Are we again misdiagnosing the problem?

Back in 2008, most people misdiagnosed the economic crisis.  A recession that was caused by tight money was wrongly assumed to be caused by a housing slump.  The housing slump was partly exogenous (due to other factors) and partly endogenous (aggravated by tight money.)

Now we have a (much milder so far) global economic slowdown that is being attributed to the collapse of oil prices, a “problem” that is partly exogenous (fracking, the Saudi’s fighting back, etc.) and partly endogenous (slower NGDP growth reducing oil demand).   Falling oil prices are clearly a problem for oil exporting countries, but they also benefit oil importers.  Is there a Keynesian savings/investment mechanism here?  I don’t see how, the oil exporters are massively reducing their saving rates.  The only even halfway plausible story is “reallocation” as jobs are lost in oil production faster than they can be created elsewhere.  That’s possible, but that’s a negative supply shock, which would raise inflation.  Do you see inflation sweeping the globe?  Me neither.

The following is from a Quartz article that attributes the global economic slowdown to falling oil prices:

We live in a time of bad forecasting of all types. Examples include the failed predictions of political pollsters gauging a host of critical elections around the globe, and the delusionary thinking that led to the last American economic catastrophe wreaked on the world—the 2008 mortgage crisis. It’s hard to predict events, as Philip Tetlock described last year (paywall) in his book Superforecasting.

I would love for someone to explain how the American economic “catastrophe” wreaked havoc on the world back in 2008.  The Great Recession ended up being worse in Europe than the US. The US housing shock might produce some incidental damage in other regions such as Europe and Asia, but surely not as bad as in the US.  And if it were a negative supply shock then global inflation would have risen in 2009.  Most people, including me, strongly believe the global recession was a negative demand shock.  But how could a subprime crisis in America reduce AD in Europe?  The ECB controls the path of AD in Europe, and they didn’t even hit the zero bound until 2013.  Obviously the eurozone recession was mostly caused by tight money.

Falling oil prices didn’t cause NGDP growth in the US to slow to 2.9% in 2015, the Fed did.  Falling oil prices didn’t cause China’s official NGDP growth rate to fall to 5.8% in 2015, their decision to peg to a strongly appreciating dollar did.

This is a never-ending battle.  There is an economic slowdown.  At the same time one industry stands out because it is going through wrenching changes.  Before it was housing, now it’s oil. There’s always something.  Because pundits don’t understand how monetary policy drives NGDP, they simply assume that whatever industry is in the headlines is what’s causing the economic slump. In some ways this is even worse than 2008.  At least then the slumping housing industry was in the US, so you can sort of imagine how people would be fooled into thinking that it might directly impact our GDP.  But regions like the eurozone import almost all of their oil.  For decades we’ve been taught (correctly) that importing nations benefit from lower oil prices.  And now we simply throw out mainstream theory and assume that for some magical reason importing nations are suddenly now hurt by cheap oil.  Why are the stock prices of European firms that import their oil falling along with stock markets in the oil exporters?

At the beginning of 2014, the world was marveling in surprise as the US returned as a petroleum superpower, a role it had relinquished in the early 1970s. It was pumping so much oil and gas that experts foresaw a new American industrial renaissance, with trillions of dollars in investment and millions of new jobs.

Two years later, faces are aghast as the same oil has instead unleashed world-class havoc: Just a month into the new year, the Dow Jones Industrial Average is down 5.5%. Japan’s Nikkei has dropped 8%, and the Stoxx Europe 600 is 6.4% lower. The blood on the floor even includes fuel-dependent industries that logic suggests should be prospering, such as airlines.

Heh world, don’t abandon EC 101, it’s the NGDP, stupid.

And please, can we have our NGDP futures markets now!?!?!?!?

PS.  I have a new post at Econlog that addresses the question of why easier money sometimes raises long-term rates, and at other times lowers them.

 


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45 Responses to “Are we again misdiagnosing the problem?”

  1. Gravatar of Britonomist Britonomist
    1. February 2016 at 14:13

    “The only even halfway plausible story is “reallocation” as jobs are lost in oil production faster than they can be created elsewhere. ”

    I don’t think of that as a ‘negative’ supply shock, that’s still a positive supply shock. A commodity glut (which is a positive supply shock) is deflationary.

  2. Gravatar of M.R. M.R.
    1. February 2016 at 14:51

    Is the nonexistence of a robust NGDP futures market a failure of policy? Or does its nonexistence reflect lack of demand for the product?

  3. Gravatar of ssumner ssumner
    1. February 2016 at 14:52

    Britonomist, Fine, but if it’s a positive supply shock it obviously doesn’t reduce RGDP.

  4. Gravatar of ssumner ssumner
    1. February 2016 at 14:52

    M.R. Policy failure–it’s public good. Also a failure caused by people not responding to my emails

  5. Gravatar of M.R. M.R.
    1. February 2016 at 15:32

    Heh.

    I just wonder if you build it will they come … If market participants wanted it it would probably already exist.

  6. Gravatar of Carl Carl
    1. February 2016 at 15:46

    M.R.
    If what you said were true, there would be no need for invention and advertising; everything people needed would exist and be fully utilized.

  7. Gravatar of Effem Effem
    1. February 2016 at 16:21

    Or maybe, just maybe, transmission mechanisms matter. I know: if i have a piece of art hanging on my wall that appreciates by $10m that is supposed to lead to higher AD via the hot potato effect. Perhaps we should think a bit harder about the divergent paths of financial wealth and AD (not to mention the potential consequences of using a loosely-related tool to stimulate AD…political volatility perhaps?!).

  8. Gravatar of Mark Mark
    1. February 2016 at 16:23

    “Britonomist, Fine, but if it’s a positive supply shock it obviously doesn’t reduce RGDP.”
    You’re confusing me. At first, I thought exactly as Britonomist did; that declining oil prices should be deflationary. Then I came up with the rationalization that, if job losses from declining oil prices are exceeding job gains in other sectors, than production in other sectors may not be able to expand fast enough to meet the increase in demand for other goods and services resulting from the money consumers are saving due to lower gas prices, and therefore spending elsewhere. But you’re saying now that declining oil prices are in fact deflationary?

    And speaking of misdiagnosis, those of us who read Kevin Erdmann’s splendid blog may be convinced that the public misdiagnoses the 2008 recession for the same reason the Fed caused it: because both misdiagnosed the rise in housing prices as a standard bubble, rather than largely the result of supply constraints on housing.

    One wonders if central bankers have been reading a lot of Akerloff and Shiller lately, and see markets naturally overheating and their job being to throw cold water on them? So speculation of a new housing bubble that one sees occasionally these days could justify another dose of ‘cold water.’

  9. Gravatar of Mark Mark
    1. February 2016 at 16:25

    Carl: “M.R.
    If what you said were true, there would be no need for invention and advertising; everything people needed would exist and be fully utilized.”
    Carl, have you heard the joke about the two economists walking down the street? One says ‘look, there’s a $20 bill on the ground’; the other just says ‘no there isn’t, that’s impossible; if there were, someone would have already picked it up’ and keeps walking.

  10. Gravatar of Matt Moore Matt Moore
    1. February 2016 at 16:27

    ‘At the same time one industry stands out because it is going through wrenching changes.’

    Out of interest, what are the industries that went through such changes in the intervening years, that would have been blamed had the tight money problem occurred earlier? I’m struggling to think of any on the order of housing (then) and oil (now).

    Could it be that a negative shock to a totemic industry depresses optimism, and then central banks fail to correct?

  11. Gravatar of E. Harding E. Harding
    1. February 2016 at 17:08

    “Do you see inflation sweeping the globe?”

    -In Russia and Brazil. Not sure why low oil prices affect Brazil’s dollar exports so negatively.

    “And if it were a negative supply shock then global inflation would have risen in 2009.”

    -Belarus had stable inflation in 2009. Ukraine had falling inflation, but it was very high. Ukraine had a very bad recession, but Belarus, like neighboring Poland, recorded mild per capita growth in 2009, despite bordering Russia, the Baltics, and Ukraine, all of which had very severe recessions. Poland managed to keep a stable inflation rate of above 2.5% in 2009.

    And, yes, the present problems in the EZ, U.S., and China are mostly due to NGDP. Those in Russia, Saudi Arabia, Iran, and probably Brazil are mostly due to low oil prices.

  12. Gravatar of Benjamin Cole Benjamin Cole
    1. February 2016 at 17:20

    Excellent blogging. Cheaper commodities are a positive, always (macroeconomically).

    Scott Sumner: Perhaps you need to write a second book: “The Big Shift”. Something has changed in the last 10-15 years. Central banking cannot be what it was before. It may be the long-term battle ahead is against deflation, stagnation and capital gluts and will require constant QE and extremely low interest rates and perhaps some other mechanisms, such as aggressive tax cuts on people who will spend.

    To be for 7% NGDPLT growth is fine. But we need implemenation plans.

  13. Gravatar of bill bill
    1. February 2016 at 18:00

    Thankfully the oil problem will stop getting worse once oil is free!
    [Just joking!]

  14. Gravatar of Major.Freedom Major.Freedom
    1. February 2016 at 18:29

    Sumner, you and those you are attacking in this post have been misdiagnosing the problem since day one.

    The cause was not a housing collapse, and the cause was not a lack of inflation after the financial crisis.

    The cause is what made the inflation necessary to postpone the corrections, that is, the cause is previous undue inflation, or more specifically undue credit expansion.

    You continue to bloviate about the symptoms, never even engaging the question pf why there was a sudden widespread increase in cash preference all throughout the economy.

    It is truly absurd that even after all these years, of you having literally free access to the knowledge, that you nevertheless evade and ignore it on purpose. That is not the mark of an intellectual, but a propagandist.

  15. Gravatar of Dan W. Dan W.
    1. February 2016 at 19:24

    Accepting monetary inflation as the goal I am a bit puzzled at the insistence it be accomplished through lame attempts to expand bank credit. Why not simply print money? If you want to devalue the currency by 5% a year then do it! Print the money and give it to people. OK, this might require an act of Congress to make it legal but imagine the power of the central bank to truly achieve its NGDP target if it could write checks (truly Fiat money backed by nothing) and send them out to every American household.

    Alas, it does not seem to be the goal of the monetarists to devalue the currency that way.It almost makes one convinced that the goal is something other than that.

  16. Gravatar of ssumner ssumner
    1. February 2016 at 19:35

    MR. You subsidize trading, that’s what Hypermind did last year.

    Mark, You said:

    “But you’re saying now that declining oil prices are in fact deflationary?”

    Whether a shock is inflationary or deflationary depends on whether it’s a demand shock or a supply shock. If you believe the oil shock is driving prices and output lower, then you are essentially claiming it’s a demand shock. It’s fine for someone to say no, they think it’s a supply shock, but not kosher to then claim it’s reducing both prices and output. A supply shock can’t do that. So tell me the impact you think it’s having on prices and output, and I’ll tell you whether it’s a supply or a demand shock.

    Matt, You asked:

    “Could it be that a negative shock to a totemic industry depresses optimism, and then central banks fail to correct?”

    Yes it could. Recall that the Fed raised rates in December TO PREVENT THE ECONOMY FROM OVERHEATING. Yes, that’s not a typo.

    E. Harding, You said:

    “And, yes, the present problems in the EZ, U.S., and China are mostly due to NGDP. Those in Russia, Saudi Arabia, Iran, and probably Brazil are mostly due to low oil prices.”

    I agree.

    I don’t follow politics very closely, but if Trump doesn’t win Iowa, does that mean his national numbers are also being inflated in the polls?

    Ben, One book at a time.

    Bill, At least the price will stop falling, unless the negative IOR concept is applied to oil. :)

  17. Gravatar of Steve Steve
    1. February 2016 at 19:36

    Cruz! Cruz! Cruz! Rubio? Cruz! Cruz! Cruz! Rubio?

  18. Gravatar of ssumner ssumner
    1. February 2016 at 19:58

    Steve, I wonder how good the betting markets are in this area. Seems to me that Rubio’s chances of getting the nomination just went up at least 5 or 10 points. I know he’s still far behind in the national polls, but he was 12 points behind Trump in the Iowa polls, and only ended up one point back. And he’ll pick up lots of support from the other mainstream candidates as they drop out.

  19. Gravatar of Steve Steve
    1. February 2016 at 20:04

    Rubio has been the logical consensus/compromise from day one. I agree I’m not convinced betting markets got that right.

    Of course Trump, Carson, and Paul would logically fall to Cruz, while everyone else might fall to Rubio. That would be ~60 Cruz ~40 Rubio. But Cruz gets haircut because he has ruffled a lot of special interest feathers.

    I’m hoping this turns into a fair race.

  20. Gravatar of E. Harding E. Harding
    1. February 2016 at 20:10

    Sad. “New American Century” Rubio will be an absolutely terrible candidate. Even Cruz would be better. I can only weep for the nation. He’s much worse than Trump on foreign policy, and just as bad as him on civil liberties. On the issues that matter, he’s much more fascistic than Trump. I can only see disaster coming from that man, no matter what happens to him. I don’t want another one of the Great Satan’s more despicable demons making a go for control of its head.

    Ground game, Trump! Ground game! You’re not exempt! Demand people vote for you, and bring their friends. [Sheds tear].

    “I don’t follow politics very closely, but if Trump doesn’t win Iowa, does that mean his national numbers are also being inflated in the polls?”

    -Yeah, probably, but to a lesser extent than in Iowa. Cruz was bound to put on a good show in Iowa due to its tendency to support such loser religious conservative figures as Huckabee and Santorum.

  21. Gravatar of Steve Steve
    1. February 2016 at 20:22

    Harding, Sumner,

    I have defended Trump and opposed Trump at the same time. I wish he could have developed a policy platform beyond “I will build/do/ban/deport deal with x”. I wish there were principles there. I agree Rubio’s aggressive foreign policy views are a risk–he’s not perfect.

    I will be voting in a week, likely for Cruz in an otherwise weak state. I suspect Kasich will rise in NH, possibly to 2 or 3, and then there will be only four left.

  22. Gravatar of Steve Steve
    1. February 2016 at 20:36

    My job is to winnow, not pick.

    The current plan is to send Cruz, Rubio, Kasich, and Trump to South Carolina, leaving everyone else hopelessly damaged. We will see.

  23. Gravatar of Ray Lopez Ray Lopez
    1. February 2016 at 20:44

    I found the fly in Sumner’s ointment. I now see why he’s misguided and why Major Freedom is right in this thread. Read on, it gets better.

    First, using Sumner’s terminology in his back-and-forth with Mark, we see that we’re in a demand shock. A negative demand shock to be precise. Fair enough, and I agree.

    Now here’s were Sumner goes wrong: “Most people, including me, strongly believe the global recession was a negative demand shock [which causes deflation–RL] But how could a subprime crisis in America reduce AD in Europe?”

    Easy: housing was in a worldwide bubble. See – Wikipedia https://en.wikipedia.org/wiki/Real_estate_bubble#2007:_many_countries (“The Economist magazine, writing at the same time [mid-2005], went further, saying “the worldwide rise in house prices is the biggest bubble in history” – see list of bubble countries which includes almost the entire world. Only the crank K. Erdmann would disagree).

    Now why is Major Freedom right? Because most people buy houses on credit (pace my 1% family, we just write a check). So if the finance sector is over-expanded due to supply too many bank loans, this causes “malinvestment” that must be corrected with a beneficial recession later. Exactly what happened.

  24. Gravatar of Steve Steve
    1. February 2016 at 20:58

    Ahh, I should respond to the post:

    “Before it was housing, now it’s oil.”

    It’s ironic, in 2008 the US had to rapidly reallocate capex from housing, to oil production.

    Now, in 2015-16, the US has to reallocate oil capex back to housing capex, with rents rising out of control.

    Mirror image, but the Fed is always paranoid about the one time series that is rising in price.

  25. Gravatar of ssumner ssumner
    1. February 2016 at 21:31

    E. Harding, They are all too hawkish for me, except Rand Paul (in the old days)

    Why even pay attention to Trump’s “views”, no one with half a brain believes that Trump actually believes anything he says—it’s all an act.

    Steve, Thanks for those insights. Kasich seems like a long shot to me–I think it’s either Trump, Rubio or Cruz, with Cruz the least likely of those three to go all the way, but then I know nothing about politics anymore.

  26. Gravatar of Steve Steve
    1. February 2016 at 21:40

    I agree Kasich has almost no chance nationally, but I get the sense he will be the surprise in NH due to the open primary.

    I also agree the Rubio is now the establishment and overall favorite now. However, there is still a big element of unpredictability, depending on who decides to linger and play spoiler. Trump could spoil Cruz, and Bush could spoil Rubio. Both Trump and Bush seem to want to destroy the Republican party.

  27. Gravatar of E. Harding E. Harding
    2. February 2016 at 04:19

    I’m not afraid Trump actually believes anything he says -I’m afraid Rubio does.

    “I think it’s either Trump, Rubio or Cruz, with Cruz the least likely of those three to go all the way”

    -Same here. I hope Bush, Christie, and Kasich put a dent into Rubio in NH, allowing Trump to come away with the gold.

  28. Gravatar of BC BC
    2. February 2016 at 07:21

    Scott: “Seems to me that Rubio’s chances of getting the nomination just went up at least 5 or 10 points.”

    In this betting market [https://www.electionbettingodds.com/], Rubio surged yesterday by 23 points and now has greater than 50% chance of winning. Trump fell by 17 points.

  29. Gravatar of BC BC
    2. February 2016 at 07:25

    Scott: “Recall that the Fed raised rates in December TO PREVENT THE ECONOMY FROM OVERHEATING.”

    Mission accomplished.

  30. Gravatar of Chris Brown Chris Brown
    2. February 2016 at 08:22

    “I would love for someone to explain how the American economic “catastrophe” wreaked havoc on the world back in 2008.”

    Here goes:
    – unregulated shadow banking system (e.g. bank SPVs, conduits) and the securitisation market had a big exposuse to US sub-prime
    – nearly all (>80%) of the investors in these vehicles where short term, low risk investors who thought they had 100% safe, AAA collateral
    – when sub-prime started to look scary they pulled their money from anywhere that looked like it had sub-prime exposure: including European Banks, Bear Stearns, money market funds
    – the banks were also sitting on trillions of revolver lines that could be called at any times
    – shutting of securitisation market also hit the mortgage markets and leveraged loan markets hard; banks were in no position to meet to collapse in supply
    – result: no new risky loans, everyone selling assets to raise cash, credit crunch
    – falling asset prices = insolvent banks, government support needed
    – sudden stop in supply of credit = fear up, teasuries the only OK asset class, cost of capital up, recession

    De-leveraging of European banks (who also had large global lending arms) were a big part of the transmission mechanism.

  31. Gravatar of Dan W. Dan W.
    2. February 2016 at 08:39

    BC,

    Perhaps the Fed raised rates because it knows that lowering them WILL NOT move the economy closer to the 2% inflation target. Of course by raising rates the Fed will, at least temporarily, dampen investor sentiment.

    Williamson has the charts that show low interest rates beget low inflation.
    http://newmonetarism.blogspot.com.br/2016/01/central-banking-by-process-of.html#comment-form

  32. Gravatar of ssumner ssumner
    2. February 2016 at 09:31

    Steve, Good points.

    BC, Thanks for the info. It’s odd how many people said Trump had it locked up before any votes. He still might get it, but in politics nothing is certain (as I learned when I said earlier that Trump had no chance).

    Dan, You said:

    “Williamson has the charts that show low interest rates beget low inflation.”

    Face palm.

  33. Gravatar of Bob Murphy Bob Murphy
    2. February 2016 at 09:51

    Scott,

    Isn’t there something a bit odd in how you routinely describe households and firms making all of their important decisions on the basis of expectations of NGDP growth, and yet you also have to keep begging the government to spend a piddly amount of money to create a market in these contracts?

    Google (I mean Alphabet) will spend $3 billion in a year on self-driving cars and other fanciful projects, but they won’t spend $3 million setting up a market that you think Google would use as the basis of every major decision?

  34. Gravatar of Bob Murphy Bob Murphy
    2. February 2016 at 09:53

    Just to be clear, Scott, I’m not (here) challenging your claim that an NGDP futures market would be a great thing to benefit humanity. I’m challenging your claim that everybody cares about NGDP. I don’t think anybody except you, Nick Rowe, and a few other people care about NGDP.

  35. Gravatar of ssumner ssumner
    2. February 2016 at 10:24

    Chris, Yes, but how does any of that reduce AD in Europe? The ECB controls the path of AD.

    Also note that if you are correct then the US would not be to “blame” for the recession in Europe, the blame would fall on European banks that made foolish loans and investments. It was my impression that the Europeans blamed the Americans for their recession.

    Bob, People as a group care about NGDP. People and firms as individuals care about the revenue they will earn. Google might want to have prediction markets for future online advertising revenue. Markets aggregate preferences.

  36. Gravatar of Ben P Ben P
    2. February 2016 at 11:42

    If the fed stated that its policy was to target NGDP, futures markets for NGDP would be created the next day by private firms just as we have federal funds future markets now.

  37. Gravatar of Ray Lopez Ray Lopez
    2. February 2016 at 17:53

    Notice: Sumner avoids the embarrassing post that points out how the entire world had a housing bubble, which pops his OP.

    And Bob is right: nobody cares (about NGDPLT).

  38. Gravatar of Dan W. Dan W.
    2. February 2016 at 17:55

    Scott,

    I get it, you are not a neo-fisherian. You have your theory and your are not going to give it up without a fight. But what will make you realize your theory doesn’t work? What evidence would disprove the notion that ZIRP and NIRP can elevate inflation and NGDP?

    Bullard of the St. Louis Fed indicates he is going to be patient, but not for forever:

    “If the neo-Fisherian effect is strong in the quarters and years
    ahead, however, we will need to think about monetary policy
    in alternative ways.”

    https://www.stlouisfed.org/~/media/Files/PDFs/Bullard/remarks/Bullard-Expectations-in%20Dynamic-Macroeconomic-Models-08-13-2015.pdf

  39. Gravatar of Mark Mark
    2. February 2016 at 21:54

    Scott: “Whether a shock is inflationary or deflationary depends on whether it’s a demand shock or a supply shock. If you believe the oil shock is driving prices and output lower, then you are essentially claiming it’s a demand shock. It’s fine for someone to say no, they think it’s a supply shock, but not kosher to then claim it’s reducing both prices and output. A supply shock can’t do that. So tell me the impact you think it’s having on prices and output, and I’ll tell you whether it’s a supply or a demand shock.”

    Couldn’t it also be both? Oil production has clearly increased; this of course causes a decline in prices and an increase in output and employment. But I suppose one could argue (I have no idea with what data, just speculating) that there was also a big decline in demand, and that’s what really drove down prices. No reason a price change has to be purely from a supply or demand shock, could be some mixture of both if demand and supply go in opposite directions.

    Of course now I’m just throwing wrenches into a simple hypothetical scenario. In any case, I guess I should stick with ‘inflationary supply shock’ as my answer until someone informs me of a big drop in oil consumption equal or greater in magnitude than the increase in supply.

  40. Gravatar of ssumner ssumner
    3. February 2016 at 11:40

    Ray, You said:

    “Notice: Sumner avoids the embarrassing post that points out how the entire world had a housing bubble, which pops his OP.

    And Bob is right: nobody cares (about NGDPLT).”

    Thanks for making my day—two whoppers in one short comment.

    The entire world did not have a housing bubble, not even close. And NGDPLT doesn’t exist, so why would anyone “care about it”?

    Dan, Of course the Fisher effect is strong.

    Mark, Not only could there be both, there probably was both of those events.

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