “distorts fundamental decision-making” needs to be spelled out more clearly (though he does offer a couple of examples that hinge on a presumed ability on the part of the Fed to influence long-term real interest rates). I am sure that many of you have your own favorite examples.

I think Andolfatto’s being way too kind with “needs to be spelled out more clearly.”  From mid-2008 to mid-2009 we saw the Fed let NGDP plunge 9% below trend.  That was the main cause of the wealth crash in America, not the subprime bubble.  If falling wealth is the problem (which I doubt) then more monetary stimulus is the solution.  We shouldn’t be basing monetary policy on guesses about where the “potential output” is, no one knows where it is.  We should have steady 5% NGDP growth, level targeting, because all the supposed “welfare costs of inflation” are actually welfare costs of unstable NGDP growth.

Milton Friedman said ultra-low interest rates are a sign that money has been very tight.  Of course he’s right, but I don’t sense that there’s anyone at the Fed that understands this.  They seem to think their zero rate policy is a sign of “easy money,” and indeed might be distorting the economy by being too easy.  If near-zero rates are easy money, then the only two cases of even easier money in all of world history would be the Great Depression and the Great Japanese Deflation.

Yes, we’d all be much better off if interest rates were much higher now, as long as those higher rates were produced by a Fed that kept NGDP growing at 5% after 2008, which would have made both the wealth crash and the recession much milder.  But there are always two ways to raise rates, easier money or tighter money.  My big fear is that the Fed will mistakenly choose the latter course.  It was tried twice in Japan at the zero bound (2000 and 2006) and once in Europe (April 2011), and all three times failed abysmally.  Yes, by all means let’s have higher rates, but as a result of an expansionary monetary policy that boosts NGDP growth, wealth, consumption, and RGDP.

The Fed let NGDP fall in 2009 at the sharpest rate since 1938.  That’s their policy failure.  Their failure to fulfill their dual mandate.  Mainstream macro theory says a sudden fall in NGDP will have a devastating effect on both the real economy and the financial system.  It’s distressing to see top Fed officials suggest this isn’t the problem, that “potential output” mysterious declined at the same moment.


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115 Responses to “A loss in wealth should boost economic growth”

  1. Gravatar of Morgan Warstler Morgan Warstler
    9. February 2012 at 13:30

    But if the level target was 4.5% (better 4%) since say 2000, then we were OVER TREND and just had a correction in 2008.

    We weren’t supposed to build all those houses, we weren’t supposed to give public employees pay raises.

    If we assume those as true (and I will go to my grave assuming those are true) then we were indeed over trend, no?

    Public employees are earning $500B TOO MUCH this year (compared to 1998 compensation at inflation), if they are back where they are supposed to be, what does that do GDP assumptions about trend.

  2. Gravatar of Morgan Warstler Morgan Warstler
    9. February 2012 at 13:32

    Aren’t there little econ logic games you play where people are made to think they are richer than they are (embezzlement)…

    We woke up in 2008 and it was true.

  3. Gravatar of Barry Barry
    9. February 2012 at 13:37

    “although I’d ask why monetary stimulus couldn’t fix the problem.”

    Unless you directly wire the money to ordinary citizens, this money just makes banks and some wealthy people more well off by boosting some asset prices, but ordinary people see no real benefit as the banks aren’t interested in lending to them, their wealth is never restored so demand is never restored. At the zero-bound, any monetary policy short of something extremely radical will be ineffective to prevent a recession.

  4. Gravatar of Jason Jason
    9. February 2012 at 13:42

    If you’ve studied some finance, its best to think about this issue in terms of a Campbell-Shiller log-linear framework. Wealth is a claim to all future consumption. The wealth-consumption ratio can go down either because future cash flows (expected consumption growth) falls or because expected asset returns increase.

    In the second case the fall in wealth is followed by higher future returns on wealth as the wealth consumption ratio mean reverts. In the first case, the fall in wealth predicts sustained lower consumption growth.

    Note this is an accounting identity and doesn’t require imposing any form of expectations. In the past, falls in wealth almost always predict returns and not cash flows but maybe this time is different, you never know.

  5. Gravatar of Major_Freedom Major_Freedom
    9. February 2012 at 13:47

    “Milton Friedman said ultra-low interest rates are a sign that money has been very tight. Of course he’s right, but I don’t sense that there’s anyone at the Fed that understands this. They seem to think their zero rate policy is a sign of “easy money,” and indeed might be distorting the economy by being too easy.”

    In order to hold the overnight interest at 0-0.25%, the Fed has to increase reserves. If they don’t, then the overnight rate will increase above target.

    That’s “easy money”, not “tight money.”

    “If near-zero rates are easy money, then the only two cases of even easier money in all of world history would be the Great Depression and the Great Japanese Deflation.”

    Bad inference. It does not follow from X% overnight interest rate requiring $Y of inflation of bank reserves in one period time, that X% overnight interest rate in another period of time somehow means that money is “as loose”, or that (X-x)% overnight interest rate in another period of time somehow means money is “even looser.” There is no constancy there. 0.25% overnight rate today could mean money is “tighter” than an 0.25% overnight rate in the past.

    During the 2008 financial crisis, when banks wouldn’t lend much money to each other in the overnight market, that would have otherwise made the overnight rate skyrocket. So the Fed had to MASSIVELY increase bank reserves to keep the rate where they wanted it.

  6. Gravatar of Major_Freedom Major_Freedom
    9. February 2012 at 13:50

    “But there are always two ways to raises rates, easier money or tighter money. My big fear is that the Fed will mistakenly choose the latter course.”

    Yes, it’s “scary” to contemplate income earners having a higher purchasing power and higher standard of living than they otherwise would if the Fed printed even more funny money.

  7. Gravatar of Major_Freedom Major_Freedom
    9. February 2012 at 13:53

    “The Fed let NGDP fall in 2009 at the sharpest rate since 1938. That’s their policy failure.”

    The Fed printed too much money and held interest rates too low, too long PRIOR to 2009, blowing up an economic bubble that was concentrated in the housing market.

    That’s their policy failure.

  8. Gravatar of Cthorm Cthorm
    9. February 2012 at 13:53

    I find this “potential output” shock argument completely offensive. As you said early on, the broad tendency will be for people to work longer hours, save more, and consume less to compensate so that they catch up to their prior wealth/income trend. Even if you disagree and think that consumers don’t try to reduce this gap, why on Earth would the POTENTIAL output stay low? Do they really think the US economy (of all economies) is so capital constrained that this would represent a permanent loss in output potential? Technology, institutional burdens, and the size and quality of the labor force are the chief determinants of our output potential. No, the potential output is just as high, we’re just operating well below potential without a clear exit, because nominal debt burdens (created when NGDP growth was much higher) and institutional barriers are weighing us down.

  9. Gravatar of Charlie Charlie
    9. February 2012 at 13:56

    Bullard Speech:

    “But housing prices are special in that they represent valuations on a significant fraction of the wealth of the nation, defined as the value of the physical capital stock. To have those prices fall hard and stay down without much prospect for rapid recovery is a one-time, permanent wealth shock. This is a different type of shock than the ones that have caused previous postwar U.S. recessions.”

    He seems to be saying that the capital stock is much smaller than we thought it would be.

    If you take a regular old Prescott style RBC model and get it to a steady state, it says we consume X% and invest 100-X% and that stays constant. [The steady state--you can then put some shocks in or whatever...].

    You could compare two different economies that have different capital stocks and if they were both at the steady state, they’d both grow at the same growth rate, they’d both have X% consumption and the rest investment, but the one with less capital would never catch up to the other one.

    Why is there unemployment?

    “I mentioned that a wealth shock significantly upsets labor market relationships. This is because output declines, so less labor is required. It takes a long time for those displaced by the shock to find new working relationships. I would expect to see high unemployment and only slow improvement in labor markets following the wealth shock.”

    I can’t find coherence. The first sentence maybe invokes PSST. The second says output declining means less labor is required, but that’s false. Output is down because the capital stock is lower. In the RBC model prices adjust to keep the economy at full employment. You need some sort of friction to explain the unemployment. It’s not clear what Bullard thinks the friction should be.

  10. Gravatar of Major_Freedom Major_Freedom
    9. February 2012 at 13:58

    “Mainstream macro theory says a sudden fall in NGDP will have a devastating effect on both the real economy and the financial system.”

    It will have cleansing effects.

    It is printing too much money that caused the problems in the first place.

    Printing money to maintain a broken system is what has already made devastating effects on the real economy a current reality, and it has made it a future reality that is now even worse than it otherwise would have been.

    While you’re fearing for fire and brimstone at the prospects of not enough money printing, you’re ignoring the fire and brimstone such a policy has already had, and continues to have, on a fragile world economy.

    You remind me of a drug addict who fears “devastating” withdrawal symptoms if he doesn’t get another hit.

    I think you monetarists’ ideas are a danger to civilized society. And the worst part is that you think you’re helping.

  11. Gravatar of Charlie Charlie
    9. February 2012 at 14:02

    I said,

    “He seems to be saying that the capital stock is much smaller than we thought it would be.”

    This should probably read: …the capital stock is much smaller than we thought it was.

    So we are in a new steady state.

    The old GDP that included high housing prices was artificially too high and the capital stock was not really as large as we though. Some of the measured growth was not real.

    I don’t agree, but I think that’s what these people are saying.

  12. Gravatar of Greg Ransom Greg Ransom
    9. February 2012 at 14:16

    Remember those bulldozed nearly completed houses in California?

    Remember those hundreds of miles of mothballld lumber rail cars?

    Remember those unfinished or unsold new condos in Florida and Nevada?

    What were assumed to be very valuable economic goods turned out to be non-economic goods — read Menger to understand the words.

  13. Gravatar of Jeff Jeff
    9. February 2012 at 14:18

    The prices of houses went down, but the houses themselves didn’t get any smaller. The idea that this is a reduction in capital stock is clearly wrong.

    This sounds a lot like crude Keynesian stuff. The marginal propensity to consume out of wealth is greater than zero, so when perceived wealth falls, so does consumption. But, as you point out, consumption is not production. You would expect a decline in perceived wealth to increase savings, investment and labor supply. All of those work in the opposite direction, and potential output, at least, goes up.

    Kling’s PSST argument would be that the changes in relative prices of houses versus everything else causes a reallocation of resources away from house production and towards something else, and that this will take some time. Very much an Austrian business cycle theory idea.

  14. Gravatar of dwb dwb
    9. February 2012 at 14:22

    i see it as argument for deflation, not a reduction in potential output. bearing in mind i am talking about the Q, not the P, i see it as an argument for a declining P (but: the Q should revert to the same old potential when wages get reduced). I can certainly buy that lower weather reduces nominal consumption in the short run. I do no not see anything in there that implies an inherently higher unemployment rate (e.g. lower potential output), or declining labor participation rate. Seems to me all those people could be gainfully employed producing the same things at lower prices, so that the lower level of nominal wealth sustains the same Q (i.e. real output).

    Now, if you add nominal debt to the mix, sure, debt-income ratios are worse with an asset shock. But eventually those debt contracts either get reset, abrogated through bankruptcy (really, the same as inflation-devaluation), or inflated away. It makes the adjustment process painfully slow, as we are discovering 3 years later. Again, I see no reason for a permanently lower Q, just the same Q at lower prices.

    all this hysteresis stuff is hysterical. I really don’t see evidence of a permanent shock to productivity that would cause permanently higher unemployment.

    If one is talking about housing in particular – an obvious source of the “persistent” decline in wealth, well, the demand for housing is coming back to life as the prices decline. In Las Vegas – one of the hardest hit – there is no evidence the Q (demand) has been permanently lowered, just the P.

    A permanently lower potential output has to come from permanently lower productivity (what else??) … otherwise we are just conflating nominal and real output and wealth.

    http://www.calculatedriskblog.com/2012/02/las-vegas-house-sales-up-12-yoy-in.html

  15. Gravatar of dwb dwb
    9. February 2012 at 14:23

    … lower “wealth” not lower “weather” lol. but that too, at least before i could shop on Amazon. lol

  16. Gravatar of Scott B. Scott B.
    9. February 2012 at 14:29

    Morgan and Greg, it may be argued that we should not have built all those houses and that the resources could have been better spent at the time, but we still have all those workers and all that construction equipment, and as far as I can tell there isn’t any shortage of the raw goods that went into building those houses. Thus, our *potential* output remains the same. And wealth, by most measures, is measure of *potential* sales, rent collection, etc. of any asset.

    The wealth collapse in this case is completely a collapse in NGDP. The factories, houses, construction workers, etc. all still exist, but their potential output is being held back by insufficient demand–the Fed’s destroying wealth. There’s been no real destruction of capacity, other than the withering away of skills of human capital (i.e., unemployed workers).

  17. Gravatar of How large is the output gap really? — Marginal Revolution How large is the output gap really? — Marginal Revolution
    9. February 2012 at 14:30

    [...] Here is comment from Scott Sumner, and Matt Yglesias.  You’ll note my post is itself non-committal, though I certainly do not [...]

  18. Gravatar of Jason Jason
    9. February 2012 at 14:38

    Wealth is not exogenous.

    My biggest problem with the way Macro people think. There is no wealth shock. There are other shocks that affect wealth.

  19. Gravatar of Anon1 Anon1
    9. February 2012 at 14:42

    Major Freedom,

    Interest rates are low across the entire yield curve. I think it has more do with the economy than with the IOR being held at 0.25%.

    http://macromarketmusings.blogspot.com/2012/02/can-raising-interest-rates-spark-robust.html

  20. Gravatar of Charlie Charlie
    9. February 2012 at 14:45

    Here’s some from Andolfatto:

    “The main point is that a crisis destroys capital, broadly defined to include relationship capital–the glue that keeps the structure of economic relationships intact and productive. Sure, a breach in this structure may lead to deflated expectations and deficient-demand-like phenomena. But do not confuse symptoms with causes. The process of reallocating resources and rebuidling relationships after a traumatic event like the recent financial crisis is likely to take some time. This would be true even if all the king’s men knew how to put Humpty Dumpty back together again.”

    Reading his stuff, I think the wealth shock is not just a shock to the capital stock, but also a “technology” shock in the language of RBC. For PSST reasons outlined above, the wealth shock is like a negative productivity shock. This drives down the return on capital and labor. The unemployment is a response by workers to consume more leisure when their wages are relatively low.

  21. Gravatar of dwb dwb
    9. February 2012 at 15:22

    also, its flawed to think of “housing demand” as exogenous. household formation is driven by the ability to find jobs (move out of your parents place, find work darnit – i hear that happens in some households). The demand for housing is endogenous. there are about 5 MM more people in the US compared to 3 years ago. gotta live someplace! The demand for rentals (along with rental prices) are up – and not because of lower potential output.

  22. Gravatar of dwb dwb
    9. February 2012 at 15:31

    …wealth shock is not just a shock to the capital stock, but also a “technology”

    what capital shock? dont confuse a reduction in you bank account with destruction of capital. no houses have been destroyed as a result of the -35% change in the nominal housing “wealth” shock (prices went down, not the Q). Well, maybe a few houses got dozed. but by and large there are about 1 million more houses today than 3 years ago (new homes @ about 350k SAAR rate for 3 years).

    what technology shock?? we are all dumber now? we all forgot how to produce things?? i just got a new smartphone. ipad and iphone sales are up in 3 years. machines used to mine coal largely still work 3 years later, as do the refineries that make the deisel. i’m not seeing it.

  23. Gravatar of CA CA
    9. February 2012 at 15:42

    “The wealth collapse in this case is completely a collapse in NGDP. The factories, houses, construction workers, etc. all still exist, but their potential output is being held back by insufficient demand–the Fed’s destroying wealth. There’s been no real destruction of capacity, other than the withering away of skills of human capital (i.e., unemployed workers).”

    Great paragraph Scott B.!

  24. Gravatar of Charlie Charlie
    9. February 2012 at 15:46

    “no houses have been destroyed as a result of the -35% change in the nominal housing “wealth” shock (prices went down, not the Q).”

    I think they would say:

    The capital stock in 2007 was some 100 houses * price of each house, call it H*P1

    Now it’s 100 houses times the price of each house in 2011, call it H*P2

    We thought the old capital stock was very large, but really it’s just that P1 was wrong. If we had used P2, the whole time then really the capital stock was always smaller than we thought it was.

    Imagine if two people just kept selling each other houses at high prices back and forth. They take a $200k home and sell it back to each other, until it costs $2 million. Now we use that price and multiply it by every home and we think the capital stock is really large. Later we realize we were using the wrong price and the homes weren’t worth that much, so the capital stock is much smaller. It’s not that homes were destroyed, but we don’t know how much a home is worth by counting the bricks. We know it buy it’s price.

    “what technology shock?? we are all dumber now?”

    It’s basically PSST reasons in RBC language. Here’s Andolfatto:

    “Hands up all of you who think that the financial crisis had a severe impact on the economy’s “structure.” What do I have in mind here? Think about the disruptions that must have occurred in the form of terminated relationships (firm/worker, creditor/debtor, supplier/retailer, etc.). Think about the disruptions created out of a growing realization that resources have been misallocated (i.e., investments that looked good ex ante, now look like a bad idea ex post)”

  25. Gravatar of Benjamin Cole Benjamin Cole
    9. February 2012 at 15:48

    Once again, Scott Sumner proves he is the best economist in the United States.

    Yes, crickey to the moon, economic output is people working, and trucks delivering goods, and corn crops and guys building buildings and what all else.

    It is not blips on some computer chip somewhere, indicative of your “savings” (unused claim on output).

    Absolutely, we should all work harder, now, and at any other time. Increasing economic output is always the answer, but especially now.

    And is the Fed “artificially” producing low rates now? Really? When the economy may be suffering from both inflation and capital gluts? Seems to me, the real “unartificial” rate of interest should be about negative four percent.

    It is hard to believe the economics “profession” is so muddled. I suspect people are dearly clinging to shibboleths and deeply ingrained partisan sentiments, and even econo-shamanism rather than facing reality.

    Milton Friedman, Ben Bernanke, John Taylor and Allan Meltzer all told Japan to print more money and monetize debt. Yeah.

    But for the USA, the monetarists say we need economic voodoo and full spectrum genuflection to gold and paper currency.

  26. Gravatar of Benjamin Cole Benjamin Cole
    9. February 2012 at 15:49

    I meant to say “when the economy is suffering from “both deflation and capital gluts.” Without the correction, I am taking a page from the Bill Gross school of straight thinking.

  27. Gravatar of Don Geddis Don Geddis
    9. February 2012 at 16:14

    Charlie, you say “really the capital stock was always smaller than we thought it was” because a house was “worth” $200K at one time, then $2M, then back to $200K. That we “know how much a home is worth by … [its] price.”

    You may not have realized it, but you basically just proved Sumner’s point. The problem, such as it is, is a nominal one. It’s the particular dollar amount used to label the house.

    The problem is not a “real” problem. It’s not a problem about whether the house exists, or can be built, or whether it functions as shelter when people try to live in it. That is actual wealth, actual capital stock, and that hasn’t changed at all.

    It is only the nominal price which is a problem. But the nominal price level is controlled by the Fed!

  28. Gravatar of Tom Cullis Tom Cullis
    9. February 2012 at 16:17

    The glaring mistake you make here

    “If you woke up one morning and found that your investment advisor had absconded with your pension, how would you react? Suppose your house burned down; how would you react? Wouldn’t it be rational to respond to a big loss in wealth by buckling down and working harder? Would you consider it a good time to take a long vacation?”

    Is ignoring the cost side of the equation, if it used to take a 40 hour work week to live your lifestyle but after an event it takes 50 hours then the cost of that lifestyle has increased. Its a pretty standard econ 101 to assume higher cost = lower consumption (absent special cases). Inverting the equation shows that our production is worth less than we previously thought so unless our value on leisure has changed as well the value of work vs leisure has tilted in leisure’s favor.

  29. Gravatar of Charlie Charlie
    9. February 2012 at 16:33

    Don,

    “You may not have realized it, but you basically just proved Sumner’s point. The problem, such as it is, is a nominal one. It’s the particular dollar amount used to label the house.”

    It’s actually not. I’m using a real price not a nominal price. There is no money in the standard RBC model, but there are prices. They are all relative prices.

    You can think of it sort of like, “we though houses were worth 10,000 hours or human labor, but we now realize they are only worth 5,000 hours of human labor.” It’s just an adjustment because our capital stock has to be normalized to some unit. We can just say we have 1000 houses, 10 office building, 50 machines… We have to multiply them by some relative prices so they are comparable. We can say that a house is worth 20 machines and an office building is worth 50 machines and measure everything in machines (rather than dollars). Then we find out later that a house was really only worth 10 machines and our capital stock measured in machines is much lower (10,000 machines lower).

  30. Gravatar of Morgan Warstler Morgan Warstler
    9. February 2012 at 16:36

    Scott,

    “Thus, our *potential* output remains the same.”

    Scott, I do not disagree, the mistake you make is assuming the output is priced properly – it isn’t.

    My plan is to provide the unemployed a Guaranteed Income (approximately $5 per hour) via Paypal and then AUCTION them in weekly bidding starting at $1 per hour ($40 per week) to their neighbors and local entrepreneurs via Ebay, and let them keep 50% of the bid…. the gvt. keeps the other half to offset.

    Mine is a perfectly feasible plan for immediately liquidating the excess capacity and doing it in a profit taking (greedy) way.

    It works EXACTLY like most proper health care solutions – it removes the “safety net” from being something the employer is responsible for.

    Don,

    How Quaint. The Fed is controlled by the hegemony. The hegemony – the A power in America is clearly those who expect to spend time in the top 80-99%.

    They have the likely voters. They have the money.

    Partnered with the B power (the top 1%), they can crush the bottom 60% (the C power)

    Partnered with the C power they can crush the B power.

    It in ONLY when the B and C power join forces that they play to a draw – the past 20 years.

    The Fed cannot do whatever it wants.

    That said, the house EXISTS, and the sooner we liquidate the inventory and let the A power buy up 6-12M super cheap houses, everything will be grand.

  31. Gravatar of marcus nunes marcus nunes
    9. February 2012 at 16:49

    Just check German and Japanese growth after the massive wealth loss they experienced by the time they lost WWII!

  32. Gravatar of Charlie Charlie
    9. February 2012 at 16:51

    Lemme just add as a side note, the end of WWII should have been a horrible time according to the PSST story or this “relationship capital” story. You had lots of young men leaving the labor force lots of ladies leaving it. You had lots of new technology, but little knowledge of what consumer goods would be in demand. Private consumption was pretty limited during the war, so people had no sense of how tastes had changed. This is a negative technology shock in these stories. Entrepreneurs should need time to figure out how to use all these resources productively.

  33. Gravatar of Mike Sax Mike Sax
    9. February 2012 at 17:04

    “If you woke up one morning and found that your investment advisor had absconded with your pension, how would you react? Suppose your house burned down; how would you react? Wouldn’t it be rational to respond to a big loss in wealth by buckling down and working harder? Would you consider it a good time to take a long vacation?”

    That all depends. If my house burned down I wouldn’t work harder, just call the insurance company. If my advisor took my money I’d take legal action. If normal channels didn’t work I’d sick a private detective on him.

    To be sure the second scenario is more problematic. Many people lost their pensions and lifetime savings in 2008. Saying they should “buckle down and work harder” seems to suggest people react with a rather passive stoicism that is not so common in real life.

    If someone is 63 and his life savings is gone, assuming he can’t get them back and fails to take legal action against pension fund managers, etc. then I don’t think he in any way ends up wealthier in the process. Maybe if he, less “works harder” than works longer he can at some point recover his life savings. Maybe in 5 or 10 years. Maybe not though.

    If he planned to retire at 65 and is now forced to work 10 years longer maybe he can recover what he lost. But even if for arguments sake we accept-the not that likely in my view-the possiblity that he is richer than he would have been if he retired, you’d have to facto in the 10 extra years of lost retirement.

    You really can’t take it with you and it helps little if you are richer if you have little time left to live.

    Overall, I think there is something to be said for the maxim “don’t work harder work smarter.”

    I like the way you seem to hold “going on vacation” in so low regard. You know the investment manager is going on vacation. He understands how to work smart-he realized working harder can give you diminishing returns.

  34. Gravatar of Justin Irving Justin Irving
    9. February 2012 at 17:05

    The output gap is clearly big. The employment cost index is suck around 1.5% y/y growth since 2009. 5 Cleveland Fed inflation expectations are around 1.4%. Headline CPI is even coming in around 0% in the last few releases. If potential output had slipped below the old trend we would see forward looking price indicators rising despite continued weak GDP growth.

    And what about the 40 billion barrels of oil under Montana and N. Dakota? 25 billion under Ohio, 4 billion under Eagle Ford in Texas? What does that do to potential growth 2 or 3 years out? These monetary goons just have a fetish for a 5% Fed Funds target.

  35. Gravatar of Steve Steve
    9. February 2012 at 17:06

    “the amount of household wealth evaporated along with the crash in house prices should likely be viewed as a “permanent” (highly persistent) negative wealth shock”

    Ugghhh! REAL wealth, or NOMINAL wealth??? This is the anti-Bastiat fallacy. Labor and capital are the same, but we are permanently poorer because the price of everything went down. Barf, barf, barf.

    P.S. Mightn’t Krugman’s ilk argue that we should come full circle by destroying capital so that the prices can go back up so that the government can hire labor to rebuild capital? Then we can combine anti-Bastiat and Bastiat to create a REAL Bullard-Krugman wealth destruction.

  36. Gravatar of Mike Sax Mike Sax
    9. February 2012 at 17:08

    Another observation on what I wrote above: I considered it only at the micro level-I don’t think a loss in wealth will boost an individual’s “growth.”

    To suggest it would at the macro level suggests the perverse incetivization where we as a whole benefit if there are a rash of investment and pension fund managers leaving with people’s money. It’s not only perverse it’s also highly dubious.

    With all the loss of wealth in people’s funds being wiped out in 2008 we should have seen gangbuster growth result. Haven’t seen it.

  37. Gravatar of Michael Mamo Michael Mamo
    9. February 2012 at 17:18

    what on earth happened to all that distinction we used to make between a substitution effect and an income effect of the change in wealth?

  38. Gravatar of Thinking about the US output gap » TVHE Thinking about the US output gap » TVHE
    9. February 2012 at 17:49

    [...] I share Scott Sumners concern about this view. It is true that a negative permanent wealth shock will in turn lead to lower [...]

  39. Gravatar of Becky Hargrove Becky Hargrove
    9. February 2012 at 18:04

    To understand what was lost, it wasn’t just about the housing value. In fact, in a sense it wasn’t about the housing at all. Some continue to argue whether or not that wealth was real or just a figment of our imagination. But the wealth was very real, very important and very necessary. Sure, housing prices going up became highly irrational. But everyone grabbed that mechanism and ran with it because it was the best tool anyone had. What, exactly was the tool needed for? The highly uncertain nature of our future, and the fact that what we would primarily need to purchase (human services) was not well aligned with our present. For the real wealth that was lost was about the financial instruments which housing created. Those financial instruments were supposed to make our futures a lot more managable than they otherwise would be. And when they failed to do the job, everyone went back to a plan that existed primarily in their minds. The alternate plans were not really discussed openly so much as they lurked behind the political and social decisions made in the fall of mortgage backed securities. Conservative? Forget government services, and let family take up the slack. Liberal? Forget growth, and let the earth rejuvinate itself. In other words, limits to growth became the stewardship link between the hippie and the conservative (Morgan this feels like that allstate commercial where the older guy tells the hippie they’re not alike!)

    But guess what. Human nature doesn’t work that way. Observe anyone chronically ill or really elderly with a strong will to live. Just try telling them they don’t need anything else or whatever. Do you really think they don’t need mental stimulation till the last day they get out of bed? We always desire to grow and move forward, we always desire momentum, until we no longer can.

  40. Gravatar of Morgan Warstler Morgan Warstler
    9. February 2012 at 18:18

    Becky all real growth comes from re-invested savings taken from productivity gains…

    if someone isn’t getting fired, if something isn’t getting cheaper, faster, better, if something old isn’t being toppled by something new.

    there is no growth.

    Growth has no limits, the future will happen, the question is how fast we get there.

    The only real gains made by humanity come from invention and innovation, everything just slows it down.

    We should never allows ourselves less invention to make everyone more comfortable today…

  41. Gravatar of ssumner ssumner
    9. February 2012 at 18:48

    Morgan, Then build something else. That’s what markets are for.

    Barry, Then do something extremely radical. (Actually, all you need is level targeting.)

    Jason, Yes, but that tells us nothing about output.

    Major Freedom, Yes, deflation is scary.

    Cthorm, Good point.

    Charlie, If he’s making an argument that output falls because people are between jobs, why does that last so long? Why aren’t other industries growing?

    And as I argued in another post, why don’t we ever see mini-recessions? After all, we see way more mini-real shocks than big real shocks.

    I’m fine with actual growth being less than measured growth, if people want to make that argument. But that doesn’t get you unemployment.

    Greg, I hope you aren’t making the same argument as him, because his argument has nothing to do with Austrian economics (at least I hope it doesn’t.) He’s saying output fell because we are poorer.

    Jeff, I agree, it starts out sounding like a Keynesian AD argument, then there’s this weird shift to less potential output. I don’t get it.

    dwb, Yes, it seems like my commenters are just as perplexed as me.

    Scott B. Exactly.

    Jason, You said;

    “My biggest problem with the way Macro people think. There is no wealth shock. There are other shocks that affect wealth.”

    Exactly; never reason from a wealth change.

    Charlie, The quote you provide from Andolfatto isn’t a wealth shock at all, in the sense of a stock market crash, it’s some sort of “real” relationship shock that I find hard to understand.

    The market is GREAT at reallocating resources. Where are the booming industries that express peoples’ desires for MORE.

    Thanks Ben,

    Tom, No, leisure is a normal good.

    Don, Thanks right.

    Marcus and Charlie, Good point about the end of WWII.

    Mike Sax, The data shows old people are working harder in this recession.

    Justin, I agree that there is an output gap.

    Michael, The evidence shows that people work less as they get richer–leisure is a normal good.

  42. Gravatar of dwb dwb
    9. February 2012 at 18:57

    there have been real incidents of pockets of capital being destroyed (in small open economies)- for example Hurricaine katrina destroyed a lot of property in late 2005. The short term effect was a bump in UE (in LA and MS) but it does not lead to a permanently higher UE. After less than a year it reverts to trend. (sure some moved, but the UE rate in surrounding states like TX did not suffer much if at all). The need to rebuild creates jobs.

    There are definite reasons I might seriously consider hysteresis attributed to labor mobility (negative equity makes it hard to move) government regulation (projects and plans are receiving a lot of new scrutiny) or skills mismatch – except the evidence does not line up with the impact and that is not what is being claimed (weath effect). The intersection of things that I can think of that might contribute to hysteresis right now, those things not fixable by monetary policy, and things which are even minimally backed up by empirical data, are very very slim and none are caused by a “weath effect.” but if its a technology shock and we are all dumber and forgot how to produce things, maybe there was an explanation, and i just forgot it.

  43. Gravatar of Major_Freedom Major_Freedom
    9. February 2012 at 19:45

    Anon1:

    “Interest rates are low across the entire yield curve. I think it has more do with the economy than with the IOR being held at 0.25%.”

    Actually interest rates are low because when the Fed increases bank reserves, it reduces the interest rates of loans of all maturities.

  44. Gravatar of Greg Ransom Greg Ransom
    9. February 2012 at 20:54

    I’m not fully certain what he is saying, but one doesn’t need to understand that much about economic goods to understand that massive systematic malinvestment can leave follks in a situation where they are poorer than they thought they were, and poorer than they would have been if they had produced goods which fit together and not goods which don’t work together.

    Output fell because the wrong production goods were being produced and inputs were flowing into the wrong production processes — when non-economic processes are halted output falls and we discover ourselves poorer than we thought we were.

    What part of the economics of that don’t you understand?

    Scott writes,

    “Greg, I hope you aren’t making the same argument as him, because his argument has nothing to do with Austrian economics (at least I hope it doesn’t.) He’s saying output fell because we are poorer.”

  45. Gravatar of Cameron Cameron
    9. February 2012 at 21:07

    The BOJ makes trying hard look so easy…

    http://www.bloomberg.com/news/2012-02-10/bank-of-japan-to-reject-more-easing-as-quake-rebuilding-supports-economy.html

    and the BOJ’s internal forecast is for 0% inflation in 2012 and 0.4-0.5% inflation in 2013:

    http://www.boj.or.jp/en/announcements/release_2012/k120124a.pdf

    As bad as Bullard and company might be, it could be worse.

  46. Gravatar of Mike Sax Mike Sax
    9. February 2012 at 21:53

    “But why would you want to produce less output just because wealth fell? That makes no sense to me.”

    “And the argument is stated in such a way that it seems like one of those “needs no explanation” points. As if the fall in wealth would obviously reduce consumption (I agree) and obviously that fall in consumption would reduce output.”

    A fall in consumption means less sales for businesses. A fall in demand means you provide less of it.

  47. Gravatar of Bill Woolsey Bill Woolsey
    9. February 2012 at 21:59

    Scott:

    Of course, you are right.

    If there is some element of truth in Bullard’s argument, he is certainly doing a poor job of explaining it.

    Why is reduced wealth leading to less consumption important?

    The obvious effect is that we consume less, save more, invest more, produce more capital goods and fewer consumer goods. We rebuild wealth and the capital stock. Total production doesn’t fall.

    Of course, it is possible that this involves lower real wages and so a smaller quantity of labor supplied. Your argument about working more rather than taking vacation would be a wealth effect on leisure. Less wealth, so less demand for leisure. It seems realistic to me.

    Rather that less wealth and less consumption, the more obvious effect is less production of houses and more produciton of other capital goods. Of course, as explained above, there might be more production of capital goods and less production of consumer goods too.

    The capital goods and labor skills relatively specific to capital goods lose some value. There is both an adjustment cost and some permanent loss. But these adjustment costs and the related permanent losses happen all the time.

    Just one final thought. Suppose real housing output were measured by deflating house prices by consumer goods prices. While the prices of the stock of houses wouldn’t impact measured real output, the higher prices of newly produced houses would raise the nominal value of that part of output and if deflated by consumer prices, the real value of that part of output would rise. But I think they are actually deflated by housing prices.

    Some of the arguments about measured output being unrealistically high are based upon reasoning where the prices of current consumer goods is the numeraire. Really, it is a sensible approach, but not the one that is actually used to measure real output.

    If nominal GDP is on a fixed growth path, and people expect that Chinese immigrants will come to the U.S. in 10 years and pay alot for houses, this will raise the value of existing houses and the new ones produced. Spending on newly produced housing rises. Spending on consumer goods and other capital goods grow more slowly. Those other goods are worth no less. Still, the signals are right. Less demand (or at least a lower growth path of demand) for these other goods and more demand for houses. Resources need to shift from producing other goods to houses.

    Well, think about it.

  48. Gravatar of Mike Sax Mike Sax
    9. February 2012 at 22:01

    ” But don’t tell me “it reduces AD, stupid,” because they are explicitly arguing that it reduces the potential level of output.”

    I admit I missed that qualifier, but in any case I think that’s the answer.

    As to potential level of output I will demur that one as I don’t even know if I agree with it or not

  49. Gravatar of Mike Sax Mike Sax
    9. February 2012 at 22:07

    Ok in any case I certainly am not with Bulliard.

  50. Gravatar of Mike Sax Mike Sax
    9. February 2012 at 22:19

    “Milton Friedman said ultra-low interest rates are a sign that money has been very tight”

    I’ve never entirely understood this claim-not saying it’s wrong necessarily… Is it because tight money depresses things which forces the Fed to drastically cut rates?

  51. Gravatar of anon anon
    10. February 2012 at 00:36

    Mike Sax, it’s because tight money drives down inflation/NGDP growth, which lowers _natural_ nominal rates through the Fisher effect. Ordinarily, we equate “easy money” with lower rates and vise versa because of changes in the convenience yield of money balances (“liquidity”), but that’s not the only effect. Setting interest rates is really an inherently unstable task, like pole balancing.

  52. Gravatar of acarraro acarraro
    10. February 2012 at 00:48

    But if you expand your argument, wouldn’t it prove that fiscal policy is effective? You can think tax as a negative wealth shock in some way. So people would work more to compensate and you’d get a multiplier. I think Nick Rowe made a related point stating that new keynes models use corvee labour to move the leisure-work equilibrium and get a multiplier that way (ignoring monetary policy offset).

    I guess the assumption Cowen and others make is that the amount of work you are willing to do is independent of your wealth. And they probably take as evidence the fact that poor people don’t work more hours than richer people (as your work-leisure trade-off would imply longer hours for poorer people which I don’t think it’s the empirical evidence).

    I am not sure there is a theoretical answer. You would really just need to do empirical studies and I doubt the results would be very stable…

  53. Gravatar of Mike Sax Mike Sax
    10. February 2012 at 01:46

    ” it’s because tight money drives down inflation/NGDP growth, which lowers _natural_ nominal rates through the Fisher effect”

    Thanks Anon. It seems to me the common idea is that inflation/NGDP lowers then the Fed thinks it better cut rates to make money easier.

    The one thing that you might think is that a lower nominal rate gives less incentive to save-at least in terms of rate of return on your account. Of course this doesn’t matter as what is sought it times like this is safety not a high return.

  54. Gravatar of Barry Barry
    10. February 2012 at 03:08

    “Barry, Then do something extremely radical. (Actually, all you need is level targeting.)”

    The sort of things needed to be done in order to achieve the required level of NGDP say in 2009 or 2008(i.e. directly wiring printed money to houses or businesses indiscriminately) would probably be declared unconstitutional or illegal, cause huge political controversy and cause a huge rally in Ron Paul style end the fed policies, it would simply not be remotely politically feasible. Not only this, but there would be a huge cost in terms of moral hazard. I haven’t seen any of your posts really address this (i.e. Greenspan put etc…) yet it is absolutely crucial.

  55. Gravatar of anon anon
    10. February 2012 at 04:34

    Barry, there is no need to wire money to households directly. Any extra money in the economy will become part of some agents’ (meaning either people or institutions) money balances. As these money balances grow, the money is exchanged away for existing goods (thus it circulates in the economy) and eventually for new goods and services as well, which raises GDP. This process always works _unless_ short-term debt (the asset which is exchanged by the Fed for newly-created money) is a perfect substitute for money, in which case the Fed just needs to buy something else. There is no shortage of options.

  56. Gravatar of bill woolsey bill woolsey
    10. February 2012 at 04:41

    Barry:

    There is no need to directly wire money to households or businesses “indiscrimately.”

    There is nothing illegal or unconstitutional about buying government bonds from households or firms and wiring the funds to them. Of course, those aren’t indiscrminate gifts, which I think is what you have in mind.

    The national debt was about 9 trillion at the time, and there was plenty more to buy.

    Base money could have been brought up to about 66% of nominal GDP without any problem. Sweden didn’t need to get even that high.

    There is nothing that requires the Fed to pay interest on reserve balances. I think assessing modest fees on reserve balances would also be legal, though that is more questionable.

    Of course, in reality, in 2008 and 2009, the Fed wanted the banks to hold reserves so that the Fed could direct lending to key credit markets. I think it is clear their goal was to rebuild the house of cards that was asset backed lending. Banks selling loans, loans bundled, asset backed securities sold to investors. This should have reversed the disruption of credit markets and maintained (or reversed the decrease) in nominal GDP.

    At the time, market monetarists were skeptical that the house of cards would be rebuilt, and we were right. Our alternative strategy would be quantitative easing to the degree needed and no interest on reserves (and maybe charges.) But most of all, a committment by the Fed to keep nominal GDP on the trend growth path.

    Monetary policy doesn’t work by the Fed giving reserves to banks and hoping they will lend them out. While giving money to households and firms and hoping they will spend them (or lend them out, I guess) would work, it isn’t necessary.

    While the Fed directly purchases securities only from primary dealers, the dealers buy the securities to sell to the Fed from households and firms, as well as banks. When the primary dealers buy from households and firms, they end up with more money (and less securities) and their banks end up with more reserves. If the primary dealers buy from (other) banks, then the banks end up with more reserves (and less securities) and no other household or firm ends up with more money. By not paying interest on reserves (or even low service fees,) the banks are motivated to buy securities rather than hold reserves. And who is left to sell? Households and nonbanking firms, who then end up with less securities and more money.

  57. Gravatar of bill woolsey bill woolsey
    10. February 2012 at 04:56

    Sax:

    Recession, expected recession, and even expected slow recovery result in high credit supply (people lend by holding securities rather than buy capital goods or consumer durables) and low credit demand (at least by credit worthy people not intersted in borrowing to buy capital goods or consumer durables. The uncredit worthy are more than willing to borrow and no one wants ot lend to them creating plenty of ancedotes about there not being enough credit.)

    Increase in supply and decrease in demand results in a lower equilibrium intereset rate.

    How does “tight money” cause a recession? People short on money reduce expenditures to build up money holdings. Those who would have sold to them respond to the lower sales by producing less and employing fewer people. While it would be possible that everyone ends up with same amount of money but just less output and income, and so are satisfied with that amount of money (due to their relative poverty,) it is also possible that some people end up with about the same income and output and more money, and other people have little or no income and output and little or no money. The real world is a mix, but the second scenario appears to dominate.

    In this state, there is a larger credit supply and lower credit demand, and so a low equilibrium interest rate.

    On the other hand, how does this situation develop? Well, under very plausible institution assumptions, money is lent into existence, and so a decrease in the quantity of money is associated with higher interest rates. Further, it is possible that if a shortage of money develops, some people will sell financial assets, leading to higher interest rates on them. This is where the “tight money” means high interest rates comes from.

    But there is the alternative story from above. It is quite possible to combine the stories for a short run/long run account where the immediate effect of a bolt from the blue restriction on money growth is higher interest rates, and then, once the economy goes into recession, interest rates drop.

    If you identify monetary policy with interest rate targeting so that interest rates are whatever the monetary authority says they are, and high ones are “tight” and low ones are “loose” then I guess all of the above can be missed.

    Oh, and if everyone always assumes that our clever interest rate targeting central bank will be successful in promptly closing output gaps and keeping inflation on target, then the recession, expected recession, or slow recovery scenarios are ruled out by assumption. Credit demand always demands on expetations of the target inflation rate and a level of output equal to potential.

  58. Gravatar of Max Max
    10. February 2012 at 05:07

    “Milton Friedman, Ben Bernanke, John Taylor and Allan Meltzer all told Japan to print more money and monetize debt. Yeah.”

    Government debt is born ‘monetized’ since it is implicitly backed by a central bank (except in the Euro zone).

    For QE to be more than a monetary placebo is has to involve buying risky assets like junk bonds and stocks.

  59. Gravatar of Mark Mark
    10. February 2012 at 05:07

    Back in the last millennium, when I did graduate macro, when we covered investment we did Q theory (marginal Q, average Q, Tobin, Hayashi, etc.). One of the canonical examples was the oil price shock of the 1970s. The increase in the price of energy reduced the value of the capital stock but everything else equal should have led to an investment boom as businesses replaced their energy-inefficient capital stock. Which is, I think, basically Scott’s example of your house burning down.

    So I agree, it’s not enough just to say “negative wealth shock” – what lies behind it has to be spelled out.

  60. Gravatar of Barry Barry
    10. February 2012 at 05:51

    Anon

    “Barry, there is no need to wire money to households directly. Any extra money in the economy will become part of some agents’ (meaning either people or institutions) money balances. As these money balances grow, the money is exchanged away for existing goods (thus it circulates in the economy) and eventually for new goods and services as well, which raises GDP.”

    This clearly isn’t happening now.

    “This process always works _unless_ short-term debt (the asset which is exchanged by the Fed for newly-created money) is a perfect substitute for money, in which case the Fed just needs to buy something else. There is no shortage of options.”

    The assets that are a near perfect substitute are such because the fed is buying them up in such a huge quantity, reducing their yield to near zero. I am with the MMTers here, despite not being an MMTer myself, but simply creating more reserves for banks simply does not mean the banks will loan this money. Banks loan money when there are people out there who can offer a credible return.

    Bill:

    “There is nothing illegal or unconstitutional about buying government bonds from households or firms and wiring the funds to them. Of course, those aren’t indiscrminate gifts, which I think is what you have in mind.”

    Even if it isn’t, everyone probably thinks it is. I’m pretty sure I recall Bernanke explicitly saying that it’s outside the functions and permits of the fed to buy from households, and that this is something the government must do. How many households even directly own government bonds anyway?

    “At the time, market monetarists were skeptical that the house of cards would be rebuilt, and we were right. Our alternative strategy would be quantitative easing to the degree needed and no interest on reserves (and maybe charges.)”

    The original QE was useful only so far as it helped to recapitalize banks and prevented further failure, but beyond that I cannot see how this would restore demand significantly because of the reasons I said to anon.

    “Monetary policy doesn’t work by the Fed giving reserves to banks and hoping they will lend them out. While giving money to households and firms and hoping they will spend them (or lend them out, I guess) would work, it isn’t necessary.”

    No, it works by lowering interest rates, usually, which requires an increase in the money stock, or by boosting asset values. Interest rates can’t really go any lower, and boosting asset values is a dangerous game, and seems to have an insignificant effect on demand for most people, it seems really only to prevent the stock market from bottoming out as more liquidity is added, but there is still the moral hazard problem.

    “While the Fed directly purchases securities only from primary dealers, the dealers buy the securities to sell to the Fed from households and firms, as well as banks.”

    Err, as far as I know, the banks are buying the t-bills to sell to the fed from the government or other banks, not from households.

    “By not paying interest on reserves (or even low service fees,) the banks are motivated to buy securities rather than hold reserves. And who is left to sell? Households and nonbanking firms, who then end up with less securities and more money.”

    There are plenty of places to buy from before buying from domestic households, e.g. foreign government debt, foreign equities, foreign exchange, emerging market equities…

  61. Gravatar of Greg Trotter Greg Trotter
    10. February 2012 at 06:01

    Looking for opinions rather than providing one:

    Do we think that inflation was under- or over-stated during the housing bubble. Would that affect our view regarding the output gap?

    Should we pay more attention to the frictional costs of re-engineering labor/capital that would reduce potential output in the near term but not in the long term? What monetary policy would you employ?

  62. Gravatar of anon anon
    10. February 2012 at 06:16

    “This clearly isn’t happening now.”

    It isn’t happening strongly enough, true. But variations in the Fed’s stance clearly have a sizeable effect on the real economy, as shown by e.g. asset market indicators: this confirms that the transmission mechanism is working. Of course removing distorting policies such as interest on reserves would also help.

  63. Gravatar of Ryan Ryan
    10. February 2012 at 06:38

    By that logic, obliterating all of society’s wealth should be one of the most powerful boosts to economic growth ever.

    But maybe I’m the one who’s missing something.

  64. Gravatar of jim jim
    10. February 2012 at 07:11

    The Fed let NGDP fall in 2009 at the sharpest rate since 1938. That’s their policy failure.

    ________________________________________________________

    By what mechanism could the Fed have prevented this?

    Personally, I think the Fed did as much as they could without revealing to everyone’s complete satisfaction that there is really not that much they can do.

  65. Gravatar of Brendan Brendan
    10. February 2012 at 07:12

    Wouldn’t Bullard’s argument- that a destruction in household wealth reduces potential GDP- apply to the 1930′s? Yet didn’t Alexander Fields’ recent book “A Great Leap Forward” convince lots of economists that potential GDP grew extremely rapidly in the 1930′s?

  66. Gravatar of StatsGuy StatsGuy
    10. February 2012 at 07:20

    @ Steve

    “Ugghhh! REAL wealth, or NOMINAL wealth???”

    Yup. That’s more or less the crux of this whole thing.

    The real question: can a large nominal negative wealth shock (all things equal) leads to a real negative wealth, and how? There are two, and possibly ONLY two mechanisms:

    1) An AD reduction – ssumner asks why NGDP targeting doesn’t fix this

    2) Distruption, which (I will argue) is due to DISTRIBUTIONAL changes in wealth not changes in OVERALL wealth. Note that if all nominal wealth (including expected future earnings capacity) drops equally why should real consumption change?

    Even if AGGREGATE demand stays the same, if the composition of demand changes rapidly due to shifts in wealth distribution, then real wealth decreases. A dramatic shift in the DISTRIBUTION of wealth translates into a dramatic shift in AGGREGATE preferences. If the country wakes up one morning and discovers that it no longer likes big houses (because all of the individuals who like big houses suddenly can’t afford them and those who can afford them don’t like them as much) the expected future value of consumption has declined at the aggregate level.

    This is an argument about heterogeneity in utility.

    This argument then propagates to structural impacts – those with the skills to build large houses find them less valuable and need to retrain (“real” wealth reduction), those with house building tools may need to repurpose them to less demanded pursuits and write down losses, etc.

    In this sense, stabilizing AD does NOT fix all of the problem – the economy must “recalculate” due to a massive change in the distribution of wealth, and massive wealth shocks NEVER HIT EQUALLY. Even if they affect all asset classes equally (which they do not), this still changes the relative distribution of wealth between asset holders and those who own future production potential (e.g. the current workforce vs. the retired workforce).

    So let me summarize:

    DISTRIBUTION

    DISTRIBUTION

    DISTRIBUTION

    The evil, evil D-word.

  67. Gravatar of StatsGuy StatsGuy
    10. February 2012 at 07:22

    A philosophical question:

    Does information change real wealth?

    Let’s say we spent a whole lot of time building technology to develop Twidgets. Everyone loves Twidgets. 30% of the economy is making Twidgets. Then suddenly someone discovers that Twidgets cause Twitterisis, a deadly and debilitating disease.

    When we learn about this horrible link, are we richer or poorer for this knowledge?

  68. Gravatar of Tom Cullis Tom Cullis
    10. February 2012 at 07:59

    @ Mr. Sumner,

    Yes Leisure is a normal good which is why it works this way. The consumption of normal goods as their marginal cost decreases and in the case of leisure the marginal cost is the marginal dollar earned by the labor given up. A decrease in the value of that dollar is the same as an increase in the value of the leisure.

  69. Gravatar of James Oswald James Oswald
    10. February 2012 at 08:31

    “If you woke up one morning and found that your investment advisor had absconded with your pension, how would you react?”

    Call the PBGC!

  70. Gravatar of bill woolsey bill woolsey
    10. February 2012 at 09:38

    Ryan:

    Sadly, the destruction of the capital stock (like in a war,) would greatly reduce output, but would almost certainly be associated with rapid growth during reconstruction. This is a reason why growth of output isn’t an absolute good. Levels are more important that growth for well being.

    Of course, the houses aren’t smaller. If they were smaller, then the housing services element of the output of consumer goods would be lower.

    The houses are just worth less, and so plans to sell them and move to a smaller house or apartment and fund retirement from the capital gain are not feasible.

    So, it is necessary to reduce consumption now and save to rebuild wealth. Or, at least, that seems sensible.

    And so, that results in lower equilibrium interest rates and more construction of capital goods, so more consumer goods can be produced in the future.

    Working more (or more years) also seems sensible. More capital goods and more labor looks like more output in the future.

    On the other hand, if it wasn’t houses, but rather other kinds of capital goods that are worth less because they don’t produce as much output as expected, then that says that output will be less than expected.

    Suppose machine tools 2.0 produce 10% more than the early version and so we produce 10% less of them and instead produce consumer goods. Then, when they are brought online, they are really no better than the old version. Output falls. The capital goods are worth less. We have to consume less and build more capital goods. Maybe working more during this adjustment period is a good idea.

  71. Gravatar of ssumner ssumner
    10. February 2012 at 09:48

    dwb, Yes, wealth itself would have little effect–see my new post.

    Greg, You said;

    “What part of the economics of that don’t you understand?”

    Which part of Bullard’s argument do you not understand? I’m not arguing against Austrian/PSST theories here. I’m addressing the wealth effect on output.

    Cameron, Yes, they’ve been doing this for almost 20 years, I don’t expect them to change.

    Mike Sax, No, a fall in consumption doesn’t mean less sales for business. It means less sales of consumer goods to domestic residents.

    In any case, he’s not making a demand side argument, he says more AD doesn’t fix the problem.

    Bill, My new post addresses some of that. Regarding work effort, real wages didn’t change much in 2009 (they might have risen) and leisure is a normal good.

    Mike Sax, I see from your later comments you agree about Bullard.

    You said;

    “Is it because tight money depresses things which forces the Fed to drastically cut rates?”

    No, a slow rate of NGDP growth directly reduces interest rates, even if (or when) the Fed didn’t exist.

    acarraro, Yes, I’ve acknowledged that argument for a positive multiplier. But it’s a weak argument, as you need to produce worthless stuff to make people work harder to boost output (because they are poorer.) Who favors that?

    Barry, It would have been far less controversial than what they actually did, as the “printing of money” would have been much less.

    Mark, Good example.

    Greg Trotter, Maybe slightly understated, but it really doesn’t matter as there is no objective way of measuring inflation. In any case we should focus on NGDP, and target NGDP. It was slightly too high in 2006, but not much.

    anon, Good point.

    Ryan, You said;

    “By that logic, obliterating all of society’s wealth should be one of the most powerful boosts to economic growth ever.”

    Yup, Mao came close to doing that, and that’s why they’ve grown at 10% a year for 33 years.

    Jim, Level targeting of NGDP. They haven’t done as much as they could. Bernanke says they have more powerful tools, such as higher inflation targets, but he says they don’t want to use them.

    Brendan, Good point.

    Statsguy, You said;

    “This argument then propagates to structural impacts – those with the skills to build large houses find them less valuable and need to retrain (“real” wealth reduction), those with house building tools may need to repurpose them to less demanded pursuits and write down losses, etc.”

    Sure, something like this COULD happen in theory. But it doesn’t happen and certainly didn’t happen in 2009. Which industries were booming in 2009? What were the products people wanted more of when they decided they wanted less houses?

    My new post addresses this issue.

    Tom, I don’t follow your comment. Normal refers to income elasticity.

    James. Good point!

  72. Gravatar of Barry Barry
    10. February 2012 at 11:28

    “Barry, It would have been far less controversial than what they actually did, as the “printing of money” would have been much less.”

    I highly doubt that, it’s quite easy to justify why QE isn’t inflationary (i.e. enters bank reserves, IOR regime etc…), and QE seems too technical and abstract for many laymen, it won’t invoke images of Weimar necessarily. Can you honestly claim that directly printing money and giving it to households and firms on the other hand, completely bypassing the banking system, wouldn’t be extremely controversial? Surely you’re not that naive of the political climate.

  73. Gravatar of CA CA
    10. February 2012 at 12:43

    I believe they have in mind the hysteresis theory of unemployment (Blanchard and Summers, 1986).

  74. Gravatar of ssumner ssumner
    11. February 2012 at 06:41

    Barry, I’m not advocating that, I’m calling for NGDP targeting.

    CA, I’m not a fan of that theory.

  75. Gravatar of Barry Barry
    11. February 2012 at 10:32

    Scott:

    “Barry, I’m not advocating that, I’m calling for NGDP targeting.”

    Same thing, it’s the only way to meet the target that you are trying to reach, that or being able to credibly threaten to do such. The only thing the fed can credibly threaten is QE, which would never, ever have been sufficient to restore demand back to trend in 2008 or 2009.

  76. Gravatar of Jason Odegaard Jason Odegaard
    11. February 2012 at 14:12

    Scott – Krugman has a post up referencing this, and he comes to the same general conclusion as you:

    http://krugman.blogs.nytimes.com/2012/02/11/bubbles-and-economic-potential/

  77. Gravatar of Greg Ransom Greg Ransom
    11. February 2012 at 14:28

    Krugman writes, “the capital stock .. is in principle measured in physical terms.”

    Is this the punch line to a Stupid Blonde Joke? It is part of a piece posted at The Onion?

    Please explain to me how anyone takes Krugman seriously.

    When know that Krugman knows the economic literature less well than my 6 year old.

    But seriously.

  78. Gravatar of Greg Ransom Greg Ransom
    11. February 2012 at 14:34

    When solar energy factories are striped bare, when hundreds of miles of lumber rail cars are left in mothballs, when nearly completed houses are bulldozed, when massive condo projects in Florida and Nevada are left uncompleted or as empty ghost towns, Krugman’s argument is that there is no downturn in “output”. How moronic are the “economic” categories of the macroeconomists anyway. This is beyond a parody of Hayek’s claim that macroeconomic thinking is a non-scientific perversion of the economic way of thinking.

    Krugman writes, “Capital gains are not counted in GDP. The direct effect of a bursting bubble on measured output is zero. Nor, by the way, is a fall in asset prices counted as a decline in the capital stock, which is in principle measured in physical terms.”

  79. Gravatar of RN RN
    11. February 2012 at 15:52

    Greg Ransom wrote:

    “When solar energy factories are striped bare, when hundreds of miles of lumber rail cars are left in mothballs, when nearly completed houses are bulldozed, when massive condo projects in Florida and Nevada are left uncompleted or as empty ghost towns, Krugman’s argument is that there is no downturn in “output”.”

    Wow, you’re truly colossally clueless, aren’t you? Krugman in no way says this.

  80. Gravatar of Greg Ransom Greg Ransom
    11. February 2012 at 19:51

    RN — what the hell is he saying?

  81. Gravatar of Greg Ransom Greg Ransom
    11. February 2012 at 19:52

    “the capital stock .. is in principle measured in physical terms.” — Paul Krugman

    Can some one explain to mean what this could possibly mean?

    That is, please explain what possible economic meaning these words could possibly have.

  82. Gravatar of Jason Odegaard Jason Odegaard
    12. February 2012 at 06:58

    Greg Ransom,

    Capital stock is what can contribute to past GDP, but is not counted as part of present GDP.

    Example: I have a tractor worth $200,000. The year it is produced it counts as $200,000 to GDP.

    In subsequent years, it is not counted as GDP. But it is capital stock – can use it for years or even decades to pull equipment in the field.

    But how do we measure that capital stock – goods produced in past GDP. One way is dollar value. But if next year I try to sell my tractor, and the best offer I get is $20,000, that doesn’t mean 90% of the capital stock in that tractor was eliminated. Maybe nobody could get financing for a loan. But that tractor can still pull equipment and be used to farm just as well as the year previous. The *physical terms* of the tractor means it is still valuable as capital stock. It’s just temporary factors are preventing market value to represent it.

    But the physical capacity is still there. That is what Krugman means, and he is correct.

  83. Gravatar of Tom Grey Tom Grey
    12. February 2012 at 07:59

    Scott, did you see “your” line on the econ blogosphere?
    We get it, NGDP targeting.

    It would be good for you to re-iterate your support for QE 3, or some other Fed policy (or policies) that you want used to support the NGDP target.

    Bullard is calling for an explicit 2% inflation target, which seems like a step in the NGDP target direction.

    He’s also claiming that there was a bubble thru excess house construction — which means the “trend” from 2002-2006/2008 was a bubble trend. Excess bubble goods were produced from unsustainable mal-investment. Bullard doesn’t mention the huge malinvestment in the Financial Products of MBS, and CDS & CDO for those MBS.

    But the point is that current, sustainable development would not go back to the bubble trend. He weakly says the current slow growth is pretty good; he mentions that headline inflation is over 2% … implying he thinks there’s too much, rather than too little, inflation. Which I’m sure you disagree with
    because
    2% inflation is not an NGDP target, and there’s too little NGDP.

    I also think it’s better to have more inflation and genuinely looser money until unemployment comes down further. But Bullard makes a strong case that the economy doesn’t know what the future booming industries will be, similar to your lament {Which industries were booming in 2009?}. Who doesn’t know, but needs to find out, are primarily the few million entrepreneurs willing to risk their own money/time in uncertain new endeavors, whether (soon to fail?) solar panels, or moon/mars travel, or deep sea treasure recovery (best in the Baltic sea?).

    I think Bullard is mostly correct, and it’s wrong to presume that any policy, including NGDP targeting, could create a new, sustainable trend that seems as good as the previously unsustainable bubble trend.
    Your disagreement with Bullard seems to claiming that the previous bubble trend “bubble” was not so serious {It was slightly too high in 2006, but not much.}

    I consider this blithe dismissal of massive mal-investment to be close to pandering to those who want some government “magic bullet” to solve the huge PSST problems. (Just as I consider most Keynesian proponents to pander to the gov’t politician’s desire to “do something”. )

    {Yes, by all means let’s have higher rates, but as a result of an expansionary monetary policy that boosts NGDP growth, wealth, consumption, and RGDP.}
    Again you repeat the boost NGDP mantra, without specifying actual Fed policies. When specifically counter to the usual policy of lower rates for more growth, you should feel an obligation to specify the actions you want the Fed to take to express that expansionary monetary policy.

  84. Gravatar of anon anon
    12. February 2012 at 08:21

    Tom Grey, re: the “higher rates” comment, Scott is arguing that we need to raise _natural_ nominal rates by increasing NGDP growth. This is a response to Bullard and Bill Gross, who pointed to the costs of a low-rates environment. He’s not arguing for a higher Fed funds target or anything like that.

    ISTM that Scott would support some form of ‘inflation’ targeting as a compromise policy, as long as it was properly implemented through either price-path targeting or inflation-forecast targeting. These policies would tighten the monetary stance in response to a slowdown in underlying RGDP growth, which is what you seem to be arguing for here.

  85. Gravatar of Jason Odegaard Jason Odegaard
    12. February 2012 at 08:52

    Correction to my comment above: I should have said “Capital stock is what DID COUNT to past GDP, but is not counted as part of present GDP.”

    I was thinking about how capital stock catalyzes greater future GDP.

  86. Gravatar of ssumner ssumner
    12. February 2012 at 09:00

    Barry, You have your reasoning process backward. When expectedNGDP is growing nicely, there is little growth in demand for non-interest bearing base money.

    Jason, Thanks for the link.

    Greg, You need to focus on his farmland example, which shows that the dollar value of farmland is not a good measure of its productive potential. He’s criticizing Bullard for implying it is. Malinvestment may matter a little, wealth doesn’t. Wealth can fall w/o malinvestment. On October 19, 1987 stock wealth fell 22%, was there a lot of malinvestment that day?

    Tom Grey, You said;

    “Bullard is calling for an explicit 2% inflation target, which seems like a step in the NGDP target direction.”

    That’s pretty much what they have now, so I don’t see it as a step in the right direction. At a minimum you need level targeting of prices not growth rate.

    Thanks, I did see that comment on my blog.

    You said;

    “I consider this blithe dismissal of massive mal-investment to be close to pandering to those who want some government “magic bullet” to solve the huge PSST problems.”

    Nobody’s dismissing malinvestment, but that’s a microeconomic problem. We were producing too much housing and too little of other goods, now we need to produce less housing and more other goods. Instead, in 2009 we started producing less of almost everything.

    BTW, I’ve explicitly described how the Fed should boost NGDP growth about a million times, have you not been paying attention?

    anon, I definitely do not support inflation targeting. Even price level targeting is highly flawed, although at least it has the virtue of taking fiscal stimulus off the table. So it would be better than current policy.

  87. Gravatar of Greg Ransom Greg Ransom
    12. February 2012 at 09:25

    Anyone who knows the slightest capital theory knows that you can’t measure the capital stock in physical terms ..

    Krugman writes,

    “Capital gains are not counted in GDP. The direct effect of a bursting bubble on measured output is zero. Nor, by the way, is a fall in asset prices counted as a decline in the capital stock, which is in principle measured in physical terms.”

  88. Gravatar of Greg Ransom Greg Ransom
    12. February 2012 at 10:24

    From the economic point of view the stupidity is built into the “explanatory” machinary of post-Keynes vulgar macro – Krugman is only stupid for being unable to see the economic point of view incompetence built into vulgar macro — it’s a paradigm clash and Krugman can see how he is trapped within a deep dark pathological explanatory sink sink hole.

    The pretense since Keynes is that production goods / “idle resources” have a fixed and give economic production output irrespective of the coordinated structure of production across time, geography, functional structure, etc (Peter Boettke, Ludwig lachmann and Roger Garrison write helpfully on this).

    GDP stats are famous for being pathologic measures — and they evidently are so pahological as blinders for “understanding” the coordination of the production exonomy that they can lead someone as “smart” as Krugman to be blind to a core part of what is happened when discoordination & reveals itself.

    This is inherently a throwback to classical/non-economic thinking.

    It’s at the core of what folks like Garrison are saying when he says here is no production goods exonomics in vulgar macro.

  89. Gravatar of Greg Ransom Greg Ransom
    12. February 2012 at 10:39

    This is the great fallacy of non-economic thinking put into the heart of vulgar macro by Keynes isn’t it.

    The hundreds of miles of mothballed lumber hauling rail cars had a “given” value output dependent on a structure of production which will never exist again.

    What part of the exonomics of this are the Keynesian brain dead to perceiving. That is the 2 trillion dollar question.

    “But how do we measure that capital stock – goods produced in past GDP. One way is dollar value. But if next year I try to sell my tractor, and the best offer I get is $20,000, that doesn’t mean 90% of the capital stock in that tractor was eliminated. Maybe nobody could get financing for a loan. But that tractor can still pull equipment and be used to farm just as well as the year previous. The *physical terms* of the tractor means it is still valuable as capital stock. It’s just temporary factors are preventing market value to represent it.”

  90. Gravatar of Barry Barry
    12. February 2012 at 12:57

    @Scott

    “Barry, You have your reasoning process backward. When expectedNGDP is growing nicely, there is little growth in demand for non-interest bearing base money.”

    So? What’s your point?

  91. Gravatar of ssumner ssumner
    13. February 2012 at 06:56

    Greg, The housing crash didn’t cause the recession, it was way to small. US business is very good at quickly re-allocating capital after a real shock. Remember the post-WWII boom?

    Barry, My point is that the Fed didn’t need to dramatically increase the base, just accommodate whatever base money is demanded when NGDP is expected to grow on target.

  92. Gravatar of Jason Odegaard Jason Odegaard
    13. February 2012 at 08:25

    Hi Greg Ransom,

    You seem to assume that lumber rail cars can never be moved and re-purposed for transportation in a different portion of the country. Have you ever seen rail cars hauling other rail cars? I have.

    Solar energy factories can be striped bare… and used for some other purpose! Sounds like capital is being utilized!

    Housing stock that was over-built but *completed* isn’t being bulldozed – and it still has value for sheltering human beings. The physical value remains.

    You seem to assume that capital goods can never be re-purposed. They are.

    Also, you quote my example about a tractor, but do you agree with that or disagree? It seems you disagree, but I’m not sure where.

  93. Gravatar of BullseyeMicrocaps.com » James Bullard, It’s Worse Than You Think BullseyeMicrocaps.com » James Bullard, It’s Worse Than You Think
    13. February 2012 at 08:53

    [...] James Bullard’s recent speech, inflation targeting in the USA. Critical reactions came from Scott Sumner, Noah Smith, Mark Thoma, and Paul Krugman. I think so far the only real support for Bullard comes [...]

  94. Gravatar of Bubbles and economic potential and potential gdp — Marginal Revolution Bubbles and economic potential and potential gdp — Marginal Revolution
    13. February 2012 at 10:35

    [...] is a Krugman post on the question, here are earlier posts from Sumner and Yglesias.  I will put my remarks under the fold…This topic is easiest to understand if [...]

  95. Gravatar of Barry Barry
    13. February 2012 at 11:11

    “Barry, My point is that the Fed didn’t need to dramatically increase the base, just accommodate whatever base money is demanded when NGDP is expected to grow on target.”

    We’re going in circles. Why would NGDP be expected to grow on target in 2008 or 2009 after a financial crisis of this magnitude. You need more than “because the fed makes it its target” because you’re assuming away the possibility that the fed fails to reach its own target.

  96. Gravatar of Ben Wolf Ben Wolf
    13. February 2012 at 11:15

    “In order to hold the overnight interest at 0-0.25%, the Fed has to increase reserves. If they don’t, then the overnight rate will increase above target.”

    Government spending adds to bank reserves because government spends by sending reserves to recipient’s banks. Spend drives interest rates DOWN which is the great irony: if the Fed wants zero interest rates, all it has to do is nothing.

  97. Gravatar of Barry Barry
    13. February 2012 at 11:46

    Ben Wolf, government spending has to be either financed by borrowing, which puts upwards pressure on interest rates, or printing more money, which puts downwards pressure. If increased government spending results in lower interest rates, that’s because there was a net increase in the government base to finance it which then went into bank reserves.

  98. Gravatar of Barry Barry
    13. February 2012 at 11:47

    correction: net increase in the monetary base*

  99. Gravatar of Major_Freedom Major_Freedom
    13. February 2012 at 21:01

    Ben Wolf:

    Government spending adds to bank reserves because government spends by sending reserves to recipient’s banks. Spend drives interest rates DOWN which is the great irony: if the Fed wants zero interest rates, all it has to do is nothing.

    Government spending doesn’t take place in a vacuum. They have to borrow or tax, which decreases the balances of the private sector and thus reduces bank reserves.

  100. Gravatar of ssumner ssumner
    14. February 2012 at 17:27

    Barry, You said;

    “Why would NGDP be expected to grow on target in 2008 or 2009 after a financial crisis of this magnitude.”

    Of what magnitude? Do think we would have had a huge financial crisis if the Fed had been doing level targeting of NGDP?

    In any case, if the Fed is as incompetent as you say, let the market do the work, and peg the price of NGDP futures at the policy goal (plus 5% growth.)

  101. Gravatar of Greg Ransom Greg Ransom
    15. February 2012 at 10:54

    REMINDER — houses are only one node in the structure of relative prices and the structure of ever changing time and heterogeneity structure of production.

    I’ve never made this claim, but this is the 4 or 5 time you’ve suggested as much.

    Scott writes,

    “Greg, The housing crash didn’t cause the recession, it was way to small.”

    #TuringTestFAIL

  102. Gravatar of Greg Ransom Greg Ransom
    15. February 2012 at 10:56

    Jason, so this is why companies have hundreds of miles of them mothballed …

    “You seem to assume that lumber rail cars can never be moved and re-purposed for transportation in a different portion of the country. Have you ever seen rail cars hauling other rail cars? I have.”

    I’ve got pictures of mile after mile of mothballed lumber hauling cars.

    Use google and my name and you will find a few of them.

  103. Gravatar of Greg Ransom Greg Ransom
    15. February 2012 at 10:58

    Jason, thousands of houses and condos have been bulldozed or have been left rotting.

    Jason writes,

    “Housing stock that was over-built but *completed* isn’t being bulldozed – and it still has value for sheltering human beings. The physical value remains.”

    I’m talking to you about fact on the ground — are are giving me hypotheticals which are contrary to fact, i.e. contrary to the reality of the actual world you can see if you take the time to look.

  104. Gravatar of Greg Ransom Greg Ransom
    15. February 2012 at 11:07

    Scott writes,

    “Greg, The housing crash didn’t cause the recession, it was way to small.”

    Scott, I’ve seen repeatedly houses are a part of a much bigger picture — it’s a debate tactic to recast an explanatory picture into a false and less plausible thing than it actually is.

    I’ve said that that the expansion and contraction of various kinds of near monies and substitute monies and reserves is a significant aspect of what took place — but of course housing mortgage securities and house asset values played a central role in all of this. (But you haven’t shown any familiarity with the literature of this and you don’t want to talk about it. Have you read any book on the topic? I can’t remember you mentioning even one.)

    See again the Credit Suisse economists on the significance of the changing size and liquidity of near money assets/reserves, i.e. the massive expansion and contraction of “shadow money”:

    http://hayekcenter.org/?p=2954

  105. Gravatar of Greg Ransom Greg Ransom
    15. February 2012 at 11:08

    “I’ve said”

    sorry. I’ve got bad eyes.

  106. Gravatar of Greg Ransom Greg Ransom
    15. February 2012 at 11:47

    This example doesn’t engage the meat and core of the argument — massive expansion and contraction o various inter-related kinds of monies and assets — interrelated with massive disequilibrium in the time structure of production intertwined with labor and wages.

    Scott wrote,

    “US business is very good at quickly re-allocating capital after a real shock. Remember the post-WWII boom?”

    If the time structure wasn’t massively out of whack and if prices abs labor and capital markets were being freed up, there is no reason to imagine deep production time incompatibilities and near money yo-yos were part of the picture — I.e, the truly difficult and intractable kind of “shocks” that lie outside of what you were taught to be able to think or imagine within the math you took to be “economics” in grad school.

  107. Gravatar of Greg Ransom Greg Ransom
    15. February 2012 at 11:57

    Scott. remind me of your story explaining what happened with money, asset prices, securities, NGDP, etc.

    Is it anything other than: after 2008 the Fed crashed the non-reserve money supply doing x, y and z. (and what are x,y & z? interest on reserves. .. what else?)

    I doubt I’m the only one who needs reminding of your causal account and the theory behind it.

  108. Gravatar of Barry Barry
    16. February 2012 at 07:48

    @Scott

    “Of what magnitude? Do think we would have had a huge financial crisis if the Fed had been doing level targeting of NGDP?”

    Financial crisis? Yes, the balance sheets of many of the large banks and their exposure to the housing bubble made them effectively bankrupt no matter how fast the money supply or NGDP grows. Recession? Yes, because nobody would believe the target would be attainable with the policy tools the fed can feasibly use.

    “In any case, if the Fed is as incompetent as you say, let the market do the work, and peg the price of NGDP futures at the policy goal (plus 5% growth.)”

    It’s not incompetence per se, just inability. And try running your NGDP futures scheme policy through congress.

  109. Gravatar of ssumner ssumner
    16. February 2012 at 11:42

    Greg, Near monies and houses are very different things. One is a financial asset and one is a real asset. I don’t see how you are grouping them together.

    Bulldozing a few thousand houses is nothing in a country of 300 million people. Anecdotes don’t make for good macro arguments.

    Barry, You said;

    “Financial crisis? Yes, the balance sheets of many of the large banks and their exposure to the housing bubble made them effectively bankrupt no matter how fast the money supply or NGDP grows.”

    The facts suggest otherwise. The balance sheets became far worse when NGDP started falling rapidly, even though the subprime bust was already fully priced in before the NGDP crash.

    With level targeting they can prevent an NGDP crash.

    Try running another fiscal stimulus through Congress.

  110. Gravatar of Barry Barry
    16. February 2012 at 12:00

    @Scott

    “The facts suggest otherwise. The balance sheets became far worse when NGDP started falling rapidly, even though the subprime bust was already fully priced in before the NGDP crash.”

    They had huge exposure to assets (CDOs, other mortgage backed securities, credit default swaps etc…) that were only valuable because of the housing bubble which was invariant to NGDP (seriously, run a regression with house prices, building costs, population growth and gdp etc…, fundamentals absolutely do not explain the sudden sharp rise in house price). As far as I can tell, the crisis happened because either banks were exposed directly to the bubble, or exposed to other banks and institutions were themselves exposed to the bubble.

  111. Gravatar of ssumner ssumner
    18. February 2012 at 06:28

    Barry, Yes, banks lost money when the housing bubble crashed in 2007. But they lost far more money in late 2008 and early 2009 when NGDP lunged. A large proportion of US bank failures were caused by commercial loans.

  112. Gravatar of Output gaps, inflation and totally awesome blogosphere debates « John Barrdear Output gaps, inflation and totally awesome blogosphere debates « John Barrdear
    18. February 2012 at 09:27

    [...] Scott Sumner, Noah Smith, Paul Krugman, Matt Yglesias, Mark Thoma and Tim Duy (apologies if I missed anyone) all disagreed with it for largely the same reason:  A bubble is a price movement and prices don’t affect potential output, if for no other reason then because potential output is defined as the output that would occur if prices didn’t matter. [...]

  113. Gravatar of When Models Trump Common Sense | Iacono Research When Models Trump Common Sense | Iacono Research
    28. February 2012 at 02:26

    [...] Bullard chucks the Solow growth model!- Noahpinion Bubbles and Economic Potential – Krugman A loss in wealth should boost economic growth – The Money Illusion The trend is your friend (until it ends) – MacroManiac It’s [...]

  114. Gravatar of Jason Odegaard Jason Odegaard
    20. March 2012 at 06:03

    Man, I should pay attention to blog post for longer, I missed the replied. I decided to go back looking through past entries, and saw some more replies.

    Greg,

    I just wanted to mention that I’m talking about facts on the ground as well. When I look around Port Saint Lucie, Florida, I see there are housing developments that are only partially occupied. For sale signs sit outside. I have family that lives in a home there, and with neighboring houses empty. However, they have not been bulldozed. Those homes are still being kept up by the builder in the hopes to sell them. Somebody even keeps coming over to mow the lawn and keep it well-kept.

    The homes are empty, and unemployment is high in Florida to be sure. But the physical value of that capital remains, i.e., the ability to house humans.

  115. Gravatar of Prince(ton) Charming is looking for a Potential GDP fight « J.uris D.ebtor Prince(ton) Charming is looking for a Potential GDP fight « J.uris D.ebtor
    23. January 2013 at 19:47

    [...] Cowen responded, then Scott Sumner, Noah Smith and Mark Thoma, and then Krugman jumped in, which caused Andolfatto to respond, [...]

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