Aggregate demand and regional demand shocks

Here’s Jordan Weissmann:

The blue line traces the consumer-spending trend in states where home prices fell the least, while the red line traces it in states where they fell the most. Each group contains about 20 percent of the U.S. population. And as you can see, the crash states are still well behind.  .  .  .

Sufi and Mian have made the academic case that spending before the recession really was driven by the “wealth effect” of rising home prices. People saw their housing values rocket up, and felt richer. Often, they took out second mortgages to spend. When the market crashed, so too did their finances. It may sound like an intuitive point to some, but it’s a key part of understanding why the recovery has been so underwhelming. The difference between states that got the full brunt of the housing collapse and states that didn’t, as shown in this chart, suggests that its scars are still very much with us. And they probably will be for a long while.  (emphasis added)

It’s important to distinguish between regional shocks and aggregate shocks.  All parts of the US use the same type of money, and hence all are affected by the same monetary shocks.  On the other hand the relative performance of various regions is dependent on all sorts of real variables. The factors that cause some regions to do worse than other regions play absolutely no role in the slow growth in aggregate demand since 2008, which is 100% a monetary policy failure.

The following analogy might be helpful.  Imagine a lake where the water level is controlled by the operators of a dam.  Also assume that the surface of the lake is very choppy, due to high winds.  The factors that explain the peaks and troughs of each wave have nothing to do with the factors that explain the average level of water in the lake.  In the same way, Federal Reserve policy determines the rate at which NGDP rises in the typical state, whereas local real factors explain why NGDP grows faster in some states than others.


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40 Responses to “Aggregate demand and regional demand shocks”

  1. Gravatar of Joe Joe
    17. April 2014 at 17:47

    Scot

    Why is v falling?

    http://research.stlouisfed.org/fred2/series/M2V

  2. Gravatar of Lorenzo from Oz Lorenzo from Oz
    17. April 2014 at 18:22

    Writing money out of the story is just such a fascinating, recurring theme. It is a big reason why the Great Recession debates are such a “rinse and repeat” of the Great Depression debates. Jean-Baptiste Say’s notion of money as a transparent medium through which we see the “real” economy seems endlessly attractive. That transaction utility is a “real” utility never seems to take, not all the way down. Even though we are immersed in transactions that would not take place without money.

    Haven’t read Amir Sufi & Atif Mian, but they seem like Richad Koo and Stephen Keen–they may be influenced by Irving Fisher’s Debt-Deflation theory of Depression, but they see just the debt, not the deflation.

  3. Gravatar of The Market Fiscalist The Market Fiscalist
    17. April 2014 at 19:12

    ‘Sufi and Mian have made the academic case that spending before the recession really was driven by the “wealth effect” of rising home prices.’

    One could make a convincing case that following the dotcom bust AD (left to its devises) would have fallen. Monetary policy was used to prevent it falling. It succeeded (for a while) even under an inflation targeting regime and NGDP stayed on a steady growth path. It succeeded (as Sufi and Mian suggest) partially because the increase in the money supply drove up asset prices and caused people to spend more due to the “wealth effect”. Eventually however a crash in asset prices (houses and stock) contributed significantly to a fall in AD that drove the recession.

    If instead of increasing the money supply via asset purchases fiscal policy (income tax cuts , sales subsidies etc) had been used to stabilize AD (post dotcom crash) would the recession have been milder since the “wealth effect” would have contributed less to the recovery from the recession of the early 2000’s ?

  4. Gravatar of Kevin Erdmann Kevin Erdmann
    17. April 2014 at 19:49

    I would add that the wealth effect is in effect regardless of one’s interpretation of events. This regional effect would be a result of the bust regardless of one’s theory of whether previous home prices were too high or not, so I don’t see how this has any bearing on Mian & Sufi’s hypothesis that the previous economy was the result of debt fueled overconsumption.

    Their post here:
    http://houseofdebt.org/2014/03/07/is-rising-housing-wealth-great-news-for-spending.html
    that says rising home prices are not helping the economy because the new home purchases are by investors instead of owner/occupiers could also explain why the subsequent regional economic growth is divergent, since losses would be local while subsequent gains could be spread outside the region. But, again, on a national level, I don’t see how having “investors” pocket gains as opposed to homeowners prevents those gains from percolating through the economy as new demand.

    I’m not an economist. This notion that economic gains to families or lower income households lead to spending while gains to “investors” or high income households leads to saving, and thus, the former is better for the economy than the latter – is this a universally accepted notion? It carries so much water for so many arguments, and it’s usually presented as an uncontroversial truth. But, it seems weak to me, like a cast-off of old Keynesianism. Am I out of the loop on this one?

  5. Gravatar of Kevin Erdmann Kevin Erdmann
    17. April 2014 at 19:56

    And, even accepting this idea that owner-occupiers would spend more and that this would benefit demand, homeowners tend to keep around a 50% debt/equity ratio. Wouldn’t we expect institutional investors to leverage their real estate holdings by more than that, thereby leading to more credit creation from the gain in current home prices?

    Individual home owners average 50% equity, but that is highly variable, and each homeowner would hold undiversified risk of their single home. An institution with thousands of homes and independent funding surely is going to leverage these properties at a much higher level.

  6. Gravatar of Major_Freedom Major_Freedom
    17. April 2014 at 20:49

    “It’s important to distinguish between regional shocks and aggregate shocks. All parts of the US use the same type of money, and hence all are affected by the same monetary shocks. On the other hand the relative performance of various regions is dependent on all sorts of real variables.”

    Monetary shocks themselves affect different regions and industries differently. The mere fact that all US regions use the same money, does not imply that monetary shocks affect them all equally.

    Don’t confuse relative differences between industries and regions as being solely a function of real variables.

  7. Gravatar of Major_Freedom Major_Freedom
    17. April 2014 at 20:53

    In other words, monetary injections are by their nature asymmetrical. It is not entitely the real factors state to state and industry to industry that explain real differences. To a large degree, real differences are caused by monetary changes.

  8. Gravatar of benjamin cole benjamin cole
    17. April 2014 at 22:35

    Might be a role for fiscal policy…spend in the weaker states and zip codes…but mostly the Fed needs to crank up the presses

  9. Gravatar of Johannes Fritz Johannes Fritz
    17. April 2014 at 22:44

    But can the water become too choppy? What I am looking for is a MM view on Optimum Currency Area theory.
    Isn’t the major difference that it is conceivable for the euro zone to dissolve while for the US/China/India it is not?

    I am not denying

  10. Gravatar of Johannes Fritz Johannes Fritz
    17. April 2014 at 22:49

    But can the water become too choppy? What I am looking for is a MM view on Optimum Currency Area theory. Thanks for any hints.

    Isn’t the major difference that it is conceivable for the euro zone to dissolve while for the US/China/India it is not?
    I am not denying that it is tougher to adjust when you don’t control your own currency. I am just missing the reason why that makes break up inevitable. Or why introducing a common fiscal sector should change anything besides making leaving more costs, and thus less conceivable for some.

  11. Gravatar of Luis Pedro Coelho Luis Pedro Coelho
    18. April 2014 at 01:55

    The real question of that chart is the implied causality. States where things are not well will have depressed house prices and depressed spending, why imply causality?

  12. Gravatar of ssumner ssumner
    18. April 2014 at 05:16

    Joe, I’m not sure, but V tends to be correlated with interest rates.

    Lorenzo, Good point.

    Market fiscalist, As I recall, fiscal stimulus was used after the dotcom crash. Excessively in my view.

    Kevin, You said;

    I’m not an economist. This notion that economic gains to families or lower income households lead to spending while gains to “investors” or high income households leads to saving, and thus, the former is better for the economy than the latter – is this a universally accepted notion? It carries so much water for so many arguments, and it’s usually presented as an uncontroversial truth. But, it seems weak to me, like a cast-off of old Keynesianism. Am I out of the loop on this one?”

    The problem isn’t you, it’s economists. Ideas like the ones you mention here were once considered nutty–now they are taken seriously by economists.

    Johannes, I agree that breakup of the eurozone is not inevitable, although clearly in retrospect the eurozone was a mistake.

    And I agree that a common fiscal policy is a bad idea.

    Luis, Exactly.

  13. Gravatar of anon anon
    18. April 2014 at 06:02

    Professor Sumner, your point about aggregate shocks is a good one. The Mian and Sufi blog post references a Zhou and Carroll paper http://www.econ2.jhu.edu/people/ccarroll/papers/zcWandCdynByState/ Figure 9 shows us how misleading the Mian & Sufi normalization in 2006 is and Figure 10 argues that the decline in housing wealth is not enough to explain the declines in consumption in the recession. The micro / regional analyses offer some very useful sources of identifying variation but they miss some of the macro shocks that are central to business cycles. You said that well.

  14. Gravatar of W. Peden W. Peden
    18. April 2014 at 06:04

    Two other factors affecting the velocity of M2-

    1. A high demand for liquid assets in the wake of severe financial instability.

    2. I’m not too sure about the US, but in the UK a lot of the falling in the velocity of M4 was due to the collapse of the interbank lending market and the movement of a lot of financial activities into short-term deposits. For this reason, insofar as there has been any focus on broad money in the UK recently, it’s been almost entirely on non-financial M4.

    Unlike in the Eurozone and the UK, the US doesn’t publish sectoral analyses of their monetary aggregates, but this series-

    http://research.stlouisfed.org/fred2/graph/?g=xJU

    – would suggest that a similar thing happened in the US as well. Incidentally, note how the financial sector’s money holdings have sent misleading messages at almost every moment of US momentary history: based on that chart, you’d think that the early 1980s were a very inflationary period, that the early 1990s saw a depression, and that 2008 was the beginning of a period of extremely high inflation. And why would the financial sector’s money holdings be associated with spending on final goods?

  15. Gravatar of TravisV TravisV
    18. April 2014 at 07:16

    Unbelievable!

    Japan inflation > U.S. inflation > China inflation

    “Yuan Depreciation Is Deeper Than You Think”

    http://blogs.wsj.com/chinarealtime/2014/04/18/yuan-depreciation-is-deeper-than-you-think

  16. Gravatar of TravisV TravisV
    18. April 2014 at 07:18

    Prof. Sumner,

    In light of the recent CPI report, is Eddy Elfenbein right or wrong to forecast that “it’s very likely that inflation will creep up to the Fed’s target zone.”?

    http://www.crossingwallstreet.com/archives/2014/04/crossing-wall-street-april-18-2014.html

  17. Gravatar of TravisV TravisV
    18. April 2014 at 07:25

    Morgan Warstler,

    I’ve got a theory: if you’re a Republican, you should be rooting for easy money right now because it makes tight money more likely in the 12 months prior to the 2016 election.

    Think about Obama’s four years. Money was tight during the first three years, which motivated Bernanke to ease in 2012. So Republicans should be rooting for the opposite right now, right?

  18. Gravatar of Kevin Erdmann Kevin Erdmann
    18. April 2014 at 07:56

    Scott,
    Is there at least some sort of new literature justifying the resurgence of the idea, or is it just a politically convenient assertion?

  19. Gravatar of TravisV TravisV
    18. April 2014 at 08:30

    Brad DeLong refers to Nick Rowe, David Glasner and Arnold Kling in a new post……

    http://equitablegrowth.org/2014/04/17/saw-monetarist-drinking-pina-colada-thursday-focus-april-17-2014

  20. Gravatar of Patrick R. Sullivan Patrick R. Sullivan
    18. April 2014 at 08:40

    For an almost pure example of the ‘Henry Ford Fallacy’, here’s an NC State econ Phd;

    http://q13fox.com/2014/04/16/kshama-sawant-interview/#axzz2z9i5BUfa

  21. Gravatar of viktor viktor
    18. April 2014 at 08:54

    Scott is there anything special a small open economy(population about 5 million)should watch out for if it wanted to try ngdplt

  22. Gravatar of W. Peden W. Peden
    18. April 2014 at 10:37

    Kevin Erdmann,

    I don’t think the idea ever went out of the public imagination, and among among economists there’s been somewhat of an uncritical awe of all of Keynes’s ideas as part of the “Resurgence”.

    By the way, your post on 02/04/2014 regarding growth and consumer debt was a fascinating debunking of a lot of received wisdom regarding the pre-crisis period.

  23. Gravatar of TravisV TravisV
    18. April 2014 at 10:45

    W. Peden,

    Here in the U.S., we notate April 2nd, 2014 as “04/02/2014″……

  24. Gravatar of W. Peden W. Peden
    18. April 2014 at 11:02

    TravisV,

    Yes, just as here we use “02/04/2014” for the second day of April in 2014.

    I would like to say that I wasn’t planning on causing a wee bit of confusion, BUT…

  25. Gravatar of Kevin Erdmann Kevin Erdmann
    18. April 2014 at 11:31

    Thanks, W.

    I can see why it’s a popular notion for left – leaning economists, because it basically makes all redistribution a free lunch. It’s kind of like the Laffer curve for the left. But at least the Laffer curve is a legitimate concept and it’s vulgar application is just a matter of ignoring it’s mitigating parameters. Is there even literature that admits to mitigating parameters for the spending/saving idea? I’ve never seen it treated by its promoters as if it has any. Are things really that bad?

  26. Gravatar of ssumner ssumner
    18. April 2014 at 11:46

    W. Peden, good point.

    Travis, Actually the Fed targets PCE inflation at 2%, the implicit CPI target is 2.4%. We are likely to remain below that level.

    Kevin, I’d guess you can find justification for almost anything in the literature.

    viktor, You’d want to avoid NGDP targeting is your economy was not well-diversified. I’d suggest target nominal aggregate wages and salaries in a smaller economy.

  27. Gravatar of TravisV TravisV
    18. April 2014 at 11:58

    Prof. Sumner,

    Which is more likely:

    (1) Core inflation creeps up from its current rate over the medium-term (Elfenbein’s forecast).

    (2) Core inflation remains at about its current rate or even creeps down over the medium-term (Benjamin Cole’s forecast).

    Five-year TIPS spreads indicate that (1) is more likely, correct? So is that your view as well?

  28. Gravatar of Matt Swartz Matt Swartz
    18. April 2014 at 15:11

    Scott, thanks for the post. I’m trying to thread together a couple of your theories with Mian/Sufi’s research and think about implications.

    Here are a few of your theories as I understand them:
    (1) Monetary policy determines NGDP, and it is up to fiscal policy to split this between RGDP and inflation
    (2) It is important to consider the monetary policy response function as an offset to any fiscal policy used as a stabilization tool

    Mian and Sufi appear to have shown some regional variation in the output gap, and monetary policy cannot target certain regions.

    Even though monetary policy cannot target depressed regions, monetary policy determines NGDP. In the presence of cyclical fiscal policy, monetary policy will do less to offset this effect, leading to the same NGDP as in the absence of fiscal policy. But if monetary policy just pushes up NGDP generally, it seems like in the absence of regionally targeted cyclical fiscal policy, the split between RGDP and inflation would be more titled towards inflation than it would have the fiscal policy closed the output gap somewhat, right? Would that not warrant some expansionary fiscal policy if it was targeted towards regions which are more cyclically depressed?

  29. Gravatar of Mark A. Sadowski Mark A. Sadowski
    18. April 2014 at 18:49

    1) Atif Mian and Amir Sufi:
    “Retail sales for March is out this morning, and we thought it would be a good time to examine *why* household spending has been so weak using data that were just updated through 2013.”

    Granger causality tests show over 1987Q1 that the Shiller national house price index Granger causes NGDP at the 10% significance level, but that NGDP Granger causes the Shiller national house price index at the 1% significance level. So the evidence seems to suggest that the dog probably still wags the tail, and not the tail the dog.

    2) Jordan Weissmann:
    “People saw their housing values rocket up, and felt richer. Often, they took out second mortgages to spend.”

    Of the five states in the group where house prices fell the most between 2006 and 2009 (AZ, CA, FL, MI and NV), Michigan doesn’t really fit that script. According to the all transactions house price index, house prices only rose by 40.3% from 1997 to 2006 in Michigan, compared to 85.8% for the US as a whole, which ranks it fourth from the bottom among states in terms of house price changes during that time period. Michigan also ranked dead last in terms of NGDP growth from 1997 to 2006 (29.0%), so Michigan already had the worst economy in the union.

    3) The correlation between state NGDP changes and house price changes is highly significant, but that doesn’t mean there aren’t some very large residuals. For example of the 15 states where house prices fell the least between 2006 and 2009 (actually, according to the all transactions house price index, prices rose in all but one of those states), NGDP rose by more in Texas between 1997 and 2006 (75.1%) than in California (73.0%), although house prices only rose by 53.6% in Texas and by 223.5% in California over that time period.

    4) Although the national all transactions price index rose 5.2% between 2011Q1 and 2013Q4, it rose by much more than that in the five states were house prices fell the most between 2006 and 2009. The all transactions house price index is up by 47.9%, 43.4%, 34.6%, 25.8% and 21.4% in Nevada , Arizona, California, Florida and Michigan from 2011Q4, 2011Q2, 2011Q3, 2011Q2 and 2011Q2 to 2013Q4 respectively. This suggests to me that the steep decline in house prices in those states was at least partially an aberation.

    5) A close reading of the Zhou and Carroll paper that Mian and Sufi reference suggests that changes in nominal income (i.e. NGDP) is a much more important factor in determining changes in personal consumption expenditures than are changes in wealth. Slide 15 shows that in the six states with the largest increase in housing wealth from 2000 to 2006, the proportion of the reduction in consumption associated with concurrent housing wealth changes declines from 50% in 2007 to 23% in 2008 to 11% in 2009:

    http://www.frbsf.org/economic-research/events/2011/march/empirical-macroeconomics-geographical-data/Zhou-Carroll.pdf

  30. Gravatar of Tom Brown Tom Brown
    18. April 2014 at 19:17

    O/T: David Glaser asks: “Why aren’t Bitcoins a bubble?” He really wants to know:

    “Either I have overlooked some material fact about bitcoins that might impart a positive value to them, or there is a problem with the theory of valuation that I am using. So I ask, in all sincerity, for enlightenment. Help me understand why bitcoins are not a bubble.”

    http://uneasymoney.com/2014/04/18/ok-tell-me-please-tell-me-why-bitcoins-arent-a-bubble/

  31. Gravatar of dannyb2b dannyb2b
    18. April 2014 at 21:39

    I had an interesting idea: is the zero interest rate implying reserves have no value?

  32. Gravatar of Tom Brown Tom Brown
    18. April 2014 at 22:35

    dannyb2b,

    “I had an interesting idea: is the zero interest rate implying reserves have no value?”

    If that were the case then banks should have no problem filling up your wheel barrel with all the worthless vault cash they’re counting as reserves.

  33. Gravatar of dannyb2b dannyb2b
    19. April 2014 at 04:08

    Tom

    Yeah it may just mean that borrowing reserves is of no value. But if given them then that’s not the case.

    Broader money has a higher interest rate though. If reserves were made a better substitute for broad money (allowing them to be widely held and used for transactions) then we wouldn’t be at the zlb.

  34. Gravatar of Mark A. Sadowski Mark A. Sadowski
    19. April 2014 at 06:57

    Scott,
    Off Topic.

    Here’s an otherwise unremarkable post:

    http://soberlook.com/2014/04/ecb-moving-closer-to-unconventional.html

    Which is nevertheless useful for this:

    http://4.bp.blogspot.com/-gxRY3DadILs/U08LGQtm8OI/AAAAAAAAea8/4pABQdlcoGw/s1600/ECB+eligible+securities.PNG

    This is the first time I recall seeing the amounts of ECB repo eligible marketable debt securities presented in such a simple fashion.

    Non-Euro Area debt securities do not appear to be represented in the chart. My understanding is that under its temporary framework the ECB can also accept debt securities issued in all EEA and G10 countries as collateral, so that evidently would include the US, Japan, the UK, Canada, Sweden and Switzerland (Table 2):

    http://www.ecb.europa.eu/pub/pdf/other/collateralframeworksen.pdf

  35. Gravatar of flow5 flow5
    19. April 2014 at 08:41

    Bankrupt U Bernanke drained legal (required), reserves for 29 consecutive months as soon as he was appointed Chairman. Immediately upon initiating his contractionary money policy the housing market (S&P Case-Shiller 20-City Home Price Index©) declined conterminously.

    That is, the rate-of-change in monetary flows (MVt), or the 24 month proxy for the inflation indices (the price level), began to decelerate. And this proxy for inflation has been a mathematical constant for the last 100 years. In other words, Bankrupt U Bernanke turned safe assets into impaired assets (even bragging that his inflation record was the most stringent of any Chairman since WWII).

    Note that the expansion coefficient (monetary base), doubled from 1947 to 1975 (28 years). It doubled again from 1975 to 2003 (28 years). But from 2003 on it began to accelerate. I.e., even as banks ceased to be e-bound in 1995, it wasn’t until 2003 that the expansion coefficient was delinked (as Bankrupt U Bernanke was hitting the brakes).

  36. Gravatar of flow5 flow5
    19. April 2014 at 09:09

    With the introduction of the payment of interest on excess reserve balances, the Fed has emasculated its primary monetary policy tool – its “open market power”. I.e., the money stock can never be managed by any attempt to control the cost of credit.

    The point is that “forward interest rate guidance” (Optimal Control Path of Interest Rates), provides false signals. I.e., Keynes’s liquidity preference curve (demand for money), is a false doctrine.

    Since the Fed’s research staff doesn’t know the difference between money & liquid assets, the FOMC has inadvertently fallen back on bank credit proxy exclusively – in order to steer the economy.

    Required reserves (RRs), then are based on transaction deposits 30 days prior (& over 95 percent of all demand drafts clear thru these deposit classifications). RRs represent the BOG’s de facto policy driver.

    Roc’s in RR = roc’s in nominal-gDp (a proxy for all transactions in Irving Fisher’s “equation of exchange”). The distributed lags for both bank debits & MVt are not “long & variable”. The lags have been mathematical constants for the last 100 years.

    The proxy for real-output is exactly 10 months (courtesy of the “Bank Credit Analyst’s” [debit/loan ratio].

    The proxy for inflation is exactly 24 months (courtesy of “The Optimum Quantity of Money” – Dr. Milton Friedman.

    Note: their lengths are identical (as the weighted arithmetic average of reserve ratios & reservable liabilities remains constant)

  37. Gravatar of flow5 flow5
    19. April 2014 at 09:17

    “It is hard for me to envision or accept that a substantial rise in the federal funds rate from 1% to 5.25% is not a tightening”

    I.e., real-gDp (where roc’s in MVt = roc’s in real-output), didn’t fall below a 3 percent rate-of-change during this pseudo tightening period.

    A “tight” money policy is defined as one where the rate-of-change in monetary flows (our means-of-payment money times its transactions rate of turnover) is no greater than 2-3% above the rate-of-change in the real output of goods & services. I.e., AD rose (didn’t decelerate or contract) from June 2004 until February 2006.

    And then Bankrupt U Bernanke NEVER eased.

  38. Gravatar of ssumner ssumner
    19. April 2014 at 10:00

    Travis, I’d go with the TIPS.

    Matt, I’ve argued that individual countries might benefit from employer-side payroll tax cuts, or other similar supply-side fiscal policies. The problem of course is that they are broke.

    Tom, I left a comment over at Glasner’s site.

    Mark, That’s interesting data on eligible assets. If they included foreign sovereign debt the amount would increase sharply.

  39. Gravatar of Tom Brown Tom Brown
    19. April 2014 at 11:54

    “Tom, I left a comment over at Glasner’s site.”

    I saw: I figured you’d be the one to raise an objection. 😀

  40. Gravatar of marvel mighty heroes cheats marvel mighty heroes cheats
    17. April 2015 at 02:15

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