Where Bullard is right and where he is wrong
Via Mark Thoma, James Bullard has a reply to Tim Duy that sheds further light on his argument. In this piece he concentrates his criticism on the concept of “potential output.” Here I actually agree with Bullard; potential output is hard to measure, may move around at times, and can easily lead monetary policy astray. But I still have major problems with his overall argument:
So, what Irwin’s picture is doing is taking all of the upside of the bubble and saying, in effect, “this is where the economy should be.” But that peak was based on the widespread belief that “house prices never fall.” We will not return to that situation unless the widespread belief returns. I am saying that the belief is not likely to return–house prices have fallen dramatically and people have been badly burned by the crash. So I am interpreting your admonitions on policy as saying, in effect, please reinflate the bubble. First, I am not sure it is possible, and second, that sounds like an awfully volatile future for the U.S., as future bubbles will burst once again.
Now we can see the damage to monetary policy by the widespread (but false) view that this recession was caused by the bursting of the housing bubble, and the resulting financial crisis. Interestingly, this is exactly that same argument that the Fed used in the 1930s; “Do you mean you want us to go back to the false prosperity of 1929?” Most economists would now say; “Yes. The 1927-29 expansion saw no inflation at all. There is no evidence the economy was overheated in 1929.”
Now I’m willing to concede that this perception may be wrong, about both 1929 and 2007. Both years might have seen output slightly above the mythical “natural rate.” There’s really no way to know for sure. But it’s important to recognize the nature of Bullard’s argument—in some respects it’s a return to 1930s macro after a 70 year hiatus. Why did the Fed ignore bubble theory for so long? Two reasons. Modern macro models really don’t have much of a place for bubbles, except to the extent they throw monetary policy off course and lead to excessive NGDP growth. But NGDP growth followed a fairly stable path along a 5% trend line after 1990. It might have been slightly too high in 2007, but nothing of the sort that would cause a major crisis. The second reason is that between 1929 and 2000 we didn’t seem to have bubbles that influenced the business cycle. The huge 1987 stock market crash didn’t even dent the economy. So macroeconomists naturally (and correctly) ignored bubbles. Bullard continues:
This is admittedly a qualitative story, but much of the rhetoric about the U.S. economy during this period fits this description. So it is not that the bubble destroyed potential, instead it is that actual output was higher than properly-defined potential during the mid-2000s, and then it crashed back as the bubble burst.
But where is the evidence for this? I think everyone agrees that housing construction was too high in 2004-06. But that doesn’t mean RGDP was too high. After all, the resources that went into housing could have come at the expense of other sectors. Housing is only about 5% of GDP. Is there evidence that AD was too high? Maybe a tad too high, but nothing out of the ordinary compared to other business cycle expansions. How about SRAS? Bullard mentions a rise in labor supply caused by the housing bubble, but I don’t see the logic. What would be evidence for a rise in labor supply? Presumably you’d see unusual patterns in the employment to population ratio during the 2000s, but I just don’t see it. His best argument would be that the desire to work has been dropping sharply for many years, and that this increased preference for leisure was temporarily covered up by a housing bubble that mysterious caused people to want to work more. Then when they found they could no longer build houses, they decided they didn’t want to work at all. They didn’t like other jobs being offered. I’m probably being unfair here, but I just don’t see the argument, or the data to support such an argument.
Of course you could make a “recalculation” argument, but that wouldn’t fit Bullard’s claim of a semi-permanent downshift in trend output. And it doesn’t even fit the data, as the big housing construction crash was mostly during the period of January 2006 to April 2008, and yet the unemployment rate was unusually low during that period of supposed “recalculation.”
Here’s the Bullard argument I find most troublesome:
As I noted earlier, the Irwin description is the dominant view of the U.S. economy. But, as you and many others have stressed, we have not seen the bounce back toward potential that would be suggested by that picture. That is giving me pause, and frankly I think it is giving everyone who follows the U.S. economy pause.
At a superficial level Bullard may be right. We may not ever get back to “potential output” as described in many conventional macro models. But I think at a deeper level Bullard is confusing two completely unrelated issues, the link between monetary policy and NGDP, and the link between NGDP and RGDP. Let’s start with the data. Bullard’s right that potential output is very misleading. In my view employment is a better indicator of cyclical patterns. For example, over the past 14 months the level of employment has risen by somewhere between 2.3 million and 2.9 million. Both of those numbers are above trend growth in jobs. So we are having an (admittedly weak) recovery in jobs. But at the same time RGDP is growing well below the 3% long run trend. Let’s assume Bullard’s right that the potential output estimates are too high, perhaps due to reasons outlined in Tyler Cowen’s The Great Stagnation. In that case the jobs numbers show us slowly recovering toward a reduced trend. The next question is; why isn’t the recovery faster? That’s where I suspect Bullard and I would part company.
Now let’s look at NGDP growth. During this period of recovery NGDP has been growing at about 4%, which I consider tight money. So the explanation for the slow recovery is quite easy, money has been too tight. Bullard would presumably reject that argument, as the Fed insists that money has been very easy—even though they’ve followed the same low interest rate/high monetary base policy that the Hoover Fed adopted. But even if money has been easy, it doesn’t help Bullard’s case. Now the mystery would be why the “easy money” hasn’t boosted NGDP, not why slow NGDP growth hasn’t triggered fast RGDP growth. There’s no direct effect of easy money on RGDP. It works, if it works at all, by boosting NGDP growth. Then if we assume wages and prices are sticky in the short run, the higher NGDP growth will (partly) translate into higher RGDP. But only if you get the desired NGDP growth. And that hasn’t happened. In contrast, during the first 6 quarters of the 1983-84 recovery, NGDP grew at an 11% rate, and RGDP grew at a 7.7% rate. The proximate cause of the slow recovery is obviously slow NGDP growth. The only debate is (or should be) whether the Fed or the fiscal policymakers are to blame for the slow NGDP growth.
[BTW: Ben Bernanke has called for fiscal stimulus at various times, tacit admission that the Fed sees an AD shortfall.]
The Fed’s current position is very similar to the Fed’s stance in 1932—they’ve done their job, provided low rates and a greatly enlarged monetary base, now why isn’t the economy recovering? I think we now know why the economy wasn’t recovering in 1932, money was way too tight. As soon as FDR adopted a (Woodfordian) price level target, the economy turned around on a dime. Even Vincent Reinhart, the guy who (according to Lawrence Ball) turned Bernanke from a bold advocate of monetary stimulus at the zero bound to a timid Fed-clone, now says the Fed isn’t moving fast enough in a Woodfordian direction.
If we get adequate NGDP growth, growth high enough where Bernanke doesn’t have to worry about Congress suddenly getting religion on the deficit, and if the economy still doesn’t recover, then we can entertain real theories of the recession.
Mark Thoma also links to Barkley Rosser:
The basis of this argument is that the fall in output following the collapse of the bubble has reduced the rate of real capital investment. Of course, the sharpest decline was in the real estate construction sector, the part of the economy that was most severely distorted by the housing bubble, and we should expect that part of investment to remain reduced for some time.
If Rosser means “reduced from 2006 levels” I obviously agree. But housing construction is also greatly reduced from normal levels, and hence there’s no reason why some recovery isn’t possible. What about the huge “overhang” of housing caused by “overbuilding?” Actually housing construction over the past 10 years has been well below normal. That’s why many young people are living with their parents. They have no job, because the Fed hasn’t provided enough AD.
I do like Bullard’s new argument better than the old one. This is what I strongly objected to earlier:
A better interpretation of the behavior of U.S. real GDP over the last five years may be that the economy was disrupted by a permanent, one-time shock to wealth. In particular, the perceived value of U.S. real estate fell substantially with the 30 percent decline in housing prices after 2006. This shaved trillions of dollars off of the wealth of the nation. Since housing prices are not expected to rebound to the previous peak anytime soon, that wealth is simply gone for now. This has lowered consumption and output, and lower levels of production have caused a significant disruption in U.S. labor markets.
This is doubly wrong. There is no reason to assume that building too much investment goods (housing) would cause people to want to build fewer consumer goods. Indeed in a well functioning economy overbuilding in one sector should cause resources to re-allocate into other sectors. Output of consumer goods would probably rise (although it’s theoretically possible that this could be offset by an increased preference for leisure that was even bigger than the fall in labor utilized in housing construction.)
And even if I’m wrong about the effect of less housing wealth on consumer goods production, the “consumption and output” connection is completely unjustified. You can’t simply assume that lower consumption translates into lower output; it could lead to higher investment or exports. Indeed that’s the sort of adjustment predicted by most equilibrium models. Now you might make a Keynesian argument that less wealth depressed AD, but Bullard is claiming the problem is not a lack of AD.
I notice that Bullard did not repeat this argument in his second piece, so the widespread criticism by economics bloggers may have nudged him in the right direction. This represents a sort of victory for the economics blogosphere, and especially Tim Duy.
Tags:
15. February 2012 at 12:09
Scott Sumner once again proves himself the Best Economist.
To Bullard: P.U., just shut up and go back to the Fed and print more money. We don’t want to be Japan, a nation that has tried your approach. Really, I prefer even inflationary prosperity to deflationary recessions.
Print more money until we see either sustained and healthy NGDP growth, or inflation into the five percent range for several years. Then maybe, maybe, we can talk about cooling things off. Maybe.
Or better yet, ask Scott Sumner to run the Federal Reserve.
15. February 2012 at 12:23
Good read so far. Latest Fed minutes are out by the way. Read them here
15. February 2012 at 12:29
You keep mentioning 1987 as if that crash was in the same ballpark as what we’ve seen since. The dot-com crash was several times larger as a share of GDP. The housing crash was larger still, and houses are far more broadly held than are stocks.
15. February 2012 at 12:40
A great posting, but it is tainted with “(but false) view that this recession was caused by the bursting “. Why bring that debate of causation in again. If car ‘A’ hits car ‘B’ that runs the red light, we all agree the accident was caused by ‘B’ not by ‘A’ failing to avoid ‘B’. Can you be happy with words like “monetary policy failing to adjust to housing contraction put the ‘great into ‘Great Recession'”?
15. February 2012 at 12:41
[…] Scott Sumner discusses why this doesn’t make sense for the US. However, I think it is a partially workable argument for NZ given the inflationary pressures we […]
15. February 2012 at 12:43
Scott,
“Now let’s look at NGDP growth. During this period of recovery NGDP has been growing at about 4%, which I consider tight money. So the explanation for the slow recovery is quite easy, money has been too tight.”
Now wait a second…
You are OK with 4.5% as a level target, and when I said 5.2% since 2000 adds up to a big lift over 4.5%…
You waved it away. In your case .7% YOY too high is no big deal, money wasn’t too loose.
BUT, when it is 4%, and off by .5% YOY you say that is too tight.
Look, I’m kinda bummed because I have saying exactly this for 18 months, that the critical story line for you is 2000-2006, because in order for you to be right, you MUST admit the trend path was higher than normal.
You have never taken that seriously.
And now, you are.
And during that rebuttal, you are now getting REALLY NIT-PICKY about .5%-1% YOY
But just last week you waved away .7% YOY too high.
——
Scott, you have admitted before countless times, that in order for the expectations of Fed action to be real, the FED has to be just a stingy on the topside as the bottom side.
But you aren’t that stingy.
And if YOU AREN’T, how can we expect the Fed to piss on booms at 4.5% trend?
15. February 2012 at 13:10
From the Fed Minutes:
“One participant reported that a survey of business inflation expectations indicated firms were anticipating increases in unit costs on the order of 1¾ percent this year, just a bit higher than last year.”
Fantastic, so who is the clown that thinks small sample size surveys will produce a more accurate forecast of inflation this year than the multi-trillion dollar treasury and TIPS markets?
15. February 2012 at 13:19
If there was a semi-permanent downshift in trend RGDP, this should show up as an increase in inflation expectations, holding NGDP growth constant, i.e. what Bullard calls a “decline in potential output” looks quite similar to a supply shock. Is there any evidence at all for this POV?
15. February 2012 at 13:35
I generally disagree with Bullard, but let me try to offer the most favorable interpretation I can.
“But NGDP growth followed a fairly stable path along a 5% trend line after 1990. It might have been slightly too high in 2007, but nothing of the sort that would cause a major crisis. The second reason is that between 1929 and 2000 we didn’t seem to have bubbles that influenced the business cycle.”
It’s not just that 2007 was an anomoly, but rather than the entirety of 2001-2007 was off, and perhaps much earlier (1987 forward). This would be reflected in an economy driven by unsustainable consumption due to debt and trade balance. In other words, that NGDP growth (given our structural policies) should only have been 4-4.5% in those years, and that by 2007 we’d built up a total of 8-10% above “natural” rate bubble that popped. The popping was not a paper wealth loss so much as a sudden awareness of less real wealth (the houses we had were not sustainable due to operating costs, and so had to be marked down in a real sense), while debt still needed to be paid back at nominal rates. This means reduced consumptionto repay debt.
But again, this is a fundamentally distributional argument – wealth shifted out of the hands of those wanting to consume (net debt has no relationship to aggregate wealth, so why should it affect AD?).
I think there’s one MAJOR component of the argument that Bullard is missing. In a closed economy, decreased consumption of resource inputs (did you now that US TOTAL oil, gas, electricity consumption has been DECREASING for the last 4 years?) would drop input prices massively, cutting inflation, and allowing the FOMC to substantially reflate the economy while keeping to a 2% inflation target. HOWEVER, demand for globalized commodities elsewhere has prevented this collapse and thus prevented the Fed from engaging in reflation – OTOH, if this is the case, we should expect to see that US exports are picking up (they are, but real economy reacts slowly due to many years of sapped production due to the overvalued dollar).
15. February 2012 at 13:37
Scott,
Good stuff, as usual. Did you see this paper?
What Explains High Unemployment? The Aggregate Demand Channel
http://faculty.chicagobooth.edu/amir.sufi/MianSufi_WhatExplainsUnemployment_Nov2011.pdf
Abstract:
“A drop in aggregate demand driven by shocks to household balance sheets is responsible for a large fraction of the decline in U.S. employment from 2007 to 2009. The aggregate demand channel for unemployment predicts that employment losses in the non-tradable sector are higher in high leverage U.S. counties that were most severely impacted by the balance sheet shock, while losses in the tradable sector are distributed uniformly across all counties. We find exactly
this pattern from 2007 to 2009. Alternative hypotheses for job losses based on uncertainty shocks or structural unemployment related to construction do not explain our results. Using the relation between non-tradable sector job losses and demand shocks and assuming Cobb-Douglas preferences over tradable and non-tradable goods, we quantify the effect of aggregate demand channel on total employment. Our estimates suggest that the decline in aggregate demand driven by household balance sheet shocks accounts for almost 4 million of the lost jobs from 2007 to 2009, or 65% of the lost jobs in our data.”
I think its an interesting approach and novel to me. I’d be curious to hear your thoughts, if you get a chance to look at it.
15. February 2012 at 13:52
The evidence continues to mount that “structural” theories of the recession have been completely wrong and yet these theories remain as popular as ever.
I wonder how Bullard accounts for the fact that nominal wages are growing at their slowest rate since the1930s. Does he think it could possibly be related to the fact that we’ve had the weakest 4 years of NGDP growth since the 1930s? Or is that just a coincidence?
Scott, I disagree with you about the concept of potential output (LRAS). I find it absolutely essential to talk about the productive capacity of the economy when trying to swat down bizarre Bullardesque and PIMCOesque theories of “structurally weak aggregate demand”. Yes, you can’t measure it precisely, but you can come up with a reasonable range of estimates. Whatever potential is, we’re nowhere near it now.
Also, Bill Whyte was another big proponent of structural theories. Back in 2009, he argued that we were not only building too many houses in 2006 but too many cars as well. He claimed that auto sales would remain at their recessionary trough for years to come because we could never really afford all those cars that we were buying in 2006 – it was all just a “debt-fueled bubble”. I wonder if he’s noticed that as employment has improved in recent months so too have auto sales and motor vehicle assemblies. Motor vehicle sales are right about where you’d expect given the level of the unemployment rate (and the recent change in the unemployment rate given the vehicle sales tend to lead the cycle somewhat).
For all the exotic and bizarre theories out there, when you look at the data, you can see that everything you need to know about this recession you learned in macro 101 – or, even better, in Krugman’s baby-sitting co-op piece. Now only if we could get someone to print more script…
15. February 2012 at 13:59
Scott, you write:
“This is doubly wrong. There is no reason to assume that building too much investment goods (housing) would cause people to want to build fewer consumer goods.”
Actually, this is possibly wrong. It’s plausibly the case:
1) Housing is a large part of income and wealth
2) Cost of house maintenance increases (energy costs, etc.), and/or perceived cost increases relative to future expectatiosn of asset values (a perceived wealth effect)
3) Consumers repurpose income to expenses (or, repurpose expected income – which is to say net debt – to house maintenance)
4) Less income remains to cover other goods. In this sense, Housing is like a Giffen good… if you think of the cost of housing as: yearly maintenance cost – (net expected future price – price paid)/years held, the perceived COST of housing increases as house price decreases (particularly if cost is mortgaged), and this causes people to cut consumption elsewhere (even if credit is available).
5) If we argue that there was a long period of people living beyond their ‘sustainable’ means due to credit and expected house asset price appreciation, then there should be a real component to this – I would argue there is, and it’s the trade deficit.
The fundamental issue with housing policy is this – if the Fed reflates aggregate wealth (now), it doesn’t flow to the people who need it (to rebalance consumption). It flows to the people who have assets that people think will be valued in the future, which exacerbates the structural shift in the economy away from the previous demand structure (yes, demand has a STRUCTURE because people are heterogeneous and because individual demand curves for specific products are concave) and toward a new demand structure, which actually increases the dislocation.
The thought experiment? What if you took all the money the Congress is running as a deficit, and gave it out as a one time housing subsidy to 20 and 30 somethings living with their parents? Or just forgave all student debt? (ouch – the corrupted incentives!)
I don’t know how much of this I believe. It doesn’t change the fact that an NGDP target would help, at least somewhat, unless you really think that FUTURE structural dislocations resulting from future demand changes (the anti-redistribution effect of wealth concentration) will dominate the aggregate increase in AD. If you believe this (housing is a giffen good?) then you would also believe that we can’t fix the economy simply by sustaining AD – we need a targeted approach to reflate housing prices, which Bullard rejects as unsustainable. Maybe this is what people mean when they say we have to “fix housing first”.
15. February 2012 at 14:12
I agree with Bullard that the “output gap” is the “is the difference between the sticky price and flexible price level of output, not the difference between actual output and a measure of trend output as in the Irwin graph.”
IMO where Bullard gets mixed up on the “housing bubble” is that he does not see that the sharp drop in the money multiplier due to the financial crisis and credit contraction was highly deflationary. We in fact have seen “mini-bubbles” I would argue (i.e. credit contraction or velocity shocks), they were just not on the order of magnitude of the most recent one, and inflation was high enough such that the economy more quickly reverted. velocity shock = deflation = large output gap.
Now, we can get into all the reasons why ooops it turns out banks needed more capital against those loans. bottom line: lower bank leverage requires more money – IMO the proper response to a velocity shock is a compensating increase in the money supply (to the extent wages/prices are rigid). wages and prices are evidently extremely rigid. or: keep MV constant, duh.
otherwise, if there is no compensating increase, rigid wages and prices results in an output gap and a painfully slow adjustment.
or, in other more simple words: keep MV constant, and money is still too tight.
P.S. the labor supply agrument is bogus. If there was some movement into the labor force due to the “bubble,” then this would be a good time to move out and UE would drop faster. I see no bubble in labor force participation and I certainly never heard this argument before now (no one in 2007 was making this argument!). Also, as many have pointed out, many industries were affected not just housing. Also, the demand for housing has picked up in many places – just at lower price levels, proving its not about the Q its about the P. Finally, demand for rentals is still robust(and we have actually built about 1 MM new homes since 2008) proving that the demand for “housing” is not limited to single-family real estate and the ever-increasing population continues to demand somewhere to live.
15. February 2012 at 14:50
What was fascinating about the Bullard speech was the number of fine blog posts in reaction to it. In addition to you Scott there was Noah Smith, Mark Thoma, Paul Krugman, Brad DeLong, David Andolfatto, Tim Duy, David Beckworth, Steve Williamson, Matt Yglesias Tyler Cowen, and Barkley Rosser (if I left somebody out correct me, I’d love to read it).
But it was Tim Duy’s criticism was the one that drew me into commenting over at Economistview. And it was Tim Duy’s criticism that drew Bullard’s response and forced him to redefine his argument. What follows is a distillation of the many things I said there.
I was perplexed by his original speech because of his seeming misunderstanding (unlikely because he’s a very smart fellow) of how potential RGDP is estimated. I thought he might actually be responding to NGDP targeting and had mispoken (or elided). His response to Duy’s criticism makes it clear he was indeed referring to potential RGDP.
In his revised argument he essentially seems to be saying that our estimates of potential output are highly questionable and that we were over capacity due to the housing bubble and not as much under capacity now as thought.
If so there has to be some empirical reason for making such a claim. Certainly during 2004-2008 core PCE was rising at more than 2% a year but at no time did it rise by more than 2.3% on an annual basis. If you believe in the accelerationist hypothesis this is hardly symptomatic of an economy that was much above capacity. Moreover if 2% is the Fed’s implicit inflation goal then it should be noted that the average rate of increase in core PCE over the ten years through 2007 was 1.9%.
Second most of the economy’s problems started after the housing bubble had already greatly deflated. The big implosion in real GDP did not occur until 2008Q3. Real residential construction had declined by 40.9% from 2005Q4 through 2008Q2 and real housing prices (Robert Shiller) had declined by 23.7%. And yet the unemployment rate was only only 5.2% in 2008Q2. So the housing bubble had undergone considerable deflation without so much as burp macroeconomically.
Third if a massive technological change or misallocation of resources has suddenly caused the value of the marginal product of workers to decline then we should see this in the data. Instead what we see is:
1) Employment Dispersion
If the source of unemployment were structural we should see great dispersion between sectors in terms of employment growth such as we saw in the 1974-1975 recession. That is not the case. Every sector with the exception of utilities, educational and health services, and government, suffered large declines in employment (about 7%-23%) from peak to trough. Employment growth dispersion in this recession is unusually small lending strong evidence that current unemployment is overwhelmingly cyclical, not structural or technological.
2) Job Openings Rate
Not surprisingly, given the lack of disperson in job growth, employers are having little difficulty filling openings. The job vacancy rate plummeted from 3.3% in mid 2007 to 1.6% in July 2009. It had never fallen below 2.3% prior to this recession. This is hardly consistent with the sectoral imbalance or negative technological shock point of view.
3) Unit Labor Costs
Given that employers are having little trouble filling vacancies it should come as no surprise that compensation is no longer rising faster than productivity as would be consistent with a positive inflation rate target. ULC rose by a modest 1.6% annual rate in the ten years through the fourth quarter of 2008, hardly consistent with an overheated economy. It plunged by 4.9% through 2010Q4. That is certainly not consistent with the structural or negative technological shock hypothesis.
So I see no reason to question the CBO’s estimates of potential RGDP.
And Tim Duy referred to this statement:
Bullard said:
“As Basu and Fernald stress, we need a full DSGE model to be able to discuss the appropriate measure of the output gap for monetary policy.”
I hadn’t actually noticed how imperative his statement was when I read it the first time. I think it’s quite revealing.
Granted, DSGEs can be useful in providing insights into the workings of the macroeconomy. But they also have significant defects. As Tim Duy notes (via Menzie Chinn) it is possible to generate some very counterintuitive results using them (such as we currently are above potential RGDP). The value of the CBO’s approach to estimating potential RGDP (and similar approaches) is precisely that it takes into account measures of capacity.
I don’t disagree that a full DSGE model of potential RGDP might be valuable. But that remains to be seen, and I’m not holding my breath. I don’t feel the *need* for it as Bullard apparently is so overwhelmed by. Perhaps that’s because I’ve always had a great deal of scepticism of DSGEs (and their predecessors, the RBCs) despite that fact that (for some bewildering reason) they form an important part of the current published research.
But in the final analysis, as you’ve noted Scott, we shouldn’t be basing monetary policy on guesses about where the “potential output” is, as no one really knows where it is. I think Bullard’s comments on potential RGDP are a huge distraction from how poor a job the Fed had done with respect to NGDP since 2007.
15. February 2012 at 14:53
cthorm:
“One participant reported that a survey of business inflation expectations indicated firms were anticipating increases in unit costs on the order of 1¾ percent this year, just a bit higher than last year.”
Oh how terrible! A 1.75 percent increase in unit costs–and we are in the deepest recession since the Great Depression. Oh boo-hoo. This means we have to really crank down on the money supply.
Is this not the most timid group of ninnies ever assembled in one place in human history?
They are quivering at the thought of possible inflation, when the GDP is 13 percent below trend and labor participation rates are falling to historic lows?
Chuck Norris, please channel Scott Sumner and join the Fed board.
15. February 2012 at 15:11
The recession was not triggered by the bursting of the housing bubble? Could you point me to documents explaining your point of view?
Thanks.
15. February 2012 at 15:14
Modern macro models really don’t have much of a place for bubbles, except to the extent they throw monetary policy off course and lead to excessive NGDP growth.
Ergo the utter fallaciousness of modern macro modelling that fails to take into account the fact that monetary policy generates bubbles and “excessive NGDP growth.”
15. February 2012 at 15:17
Of course you could make a “recalculation” argument, but that wouldn’t fit Bullard’s claim of a semi-permanent downshift in trend output.
Of course it would, especially when the central bank put interest rates even lower, preventing recovery, and the Treasury has been borrowing and taxing and spending, also preventing recovery.
A semi-permanent downshift in output is exactly what is expected by the recalculation argument.
15. February 2012 at 15:19
Now let’s look at NGDP growth. During this period of recovery NGDP has been growing at about 4%, which I consider tight money. So the explanation for the slow recovery is quite easy, money has been too tight.
5% – 4% = 1%
1% less NGDP than the supposed ideal is supposedly responsible for the slow recovery? Give me a break! This is a textbook example of cognitive dissonance.
15. February 2012 at 15:23
Here’s my problem with “X industry did it” arguments. What is the contagion factor? What makes X industry’s problems spread across economy? Monetary arguments lack such a contagion problem, because in a monetized economy, all industries are in the money game.
Let us suppose we have a housing industry downturn. Why would not other industries then bid for the available resources? Sure, there are adjustment issues (but not in, for example, credit) in shifting labour and other resources but these will vary greatly. Either way, any negative contagion effect from some wealth-hit will be counteracted by positive contagion effects of not competing for resources. It is not as if the history of capitalism is not full of industries waxing and waning over the same time period.
Even if people are “de-leveraging”, this will have major differences in effects depending on whether (nominal) incomes are growing strongly or not. And we are back to “if X industry is sliding, what’s wrong with income from all the other industries?”
But I guess were are also back to why no mini-recessions territory.
15. February 2012 at 15:26
There is no reason to assume that building too much investment goods (housing) would cause people to want to build fewer consumer goods.
Houses are not investment goods unless they are bought for the purposes of making subsequent sales. In some cases houses are bought not for these purposes, and so those houses are consumer goods.
The same pick up truck can be either a capital good or a consumer good, depending on the purpose the owner has for it.
It’s not the physical character of goods that makes them investment goods or consumer goods, it’s their purpose.
And it’s not about wants, it’s about possibilities. If more houses are going to be built, then less of everything else is possible at that time. The only way to build more houses is by producing less of other things at that time. Of course investment goods that go into the production of other goods, like machines (and not houses as consumer goods), can reduce the output of consumer goods in the present, but then lead to more consumer goods in the future. The state doesn’t care much about this because they only want to keep nominal spending from dropping too much because they just want to tax, and taxation just falls on “spending”.
15. February 2012 at 15:39
The Fed’s current position is very similar to the Fed’s stance in 1932″”they’ve done their job, provided low rates and a greatly enlarged monetary base, now why isn’t the economy recovering?
Because “their job” is actively preventing economic recovery and just ensuring the banks and Treasury are liquid. “Their job” is preventing recoordination on the basis of economic calculation. Who knows what people’s temporal preferences are? The interest rates are not communicating this, because they’re set by the state. Who knows what people’s cash preference and desire to spend is? GDP/NGDP/GNP/etc are not communicating this because they’re set by the state.
I think we now know why the economy wasn’t recovering in 1932, money was way too tight.
A. The Fed in the early 1930s, just like in 2008, flooded the banks with inflation. The Fed wasn’t too tight, the banks and the people weary of a crash were correctly tightening. Any more loosening and it just would have made a bad situation worse. The Friedmanite claim that the Fed wasn’t loose enough in the early 1930s is contradicted by the facts.
As soon as FDR adopted a (Woodfordian) price level target, the economy turned around on a dime.
False recovery not in line with real consumer preferences. FDR brought about an increased waste of resources that no doubt encouraged worker toil and resource usage, but that doesn’t mean the people were better off for it. It’s like saying it’s better for a person to be a guaranteed worker producing for the state’s interests that come at the expense of real consumer’s interests, than an unemployed free worker looking to work for the consumer’s interests that don’t come at the expense of anyone’s interests.
15. February 2012 at 15:46
So if I understand Bullard correctly there was a sudden realignment of the expected value of living in areas with the housing bubble and a bunch of people dropped out of the workforce because they no longer wanted to move to Miami. I must be getting that wrong.
If not though I think you’re right that people are just assuming that housing caused the recession and trying to figure out a plausible way that happened. You noted that it’s easier to tell a Keynesian story with a sudden shift to savings but that doesn’t make sense to me either. If people no longer wish to live in bubble regions as badly wouldn’t they save less and consume more? Certainly people who owned existing stock would save more but I think that would be offset by people would have bought from existing owners but now don’t feel like it.
15. February 2012 at 16:25
Off topic Scott but any comments on this?
“TOKYO “” Hoping to win its long-futile battle against falling prices, Japan’s central bank on Tuesday said it would try to kindle inflation, setting a goal of 1 percent, by pumping tens of billions more dollars into the economy.”
http://www.nytimes.com/2012/02/15/business/global/battling-falling-prices-japan-sets-an-inflation-target.html?_r=1&ref=business
So “price stability” is no longer the BOJ’s stated goal. Will this be perceived credibly?
15. February 2012 at 16:48
Scott, you’ve studiously avoided engaging the explanations of BIS chief economist William White & his research teams or the Credit Suisse economists who lay out how the changing size and liquidity of near money assets and reserves (i.e. the massive expansion and contraction of “shadow money”) interacts with the supply and demand of various kinds of money — and with the coordination of production structure of the economy across time.
For William White’s work, google “William White” and “BIS” .
For the Credit Suisse economists on “shadow money” go here:
http://hayekcenter.org/?p=2954
The expansion and contraction of various kinds of near monies and substitute monies and reserves is a significant aspect of what took place, and housing mortgage securities and house asset values played a central role in all of this.
There are many books and papers on this topic. You consistently avoid engaging them.
15. February 2012 at 16:57
If you use a productivity norm like former BIS chief economist William White does, then this statement is simply failing to understand how increasing productivity requires “inflation” — monetary expansion — to maintain “stable prices”:
Scott writes,
“Interestingly, this is exactly that same argument that the Fed used in the 1930s; “Do mean you want us to go back to the false prosperity of 1929?” Most economists would now say; “Yes. The 1927-29 expansion saw no inflation at all. There is no evidence the economy was overheated in 1929.””
In other words, you are BEGGING THE QUESTION.
See George Selgin _Less Than Zero_ to acquire a basic understanding of the productivity norm.
15. February 2012 at 17:02
“Here’s my problem with “X industry did it” arguments. What is the contagion factor? What makes X industry’s problems spread across economy?”
X = financial sector
When suddenly the liquidation value of every bank is negative, that’s a problem for the entire economy.
15. February 2012 at 17:25
Ben, Don’t look now, but Japan may be taking baby steps toward inflation.
Cthrom, Anything interesting?
DR, I usually compare 1987 to 1929, the size of the crashes were almost identical. I’m not saying that it was exactly the same as the housing crash, but I don’t see why the fall in the prices of stocks or housing would make people want to work less.
D. Gibson, You said;
“Can you be happy with words like “monetary policy failing to adjust to housing contraction put the ‘great into ‘Great Recession'”?”
Even that would be a big improvement over the status quo.
Morgan, You keep forgetting about level targeting. After a big drop you need a short period of catchup growth.
Cthrom, Yes, and even that suggests money is too tight.
anon, No there isn’t, but in fairness we don’t know what sort of NGDP growth the market expects.
Statsguy, It seems to me you are confusing nominal and real GDP. Nominal GDP is never unsustainable. But in any case NGDP growth slowed sharply in the 1980s, then slowed again in the 1990s, then slowed again in the 2000s. Indeed fell so much in the 2000s that we fell into the “liquidity trap”. And you seem to be saying the problem is that NGDP growth didn’t slow even more?
Charlie, Obviously I agree with the conclusion, but I’m not really sold on cross-sectional studies of macro questions. But I should spend more time reading it and thinking about it before saying any more. For instance, it doesn’t really show the housing crash was the cause of lower AD, just that AD fell more in states with a bigger crash. But those are two very different questions. I’d like to see what critics who favor the structural view think of the study.
Gregor, Perhaps you can come up with reasonably good estimates, and hence you might be right, but I don’t think we can measure it well enough to use as a guide to monetary policy–that was my point. With NGDP you don’t need to estimate potential GDP.
Statsguy, I can buy your argument that consumption might fall (especially via a smaller trade deficit.) I can’t buy the argument that less wealth would make people work less hours.
dwb, I agree that the labor bubble idea wasn’t well thought through.
Mark, I agree. I think on reflection Bullard realized that his argument that output was too high in 2006 was hard to justify, especially given that core inflation was low, as you say. I think that’s why he mentioned a “labor supply bubble” or something like that. It seems like quite a stretch to me.
L. H. Kevil. You could google my National Affairs piece, or there is a link in the right column to it.
Major Freeman, If you favor level targeting, the 5% isn’t ideal during recoveries.
Lorenzo, I agree.
Major Freeman, As far as I know all economists consider houses a capital good; they often last much longer than factories or strip malls.
I wish we could have a “false recovery” today.
e. I’m puzzled too.
Mark, That’s semi-important, I’m planning a post.
15. February 2012 at 17:32
Greg, I don’t have time to respond to every paper out there.
I did a post pointing out that even NGDP growth was slow in the 1920s.
Max, Yes, but how does that affect NGDP?
15. February 2012 at 17:44
Scott-
Yes, I saw the BoJ is going to target 1 percent inflation. Well, 20 years too late, and three percent would have been better (even 20 years ago).
BTW, unbelievably Richard Fisher went to Japan in 2010…and lectured them on the perils of inflation. This was a nation that has had more deflation and than inflation for 20 years, with great injury to their economy.
15. February 2012 at 19:15
Scott, under level targeting the effect of a big drop or ten years of pump is exactly the same.
Under a level target, the viciousness of interest rate racheting will be relentless if the fiscal authority doesn’t bend over and ask for more.
It won’t be any different than Greece. The futures market will insist rates go up, the fiscal authority will get pissy and refuse to stop spending, and the futures market will hit even harder.
Your plan will make Merkel look like the angel of mercy.
Level targeting under a futures market is exactly bond vigilantes who arrive every single day and squeeze Democrats to death.
Don’t pretend otherwise.
Stats, your favorable interpretation, is EXACTLY what I really think.
I really think it goes back to the GOP strategy of “spend it all”
They figure massive deficits are the only option, because it is better to not let Dems pay off their voters.
This drives an unsustainable notion of growth, and relies on the GOP having trained voters not to trust Democrats touch the economy over 30 years.
Spend it all, change attitudes, restructure the political math (SCOTUS / Redistricting), for the win.
The one GIANT unforced error, was allowing pubic employee unions to GAIN power and influence during conservatives watch.
15. February 2012 at 20:58
Scott
So if you accept that a fall in the value of housing stock shouldn’t change the natural savings rate (and I’m not sure thats right), then I think the only way you can get falling velocity is by saying that falling housing prices blew up the banks and caused disintermediation which caused velocity to crater. That seems plausible, but shouldn’t that be over by now. The XLF is still down 60% since 2007 so clearly being bank’s counterparties carry somewhat more risk than before. But still, it just doesn’t seem plausible to me that savers are hoarding cash because they don’t trust their counterparties enough to make investments. Now that we know banks are basically solvent shouldn’t that money have come back into the system and raised velocity?
15. February 2012 at 21:04
Scott if you search your own site for “level targeting” “level target” or any other turn of the phrase…
I will be using the phrase in the comments.
I will NEVER forget about level targeting, because on the top side, when public employees are getting raises, or any commodity inflation is occurring – it mean the futures market vigilantes are coming to make Congress lower regulatory burdens (drill baby drill), or make SEIU members give handjobs in the park (real productivity gains).
15. February 2012 at 22:11
“Greg, I don’t have time to respond to every paper out there.”
It’s the 5 ton elephant in the room — the interplay of unsustainable housing mortgage securities / house asset values with the expansion and contraction of various kinds of monies, near monies, reservers, and substitute monies.
It’s at the core of what Bullard is trying to get at.
It’s what William White explained to Greenspan in person at Jackson Hole in 2003, when White began laying out what in fact “just happened” to take place.
It’s what Michael Lewis and dozens of others write about in books like _The Big Short_.
It’s well explained in a Bloomberg On The Economy podcast with Credit Suisse economists James Sweeney and Carl Lantz:
http://hayekcenter.org/?p=2954
It’s out there.
It ain’t going away.
15. February 2012 at 22:44
In half-defense of “but housing crashes are worse!”: as I understand it, a construction boom is the standard way to put unused labor to work during a recession. So anything that peculiarly worsens construction, like a housing values crash, makes it harder to soak up unemployment.
My gut reaction is that “construction jobs are our key tool against recession unemployment” is more story than fact, and the key remains NGDP stabilization. My intuition is that a housing crash might make it take X amount more quantitative easing to reach your NGDP target, but it would be a detail, not a crippling burden.
But I’m not sure how to *prove* that housing crashes aren’t specially hard to recover from.
Do we have any good examples of “housing values crashed, but the overall economy rebounded just like any other recession?”
15. February 2012 at 22:51
Stephen Williamson actually gets it:
“Think of this as a collateral shock rather than a wealth shock – it’s not quite the same thing. Under any circumstances part of the price of housing is a bubble, just like money is a bubble, for example. A house is not valued only because of the stream of future benefits it provides. It is also valued because the house serves as collateral for acquiring fungible mortgage debt. Further, that mortgage debt can be repackaged in mortgage-backed securities which also serve as collateral in financial arrangments – shadow banking for example. In fact, through the process of rehypothecation, those mortgage-backed securities can be used at any given time to support multiple credit arrangements. Thus, a given house, through a kind of multiplier effect, can support a large quantity of credit, both at the consumer level, and in sophisticated credit arrangements among large financial institutions. This all feeds back to the price of the house, potentially making the bubble component of housing prices quite large.”
http://newmonetarism.blogspot.com/2012/02/three-views-of-state-of-economy_12.html
16. February 2012 at 00:24
“Yes, but how does that affect NGDP?”
Because there’s a massive contraction in the supply of credit. This is much worse than a mere stock market crash, because any company that uses short term financing is at risk for bankruptcy. Take GE as an example. This was an “AAA” rated company, and they nearly went bankrupt in 2008. The Fed prevented the worst by playing the lender of last resort role. Suppose they had not done that, and tried to use pure monetary policy. What real interest rate would make cash unattractive when “AAA” companies are going bankrupt?
16. February 2012 at 04:34
@ Mark S
“Moreover if 2% is the Fed’s implicit inflation goal then it should be noted that the average rate of increase in core PCE over the ten years through 2007 was 1.9%.”
One could argue this is because the overvalued dollar (due to foreign borrowing) permitted the trade deficit to artificially suppress inflation.
@ Morgan
Note that I don’t necessarily believe my own arguments here – I’m just trying to figure out what Bullard is saying
16. February 2012 at 04:44
@ ssumner
I’m not saying the problem is NGDP was too high in 2007/2008, I’m trying to figure out how Bullard could possibly make sense.
I do think consumption was too high leading into 2007 due to the overvalued dollar and trade gap (or, if you prefer, lack of real savings). You can think of housing not as an investment good, but as a commitment to future consumption.
I _personally_ think the problem is this – we had unsustainably LOW inflation leading into 2007 due to the 1990s successes, high dollar, low oil for the previous 15 years. This permitted a consumption increase, including a commitment to future consumption in certain sectors (low mpg cars, bigger houses further from work, more debt). This was supported via debt and trade deficit.
In 2007, long term expectations changed (various arguments above) and the value of the dollar required to clear the labor market suddenly changed because people were less willing to borrow to consume (and thus sustain the trade deficit) and imports began to grow more expensive because foreign demand for dollars decreased. To make everything clear, we actually need a LOT of inflation (and dollar devaluation), preferably in one big chunk. Not gonna happen on Bullard’s watch, says him.
Bullard is very sensitive to the accelerationist charge, btw. It’s a very common attack on the NGDP targeting position.
16. February 2012 at 04:58
Scott:
As you know, I use the CBO potential output measures frequently.
There has been a large decrease in the growth rate of potential according to them over the last decade. While the U.S. has stayed closs to a 3% growth path for real GDP for a very long time, currently the U.S. is about 5% below that growth path.
In other words, just about half of the shortfall of real GDP from trend today is due to a decrease in potential according to the CBO. The other half is real GDP below potential.
The chart that Bullard refers to in the paper is the CBO measure. You can see how potential output growth slows down. If you put a trend of real GDP from 84 to 2008 or potential from that period, you would see that they are both the same, and the current potential is way lower than that trend. Potential according to CBO is far below the trend of potential and real GDP is way further below the trend of real GDP.
Was there a big “boom” in the CBO estimate of potential during the time of the houseing boom? No. There is no such boom. For the most part, things are smooth, on the usual 3% growth path.
Now, as we move in to the 2000’s the CBO estimate of potential slows, but real GDP doesn’t, so we get a slight boom.
Bullard would have to say that the slowdown in potential started even before that, and while the estimated stayed on a 3% growth path and real GDP was pretty close to that, potenial was slowing.
This seems plausible from a CBO perspective. It is just that the same phenomenon that shows up in their estimates started a little sooner (or was just a bit more extreme.)
Nominal GDP peformed well during the period (up to 2006, and only horribly starting in mid-2008) What we market monetarists would expect is that slowing potential and stable growth path of nominal GDP would combine to create higher inflation. (From 2% to 3% or maybe 4%.) That didn’t happen, and somhow real GDP continued growth at trend (3% growth path) despite the fact that productive capacity was only growing 1% or 2%.
Can a housing boom allow that? I don’t see how. It would need to be something like sticky prices (maybe wages) in an upward direction.
As potential output grew more slowly, (resoures grow more slowly) firms try and are able to keep production from growing more slowly in order to keep from raising their prices faster than the 2% trend.
Finally, suppose the U.S. had a growth slowdown as above. Labor force grows more slowly, we consume more and save less and invest less. Everything is fine.
During this period, mexicans come work in the U.S. The Chinese put materials and equipment on boats and ship them to the U.S. In an islated area of texas, these mexican workers and chinese entrepreneurs begin constructing a bunch of houses. They are being built as retirement homes for the Chinese in 20 years. They are vacant. The entire U.S. involvement is a place to put them and it was vacant, low value desert.
What does this do to the macrostatictis of the U.S.? Housing investment in the U.S. Higher employment population ratio. More current output.
Now, if this activity just offsets the drop off of potential growth of the U.S. economy from trend, potential stays at trend. (Conincidence?)
If nominal GDP in the U.S. economy stays on trend, a deflator that is calculated using the activity in mexico as part of real GDP would stay on trend too.
The nominal GDP figure that is staying on target includes the value of all of these houses in mexico too. Nominal GDP in the rest of the economy is actually growing more slowly, so that prices keep on growing at trend.
How, the Chinese change their minds. They stop building the houses in mexico. Maybe they have enough. Maybe they regret building them. None of that matters.
The Chinese stop sending equipment and materials to the U.S. The mexican workers go home. Potential output suddenly falls.
Real output falls with it. Nominal GDP falls as well.
Now, I don’t think this story has much connection to reality. And certainly, a housing boom financed by the Chinese, organized by American entrepreneurs, with Americans actually living in the houses, and both mexican and american workers building them is more accurate. And rather than send equimpent and materials to the U.S., the Chinese send consumer goods, freeing up resources in the U.S. to produce materials and equipment to build the houses.
I don’t think this makes nominal GDP targeting less valuable. And it seems clear to me that poential income on the whole continued to grow at trend, because the immigrants and the Chinese saving are providing resouurces. It just tells a story about how U.S. productive capacity can drop off rapidly when immigration and international capital flows are taken into account.
16. February 2012 at 05:14
The only debate is (or should be) whether the Fed or the fiscal policymakers are to blame for the slow NGDP growth.
I think I agree with much of this analysis, Scott, and your location of the real debate. We need to avoid confusing the monetary/fiscal policy distinction with the distinction between central bank policy and non-central bank policy. These distinctions overlap but are not identical. The political branches of government outside the central bank can take a lot of policy decisions that can properly be regarded as monetary policy. Most of my disagreement with the Market Monetarist policy recommendations over the past few years has been due to what I see as their overestimation of the role of the central bank. The best way for the government to support additional spending is for the government to spend, and to expand the gap between its tax receipts and and its spending. You can with equal justice label this an exercise of monetary policy or an exercise of fiscal policy. Either way it is not an exercise of central bank policy.
I just don’t think you can get what is needed via CB interest rate or quantitative operations, or from the supposed powers of the central banker to orchestrate expectations.
Here’s a question I have though about Bullard. He says:
So it is not that the bubble destroyed potential, instead it is that actual output was higher than properly-defined potential during the mid-2000s, and then it crashed back as the bubble burst.
Now, this is my philosophy background speaking. But it seems to me that no matter what you are measuring or characterizing, there is no way that the actual can exceed the potential. If something was actually the case at some time, then it is by</i definition potentially the case at that time. There is no way our actual output can ever exceed our potential output, although of course our potential can itself rise over time.
Finally, I am a little bit confused about the use of the term “housing bubble”. My understanding is that those who say the housing bubble caused the crisis do not primarily mean that the crisis was caused by an overproduction of houses. What they mean is that the crisis was caused by overspending on houses, and by an overproduction of the derivative financial assets that were based on cash flows derived from the spending (or defaults in spending) on houses.
16. February 2012 at 05:16
Sorry about the excess italics. Tag fail.
16. February 2012 at 05:33
Dan Kervick,
“to expand the gap between its tax receipts and and its spending”
I think that I want to change that to “to expand the gap between its funded and non-funded expenditure”. A government can fund any particular unit of expenditure in three ways: taxation, debt or expanding the money supply. The first two are funded expenditure; the last is non-funded.
Underfunding existing expenditure would be a perfectly legitimate way of boosting the money supply, without many of the non-macro problems involved in conventional fiscal stimulus. It also is a more flexible approach than through budgets.
Whether something is “monetary” or “fiscal” is largely an institutional matter. In the UK in the early 1980s, overfunding was seen as a tool of monetary policy because it was targeting a nominal variable (the nominal quantity of money). The Green Paper on the Medium-Term Financial Strategy of 1980 actually states that fiscal policy is one of the tools of monetary policy. This all makes sense if one remembers that the UK didn’t have a central bank at the time and the Treasury was indisputably responsible for macroeconomic policy.
That said, within the existing institutions of the United States, it makes more sense for the Fed to conduct QE than for the US Treasury to change its funding policy IF one grants that QE can be effective.
PS: “There is no way our actual output can ever exceed our potential output”
Isn’t that a bit strong? Perhaps I’m not quite following what “potential output” here means, since it’s fairly uncontroversial that real output can exceed sustainable levels, both in the sense of “sustainable without accelerating inflation” and “sustainable in the sense that after an unpredictable point accelerating inflation begins to reduce output”.
16. February 2012 at 05:53
Ransom:
I think White’s notion that central banks should target credit is a mistake.
If market monetarists were targeting some measure of the quantity of money, then talk about money substitutes and credit might be relevant, though _we_ would generally speak in terms of the demand for money or velocity, rather than total lending. We don’t believe that keeping the quantity of money stable will guarantee macroeconomic stability. The demand to hold that quantity can fall, which would lead to excessive nominal GDP growth. Economic forces that make “money substitutes” more attractive is one (of many) reasons that might happen.
Most importantly, slow stable growth in nominal GDP is an outward sign that there is no excess supply of money, whether this is caused by excess growth in the quantity or the a greater attractiveness of money substitutes that reduces the demand to hold money.
If monetary equilibrium is maintained, too much spending funded by debt is always equal to too little spending out of current income (or too little funded by equity) by lenders.
Central Banks can only effect things by maintaining or destroying monetary equilibirum. By avoiding or creating monetary disequilibirum. White is proposing that central bank protect lenders and borrowers from themsevles by creating monetary disequilibrium. By disrupting economic activity when they believe that lenders are making loans that they will regret (because borrowers won’t pay them back) or borrowers are borrowing too much, because they won’t be able to pay in back, they will bring what they consider excessive credit transation to a hault. Of course, the disruption creates the problem that they believe will happen later.
This mindset is awful.
From our perspective, it lots of borrowers and lenders turn out to have regrets, which is possible, or, at the very least, just slow down the amount of these credit transactions, then the sole role of the monetary authority is to maintain monetary equilibrium during this period of adjustment. Of course, that is _always_ the task of the monetary authority.
It is plausible that if lenders cut back loans, they might choose to hold more money instead. This is really not a decrease in total lending, but rather a shift in lending to banks issuing monetary liabilities or the monetary authority itself. Anyway, the monetary authority should make sure that the quantity of money rises to meet this added demand.
This is not saying that the monetary authority should make sure that borrowers can continue to borrow, or that they will be pursuaded, perhaps by low interest rates, to borrow at levels they find “too high.” That confuses money and credit, a problem inherent in White’s approach.
The goal, rather, is to make sure that an increase in the demand to hold money by lenders is accomodated. This can occur by an increase in the quantity of money or a decrease in the quantity of money demanded by paying lower interest rates on money.
As always, keeping nominal expenditure on output on a stable growth path is the the outer consequence of maintaining monetary equilibrium.
This can occur even if total lending stops growing, or shrinks. It can continue if the demand for certain goods falls, like houses, it just requires that the demand for other goods rise so that total spending on output remains the same.
That capital goods specific to producing a product lose value (say bull dozers, or your favorite, lumber rail cars,) is possible, but the demand for other capital goods, producing the final products whose demand increases rises.
If nominal GDP remains on target, and there is a need to reallocate resources, then there is at least a temporary disruption in production. Real GDP would be lower, employment lower, unemployment higher, and inflation higher during the transition. As the transtion is completed, output and employment grow faster, unemployment falls, and inflation slows. It may be that production is a bit lower and the price level a bit higher even after the transition. But it is important to understand that the trends in productivity growth includes this element. That is why it is called creative destruction. If somehow they wouldn’t have produced that last buggy whip machines, we would have been even better off than we were anyway because the horse and buggy was replaced by cars.
And Stephenson doesn’t “get it.” It is grasping at straws.
If the attractiveness of money substitutes falls (say repurchase agreements secured by AAA mortgage backed securities) then this probably raises the demand to hold money. If we count these repurchase agreements as money, then the loss of attractiveness of them and downward adjustment in quantity was an increase in the quantity of money. The monetary authority would need to maintain the total quantity of money (by engineering increases amounts of other types of money,) or from the alternative framing, the monetary authority needs to expand the quantity of money to meet the demand.
For Stephenson, this is unncessary because prices and wages will all be set so that the real quantity of money equals the real demand for money anyway. And given that assumption, any decrease in production must be due to a drop in potential output. People don’t want to work as much, for example.
Because of the loss of collateral, the credit intermediation industry is less productive. The increases in the value of output that are generated by having savers buy less and borrowers buy more, or having risky firms inititate (and realize) risky projects rather than sound firms internally finance more mundane but less productive processes is the loss in potential output.
The way intermediation recovers (despite having lost the “wonderful” shadow banking approach,) is that people hold more deposits in ordinary banks and banks make loans and hold them rather than sell them. This requires more capital (which means someone has to buy stock in banks or else they must retain more earnings.) Capital requirements make this worse. Regardless, the banks pay lower deposit rates and charge higher loan rates, earn more and build capital and make purchasing bank stock more attractive. And so, there is less intermediation to start, and maybe permanently less than when banks made loans, sold them, investment banks securitized them, and then borrowed against them overnight, so that people could have what is in effect money. And all of this down with minimal capital and so higher interest rates on the “money” and lower interest rates on the loans.
It is plausible that the more costly intermedation approach results in less of it, and this would make current consumption more attractive, and there would be less capital goods built and so future potential output is lower. But that doesn’t show up now. In the sort of models Williamson is using, how it shows up is people don’t work as much because of the less effective intermediation. That is because the models have to be very precise to “prove” something, and that is about all that can happen.
But the effects of all of this are qualitatively similar to a price ceiling on loans or deposits. Not good, but nothing like broad based inability to sell products, and reduced hiring in nearly every industry.
16. February 2012 at 06:26
Ben, That’s a great Richard Fisher story, do you have a link?
Morgan, Yes, rates could be volatile with level targeting.
e, If the demand for mortgage loans falls, interest rates will fall and velocity will fall.
Greg, If near monies are creating too much NGDP growth the Fed should offset it with tighter money.
Daniel, I just don’t see any evidence that housing crashes affect our unemployment rate. Unemployment was low in 2007.
Greg, Steven is talking about AD, which I agree is the key to the business cycle. He’s not describing why fewer Americans would want to work.
Max, You said;
“The Fed prevented the worst by playing the lender of last resort role.”
The Fed caused the crash by letting expectations of NGDP 1, 2, and 3, years out crash. That caused asset prices to tank, and dramatically worsened the financial crisis. You are confusing cause and effect. The real interest rate is endogenous. With more robust expected NGDP growth, the equilibrium real rate will be much higher. The real rate doesn’t matter, what matters is the relationship between nominal rates and expected future NGDP.
Statsguy, You said;
“You can think of housing not as an investment good, but as a commitment to future consumption.”
No I can’t. Housing is definitely a capital good. All capital goods represent the promise of future consumption, and housing is no different. Is a hotel a consumption good?
Bill, Good points.
1. Do you have a link for the Chinese houses in Texas?
2. Ideally you’d want to target NGDP per capita, which would address the Mexican emigration issue.
Dan, You said;
“I just don’t think you can get what is needed via CB interest rate or quantitative operations, or from the supposed powers of the central banker to orchestrate expectations.”
No, the central bank can certainly provide as much NGDP as we want. In all of world history no fiat central bank has ever tried to inflate and failed. But me in charge of the Fed and I’ll show um how to create inflation!
Those who point to a “too much spending channel” are generally focusing on AD. Bullard is concerned with AS.
“Potential” doesn’t mean maximum, it means maximum sustainable output.
16. February 2012 at 06:52
This is straight Hayek:
“We don’t believe that keeping the quantity of money stable will guarantee macroeconomic stability. The demand to hold that quantity can fall, which would lead to excessive nominal GDP growth.”
16. February 2012 at 06:54
“Greg, Steven is talking about AD, which I agree is the key to the business cycle. He’s not describing why fewer Americans would want to work.”
Not really.
And why change the topic? He’s talking about Bullard.
That’s the topic.
16. February 2012 at 06:55
Scott:
“Greg, If near monies are creating too much NGDP growth the Fed should offset it with tighter money.”
Right.
16. February 2012 at 07:01
W. Peden,
I don’t think I disagree with anything you said, other than to quibble about two different kinds of borrowing. If some of the borrowing is borrowing from the central bank – i.e. bonds sold to private dealers that are then bought by the CB with minimal drain to dealer profit – then it is effectively just as good as financing the spending with monetary expansion. Such “borrowing” of the government from its own central bank can be rolled over indefinitely regardless of the nominal interest rate, and is functionally the same as direct CB crediting of a portion of the principal to the treasury.
16. February 2012 at 07:08
Scott,
Let me accept for the sake of argument that a central bank running a fiat money system can always generate any level of inflation it wants, and thereby raise nominal spending in more-or-less any amount it wants as a by-product of the inflation.
My question is why would anyone in a government choose this mechanism for raising nominal spending when they also have the option of raising spending by placing new orders for actual goods and services, and then spending their fiat money on those goods and services?
16. February 2012 at 08:14
@Scott
Re: the Fed Minutes, nothing ‘interesting’ in a positive or negative sense, but definitely ‘interesting’ in a ‘is this how they spend their time’ sense.
Research staff presented 3 different studies regarding causation in consumer spending and savings rate changes. The 3 studies had conflicting results. The first found ‘changes in credit conditions’ was an important factor in savings rate changes. The second found that ‘movements in leverage from loan repayments and charge-offs’ had a substantial effect on cash flow and thus spending. The third found that almost all of the variation is explained by changes in employment, income, and net worth.
There was a “that would be funny if it wasn’t true” citation too. “Participants also considered the possible influence on aggregate consumer spending of changes in real interest rates and the distribution of income, the potential for policy actions to affect the fundamental factors driving household saving, and whether households’ spending behavior is being affected by concerns about the future of Social Security.”
Really they seem to be looking for excuses not to act. They’re sticking their noses into policy issues they should not have any influence on. At the same time, the 3rd research report presented to them suggests that they can have a very strong effect on spending b/c incomes, employment, and net worth are all easily increased through looser monetary policy. The only exception would be to ‘structural unemployment’, which is an argument I don’t really buy (in California at least the LT unemployed are mostly construction and manufacturing workers. The 1st is clearly fixed by easier money, the 2nd is really about supply-side issues of CA being a banana republic).
UC Santa Barbara (my alma mater) is going to be hosting some sort of Econ conference May 3rd, and I think most (if not all) of the Fed presidents are supposed to attend. Interested in attending? I’m going to try to go.
16. February 2012 at 08:25
“The Fed caused the crash by letting expectations of NGDP 1, 2, and 3, years out crash.”
That makes it sound like the Fed had advanced warning that a financial crisis was coming, and they ignored it. No, it came as a surprise, and the Fed had to react to events. Since extreme action was required, it’s unsurprising that they under-reacted. It’s odd to say the Fed’s under-reaction to the crash caused the crash.
16. February 2012 at 09:07
Max writes,
“It’s odd to say the Fed’s under-reaction to the crash caused the crash.”
Notice that Scott never explains how the Fed could know in advance were NGDP was headed, or why the Fed was placed in a position where it needed to respond to falling NGDP. Magic foreknowledge, magic anticipation, magic action.
Magic, all the way down.
16. February 2012 at 09:38
“housing construction over the past 10 years has been well below normal.”
The size of the houses built was way _above_ “normal”.
In Jan. of 1991 there were 600,000 housing starts.
In Jan of 2006 there were 1,800,000 housing starts.
There were never anything like that number of new housing starts in all of American history. Nothing close.
Rental apartments are substitutes for houses.
If we think like economists, we don’t think in terms of “givens” (i.e. “given” housing demand”) that aren’t related to anything else.
16. February 2012 at 09:41
Scott:
Sorry, there were no Chinese houses in Texas. I am explaining how potential output could increase in the U.S. Import all the resources. Of course, this doesn’t increase world potential output, just the location.
Kervick:
The primary reason to increase nominal GDP by monetary policy is so that the increase in real output (if any) is consumer and capital goods for the private sector rather than public goods for the politicians.
The secondary reason is that if the demand to hold money falls again, so that the quanity of money needs to fall, then with monetary poicy, the fed just sells off the assets it purchased. If the goverment just printed the money and bought stuff, it would need to sell new, interest bearing debt. And then, taxpayers would have to start covering those interest payments.
The downside to monetary policy is that if the interest rate on base money is fixed (maybe at zero,) then it is at least possible that maintaining monetary equilibrium (nominal spending on target) would involve the monetary authority taking risk on the assets it buys. Any losses would have to be covered somehow.
Private goods now, maybe a risk of loss, and maybe losses– monetary policy
public goods now, likely a future interest cost on government debt–printing money and spending it on output.
16. February 2012 at 09:53
Ransom:
I think White and Hayek are quite different.
White is wrongheaded. Hayek exaggerated the quantitative significance of malinvestment due to monetary disequilibrium. (Well, that is my opinion about the actual significance of the phenomenon.) I think Hayek gets too bogged down into worrying about whether money can be perfectly neutral, (which it can’t) and then failing to see how the distortions from just about any sensible monetary system is a drop in the bucket compared to the process of creative destruction–new products and new production methods–disrupting planned production into the future.
Well, of course, by the Denationalizaiton of Money, he seems to think rules to keep the price level stable would not cause significant problems along those lines.
Still, I think that he didn’t see that an inflationary equilibirum does not generate persistent malinvestment. Or more to my taste, growth of nominal spending on output consistent with stable prices does not create systematic malinvestment. It can’t be neutral, but it doesn’t bias production towards the future. And low (or even high) inflationary equilibriums are the same. The real volume of credit matching the real supply of money matching the real demand for money, and the part of the real demand for credit funded by that part of the real supply of credit leave the real market interest rate at the natural interest rate.
But if the “test” is whether the exact allocation of resources is the same, that Hayek succeeds in showing that money cannot be perfectly neutral.
16. February 2012 at 09:58
Nominal GDP fell in 2008 because it was expected to be low in 2009, 2010, and 2011.
It is a mistake to understand the problem as being that the Fed failed to predict that nominal GDP would be low be low in 2008 back in 2005.
The idea is that the Fed must change the quantity of money however much needed in 2009 so that it will be back on the target growth path in 2010.
If people know this and believe this in 2008, nominal GDP will not fall very much.
The rule is to adjust the nominal quantity of money now to get it to target next year. If people know this, then that is what stablizes nominal GDP now (and last year too.)
If people come to think that the Fed doesn’t care about nominal GDP, and will let if fall to a permanently lower level, then it can suddenly collapse now.
And, the opposite it true as well. If people begin to think that the Fed will let nominal GDP grow 50% by the next two years, it could skyrocket immediately.
16. February 2012 at 10:41
ssumner:
“Major Freeman, As far as I know all economists consider houses a capital good; they often last much longer than factories or strip malls.”
I can tell you that I know that not all economists consider houses as capital goods.
Some economists know that if we had a more sound money economy, and the prices of everything gradually fell over time as more goods and services are produced, then houses will no longer be considered as capital goods by economists because their prices would gradually fall over time, and when the prices of houses fall over time, they would lose their character of being investments.
And yet, there would still be capital goods as such because there would still be goods purchased for the purpose of making subsequent sales. Firms would still be buying capital goods in order to produce, even if the prices of those capital goods are falling.
Inflation has had one of the effects of making economists believe that houses are capital goods. People buy houses, and because the Federal Reserve System is creating new money so fast, the prices of houses gradually rises over time. That makes people believe that because they can earn a return just by buying a house, the house is somehow a capital good.
If inflation were even higher, and even the prices of cars, old and new, rose over time, then most of today’s economists who view houses as capital goods, will probably start to view cars as capital goods as well. In fact, enough inflation can lead to the label “capital good” being attached to pretty much anything, including books, or televisions, basically anything that can be bought and resold at a higher nominal price as the money is inflated and devalued.
“I wish we could have a “false recovery” today.”
Oh please. For you to say that we are not having an inflation induced false recovery today is just an obvious hedging of your bets so that no matter what happens you can’t be wrong. You can stop pretending.
We are in fact getting an INCREDIBLE false recovery today thanks to Ben CTRL-P Bernanke. Just because NGDP is 4% instead of 5%, it doesn’t mean inflation is not affecting the economy and the employment sector. Inflation is in fact generating the increase in the economic statistics we’ve been seeing since around September. Track the aggregate money supply by looking at the Fed’s balance sheet to know where the economy is headed in terms of spending and “recovery.”
16. February 2012 at 12:12
Bill Woolsey writes,
“Hayek exaggerated the quantitative significance of malinvestment due to monetary disequilibrium.”
Perhaps so. The limited empirical studies on this typically support Hayek’s general empirical claims.
” I think Hayek gets too bogged down into worrying about whether money can be perfectly neutral, (which it can’t) ”
Hayek emphasizes how near monies / assets and substitutes for reserves gyrate in their liquidity and in their value — Hayek’s point is that there are all different kinds of inter-related “monies” and near monies and these relations are not stable, and have real inter-relations with the real economy.
This is _significant_ stuff — almost always neglected.
And it offers a powerful causal rival to simple monetarist pictures of money or the quantity theory.
“and then failing to see how the distortions from just about any sensible monetary system is a drop in the bucket compared to the process of creative destruction-new products and new production methods-disrupting planned production into the future.”
This isn’t clear at all ….
“Well, of course, by the Denationalizaiton of Money, he seems to think rules to keep the price level stable would not cause significant problems along those lines.”
The issues are different when we are talking about inter-related and competitive monies — and we are not talking about a single national monopoly money.
The relation between Hayek’s _Monetary Nationalism_ and his _Denationalization of Money_ are interesting. I haven’t seen a really good account. White’s paper on Hayek’s on money is only a first baby step.
“I think that he didn’t see that an inflationary equilibirum does not generate persistent malinvestment.”
This is a key contested question, isn’t it. And part of the problem of addressing this question is making sense of the relation of closed system models of a “national economy” to the real world of the actual wider international multi-money system.
“growth of nominal spending on output consistent with stable prices does not create systematic malinvestment.”
The issue is what is “stable” — Hayek in _Monetary Nationalism_ defines unstable prices and inflation in terms of unsustainable malinvestment.
“It can’t be neutral, but it doesn’t bias production towards the future.”
Again, this is what is at issue.
“And low (or even high) inflationary equilibriums are the same. The real volume of credit matching the real supply of money matching the real demand for money, and the part of the real demand for credit funded by that part of the real supply of credit leave the real market interest rate at the natural interest rate.”
This doesn’t engage Hayek’s counter-picture, of course. It just ignores it.
“But if the “test” is whether the exact allocation of resources is the same, that Hayek succeeds in showing that money cannot be perfectly neutral.”
The “test” is plan coordination across time involving heterogeneous plans & inputs with alternative time structures, etc.
16. February 2012 at 12:31
The primary reason to increase nominal GDP by monetary policy is so that the increase in real output (if any) is consumer and capital goods for the private sector rather than public goods for the politicians.
Well if the government buys a bridge or a school they have invested in the capital equipment of our society. Unless the only people taking classes and driving cars across the bridge are politicians, then these are not goods for the politicians.
Even if they buy desk chairs for the National Weather Service, which is a value generating enterprise, that is just as worthwhile a purchase as a private company buying new desk chairs. I suspect it would be a much better use of government fiat money than the purchase of additional financial assets and the stuffing of additional reserves in banks’ accounts at the Fed. At least in the former case the workers have better chairs to sit on and the makers of the chairs get more orders and more cash in their pockets.
16. February 2012 at 12:47
Bill Woolsey:
“The primary reason to increase nominal GDP by monetary policy is so that the increase in real output (if any) is consumer and capital goods for the private sector rather than public goods for the politicians.”
1. The Fed is not a part of the private sector. It is a government institution. When it inflates and buys non-monetary assets from the private sector, those who create those assets are essentially “producing” those assets for the Fed’s benefit, not the private sector’s benefit.
2. You are ignoring the fact that all the money the Fed earns through interest on the US Treasuries they purchase, is funnelled right back to the Treasury (less expenses and fixed dividends). More money in the Treasury means more Treasury spending, and more Treasury spending means more “public goods for the politicians.” Every time you call for the Fed to expand the money supply by buying Treasuries, you are ipso facto encouraging Treasury spending.
16. February 2012 at 13:05
Dan Kervick,
Good point. Another kind of funding which I forgot is borrowing from commercial banks, especially through close money subsitutes. Monetary policy in Britain from about 1914 until the 1960s largely operated via the Treasury controlling the short-term government debt market. In a few periods (1932-1939 and 1952-1960) this even produced some notably good monetary policy. Of course, in other periods, monetary policy was epoch-makingly bad.
16. February 2012 at 13:10
“But where is the evidence for this? I think everyone agrees that housing construction was too high in 2004-06. But that doesn’t mean RGDP was too high. After all, the resources that went into housing could have come at the expense of other sectors. Housing is only about 5% of GDP. ”
The housing bubble had nothing to do with construction and everything to do with the rise of total asset value 2002-2006.
This rise was driven by the 2001-2003 tax cuts and the 2002-2004 easing of interest rates from 8% to 5%, and the further easing of down payments and loan underwriting, and the introduction of actual suicide lending products — negative am, interest-only, and teaser-rate loans with pre-pay penalties (all now banned).
This resulted in the mother of all asset bubbles, peaking in 2005, and trillions of this phantom equity was liberated via serial cash-out refis and outright HELOC junior liens.
here’s the gross debt bubble:
http://research.stlouisfed.org/fred2/series/HHMSDODNS
here it its annual growth as a percent of wages:
http://research.stlouisfed.org/fred2/graph/?g=547
Need any more evidence?
16. February 2012 at 13:24
Major Freedom:
If the quantity of money expands through lending, then any consumer or capital goods produced are directly produced for the borrowers.
While it is true that the banks who make the loans have assets matching those loans, it is also true that the depositors who lend to the banks have assets matching the banks’ liabilities.
So, there is some sense in which that monetary policy is creating “assets” for those desiring to hold money. But still, in the end, these are matched by private consumer or capital goods that individual households and firms want to buy.
Leave out the Fed, and imagine someone buys a 5 year CD in a bank and the banke makes a 5 year car loan and some person buys a car.
You seem to be saying that the car was produced for the bank. That is an odd stopping place for the analysis.
As for complaints about the Fed’s interest earnings, there is no reason to assume that the Treasury earnings from the Fed involve more government spending. It could involve less other taxes. It depends.
But I favor free banking, which takes away that source of government revenue. Still, it is a drop in the bucket.
16. February 2012 at 13:34
Doesn’t Beckworth argue that 2001-2006 NGDP was indeed above trend? As I understand it, his argument is somewhat in line with Woolsey’s comment above hinging on a TFP adjustment possibly from Chinese import related productivity.
16. February 2012 at 17:47
“If people come to think that the Fed doesn’t care about nominal GDP, and will let if fall to a permanently lower level, then it can suddenly collapse now.”
Yes, but it can suddenly collapse now even if people don’t think it will fall to a permanently lower level. Stabilizing long run expectations doesn’t prevent crashes, it just helps the economy to bounce back from them. The only way to prevent crashes is to somehow regulate term mismatched financing out of existence, so that investors are ‘locked in’ and can’t flee their investments.
16. February 2012 at 18:46
Bill Woolsey:
“If the quantity of money expands through lending, then any consumer or capital goods produced are directly produced for the borrowers.”
I was referring specifically to inflation from the Fed when they buy assets. The Fed is a government institution, and so monetary policy is just the other side of the same coin as fiscal policy when the issue is producing for the government’s benefit.
“While it is true that the banks who make the loans have assets matching those loans, it is also true that the depositors who lend to the banks have assets matching the banks’ liabilities.”
“So, there is some sense in which that monetary policy is creating “assets” for those desiring to hold money.”
The assets you’re referring to are not net assets. Those who want to hold money are punished by monetary policy because their cash holdings depreciate in value.
“But still, in the end, these are matched by private consumer or capital goods that individual households and firms want to buy.”
They are not matched. You’re omitting the substantial amount of new money that is created by the Fed that leads to assets being taken out of the economy, with no goods or services or assets being put back into the economy. To take assets out of the economy, only to put money into the economy, means those who create those assets are working for the government’s benefit. If the Fed buys treasuries, then the government is just monetizing the debt it borrows and those who work for or hold dollars at all are paying for it.
“Leave out the Fed, and imagine someone buys a 5 year CD in a bank and the banke makes a 5 year car loan and some person buys a car.”
“You seem to be saying that the car was produced for the bank. That is an odd stopping place for the analysis.”
No, I am not assuming that at all. You conveniently left out the very institution that my argument was centered around. Don’t leave out the Fed, and imagine the Fed buying a MBS created by and owned by a financial institution. Here, the financial institution is creating a MBS for the Fed’s, and hence the government’s, benefit. They are paid for by the government’s central bank. So it is silly to say that monetary policy avoids the problem of people working for the government’s benefit.
As for your example of the 5yr CD, this is not an inflationary action. The lender gives the bank money in exchange for a 5 yr CD, and the bank gives the car buyer a 5yr loan. This is a legitimate real savings leading to the purchase of a durable consumer good financed by those real savings.
“As for complaints about the Fed’s interest earnings, there is no reason to assume that the Treasury earnings from the Fed involve more government spending. It could involve less other taxes. It depends.”
“Complaints”? No, just analysis. If the state can get away with spending more money without raising taxes, by borrowing money, after which the Fed buys the debt and then funnels the money back to the Treasury, the incentive to do so will persist.
“But I favor free banking, which takes away that source of government revenue. Still, it is a drop in the bucket.”
I favor 100% reserve free banking, which takes away the source of the business cycle.
17. February 2012 at 06:30
Greg, At least we agree about NGDP.
Dan, Because it’s much more efficient. Deficits are highly inefficient, they lead to higher taxes which have deadweight costs.
Cthrom, Thanks for that good summary. Regarding the conference, that might conflict with finals. In any case, I’d only be able to go if the conference paid my expenses. But thanks for the invitation.
Max, No advanced warning was needed, just soothing words when the crisis developed. The Fed didn’t provide any soothing words. The Fed meeting after Lehman failed would have been a good time.
Greg, I knew NGDP was crashing in late 2008, the markets knew, is it too much to expect the Fed to know?
Greg, You said;
“There were never anything like that number of new housing starts in all of American history. Nothing close.”
That’s false. My data is accurate.
Bill, I agree about the importance of NGDP expectations.
Major Freeman, Can you find an econ textbook that doesn’t call houses capital goods?
Troy, But that weakens Bullard’s argument, as it suggests the problem was AD.
OGT, Yes, for 2004-06, but I would argue it was only slightly above, nothing unusual.
Max, In most cutting edge macro models current NGDP is highly influenced by future expected NGDP, in a way analogous to how current commodity prices are strongly influenced by future expected prices. (See Woodford, etc.)
17. February 2012 at 08:35
“No advanced warning was needed, just soothing words when the crisis developed. The Fed didn’t provide any soothing words. The Fed meeting after Lehman failed would have been a good time.”
Soothing words! No, they needed to take radical action at that point. Like setting a hard floor on the S&P 500, for example. That probably would have stopped the panic (and not required any actual purchases), but it’s way outside the box for central bankers.
17. February 2012 at 11:01
“But that weakens Bullard’s argument, as it suggests the problem was AD.”
I’m more in Keen’s camp here, which says both Bullard and eg. Krugman are wrong.
The way I see things, debt-take on was what got us out of the tech recession in 2002-2003 and after that we had the wolf by the ears and could not let go.
http://research.stlouisfed.org/fred2/graph/?g=558
This was a stealth stimulus — monetary injection — that was hitting the middle quintiles directly, but the problem was that this was BORROWED money, from the world’s “savers”.
The underlying actual imbalances that pushed us into the tech recession remained during the housing boom/bubble and remain now.
The Fed could re-create that trillion/yr stimulus with printing now, and, yes, that would raise AD, but a sustainable economy needs to do more than just power demand.
It has to pay its way in the world — create more wealth than it consumes — and ours is far, far from that now.
Our fraudulent system has allowed phantom valuations to increase and become supported by fiction. We need to double the tax rate in this country, but that would slaughter housing values. Instead, we just dig the hole deeper, following the path that Japan did, with a little bit of Greece thrown in.
It is very annoying to me that the Krugman side of the debate does not see this, or at least does not argue it.
17. February 2012 at 23:18
What I said is not false.
Why say things that untrue, when I made the fact of the matter a click away.
Bizarre.
17. February 2012 at 23:20
Remind me of your account of why it was crashing.
” I knew NGDP was crashing in late 2008, the markets knew,”
18. February 2012 at 07:53
Max, You said;
“Soothing words! No, they needed to take radical action at that point. Like setting a hard floor on the S&P 500, for example. That probably would have stopped the panic (and not required any actual purchases), but it’s way outside the box for central bankers.”
Reread what you said. Is your parenthetical remark exactly my point?
Troy, You said;
“The Fed could re-create that trillion/yr stimulus with printing now, and, yes, that would raise AD, but a sustainable economy needs to do more than just power demand.”
You don’t need to convince me, I’m a (moderate) supply-sider. But we also need stable growth in AD.
Greg, Here’s a link showing 2,000,000 housing starts in 1978, when the US population was much smaller.
http://www.nahb.org/generic.aspx?genericContentID=554
So you are wrong, as I said. And housing starts from 2002-11 have been unusually low.
I knew NGDP was crashing because the markets were predicting it.
18. February 2012 at 07:54
Greg, Plus, If you are right about all those bull-dozed houses, then our shortage is even worse than the numbers suggest!
18. February 2012 at 09:27
[…] standard reply to this, as provided by by Scott Sumner, Tim Duy, Mark Thoma and Paul Krugman, takes the form of: If actual output was above […]
18. February 2012 at 15:52
“But we also need stable growth in AD.”
this is a catechism IMO.
Per-capita health care costs twice the global average, high rents in real estate, housing still unaffordable, $600B/yr being sucked out of the paycheck economy via the trade deficit — we have a distribution problem, not a demand problem per-se.
The way I see it, the middle class is leaking like a sieve, and that’s why low velocity is killing us.
Fix these systemic leaks and we’d have a better quality of life — more than just artificially stimulating demand with free money from on high.
19. February 2012 at 00:20
ssumner:
“Major Freeman, Can you find an econ textbook that doesn’t call houses capital goods?”
I didn’t say houses cannot be classified as a capital good. I said that not all houses are capital goods. If a house is purchased for the PURPOSE of making subsequent sales, like being rented out, then it is a capital good. If it bought for the purposes of occupying/living, then it is a consumer good.
As for textbooks that do not define houses as capital goods:
Capitalism, by Reisman.
Man, Economy and State, by Rothbard.
You’ll tend to see houses defined as consumer’s goods in Austrian textbooks.
19. February 2012 at 06:49
Troy, Everything you said is irrelevant. Free money from on high? I don’t even know what that means.
Major Freeman, Houses are of course built to be consumed. All houses are capital goods.
I don’t consider those textbooks.
20. February 2012 at 09:16
“Everything you said is irrelevant”
No, it is the core of my thesis of our economic problems.
Our health care costs are $4000 per capita over the OECD average. That’s $10,000 per household of economic rents flowing from the middle quintiles to the top 10% — ~$1T/yr.
Each household pumps 1000 gallons of gasoline a year. That’s $2000 or so of rents — $250B/yr.
And then there’s rent itself, for housing. That’s closer to a trillion too, flowing out of the middle quintiles.
Plus the trade deficit is ripping another $500B/yr+ out of the paycheck economy.
I find it odd that economists simply fail to *follow the money* with these flows.
When we incur a $300B/yr trade deficit with China, how much of that money came from middle class wages and how much is going to return to the US wage earner as wages eventually?
Economics is too much about abstract modeling and not enough about simply modeling the actual economy. It’s like weather forecasting without using maps.
And for “money on high”, I meant ‘helicopter money’, Fed injections that actually hit the working class, like mortgage purchases or student loan forgiveness via printing.
The 2002-2007 period saw the redistribution of SIX TRILLION dollars from the world’s savers to the US consumer, via the housing debt bubble:
research.stlouisfed.org/fred2/series/HHMSDODNS
That was also “money from on high”, but it was borrowed and not printed.
I don’t know which is worse.
20. February 2012 at 09:35
I’m no Austrian but I agree with Major_Freedom that housing is a consumer good, not a capital good.
A refrigerator in someone’s home is a consumer good. A refrigerator at a restaurant is a capital good.
The confusion of real estate as a form of capital goes a long ways back:
http://homepage.ntlworld.com/janusg/coe/cofe00.htm
20. February 2012 at 17:34
Troy, Homes are capital goods, it’s not even debatable. It would be like saying a factory is a consumer good. People can say anything, but economics relies on generally accepted definitions. Houses can last for hundreds of years. “Consumption” means used up. Even refrigerators should be treated as capital goods, but the government regards them as consumer goods if in a home. But most economists say consumer durables are actually capital.
The Fed doesn’t drop money from helicopters so I’m not sure what your first comment means. All the other stuff is unrelated to this post.
20. February 2012 at 18:44
Houses can last for hundreds of years.
Yes, they are a durable consumer good.
But most economists say consumer durables are actually capital.
Most economists are wrong about a lot of things.
Ask Drs Gaffney and Keen about that.
Now, given that housing is a critical human need, new supply is often severely limited, and a buyer is generally easily found, the housing good itself can in fact serve as a capital good — an actual store of value, or savings. But this is an accident of land titles and how our system incents and protects ownership in land.
But the dictionary definition of CAPITAL:
a (1) : a stock of accumulated goods especially at a specified time and in contrast to income received during a specified period; (2) : accumulated goods devoted to the production of other goods (3) : accumulated possessions calculated to bring in income
is what me and the other guy are talking about here.
The Fed doesn’t drop money from helicopters so I’m not sure what your first comment means
Without actual distribution of printed money to would-be consumers there can be no actual stimulus of the economy on the demand side — the velocity of Fed money is 0 if it is not spent into the economy somehow.
The housing boom/bubble of 2003-2007 was a brilliant stimulus in that it injected on the order of $10,000 per household per year directly into the middle quintiles. Your original post above was in apparent ignorance of this dynamic, which makes me wonder how much you understand about the real-world economy at all, frankly.
All the other stuff is unrelated to this post.
Not really, because we are talking about AD. MMT says we need to inject more money into the system. I say we need to improve how money circulates within the system –I think I am right and MMT is totally wrong, in that it will not actually fix anything but just kick the can down the road several years, like how the housing boom/bubble did.
I find the trained mainstream ignoring the ~$3T/yr flow out of the middle quintiles of this country to be utterly bizarre, frankly.
21. February 2012 at 18:42
Troy, You said;
“Yes, they are a durable consumer good.”
That’s an oxymoron. “Consumption” means used up. Houses meet your definition, as they are a capital good that produces a flow of other goods (housing services) over a long period of time. Office building produce office services. Are you also claiming office building aren’t capital?
We certainly agree about MMT.
26. February 2012 at 16:34
ssumner:
Major Freeman, Houses are of course built to be consumed. All houses are capital goods.
That’s false. Not all houses are capital goods. Houses bought for the purposes of residency, i.e. not bought for the purposes of making subsequent sales, they are consumer goods, not capital goods.
Capital is wealth reproductively employed. For someone who buys a house for residency purposes, they are not using their house in some production process to make subsequent sales, the way someone who bought a house for the purpose of making subsequent sales, such as baking cookies for the market, or “flipping” them.
I don’t consider those textbooks.
I do.
Troy, Homes are capital goods, it’s not even debatable.
First, not all homes are capital goods. Second, you’re right that is not even debatable. You are wrong, all the textbooks that claim all houses are capital goods are wrong, and everyone else who believes it are wrong as well.
Homes CAN BE capital goods, but NOT ALL houses are capital goods.
Capital goods do not derive their property of being “capital” because of their physical appearance. That’s your error. Capital is capital because of the PURPOSE for which it is bought, not because of its physicality or appearance.
A pick up truck is a consumer good if it is bought not for the purposes of making subsequent sales, but for the purposes of being a family vehicle.
That same pick up truck make and model can also be a capital good if it is instead bought by a construction company for the purposes of making subsequent sales, like transporting equipment and materials that go into buildings that are going to be sold later on.
It would be like saying a factory is a consumer good. People can say anything, but economics relies on generally accepted definitions. Houses can last for hundreds of years.
The lifetime of a good also has nothing to do with it being a capital good rather than a consumer good. For then you’d have to go down the arbitrary path of setting an arbitrary lifetime in which less than that the good is a consumer good, and greater than that it is a capital good.
For example, by your logic, a book that lasts for 1000 years should be a capital good, and a pallet of copper coil that lasts only a matter of days from the time it is produced to the time it is productively used up, should be a consumer good.
Lifetime has nothing to do with establishing whether a good is a consumer good or capital good. It is the purpose for why it is purchased that does it.
“Consumption” means used up. Even refrigerators should be treated as capital goods, but the government regards them as consumer goods if in a home. But most economists say consumer durables are actually capital.
They are all wrong. And you are wrong for claiming that refrigerators should be capital goods. SOME refrigerators should be capital goods, if they are bought by restaurants or other purchasers who buy them for the purposes of making subsequent sales. But ALL OTHER refrigerators should be consumer goods, because they are bought for the purposes of being used up and not replaced by virtue of them being used up.
Yes, durable consumer goods are “used up”, yes capital goods are “used up”, so if you say that because consumption means “used up”, shouldn’t all capital goods that are used up in production, also be consumer goods? No, of course not. Why? Because it’s the purpose of the purchase that matters.
It’s not an oxymoron to say “durable consumer good.” A book on my shelf at home is “durable”, but that doesn’t mean it’s a capital good. I didn’t buy it for the purposes of making subsequent sales.
28. February 2012 at 06:00
Major, You said;
“That’s false. Not all houses are capital goods. Houses bought for the purposes of residency, i.e. not bought for the purposes of making subsequent sales, they are consumer goods, not capital goods.”
Of course the purpose is residency, that’s WHY they are capital goods. Are you saying hotels are not capital goods?
1. March 2012 at 22:41
ssumner:
“That’s false. Not all houses are capital goods. Houses bought for the purposes of residency, i.e. not bought for the purposes of making subsequent sales, they are consumer goods, not capital goods.”
Of course the purpose is residency, that’s WHY they are capital goods.
So now you’re saying it’s the residency aspect that makes a home a capital good?
Is there such thing as a non-residency home that would presumably make it a consumer good?
What if someone “resides” in an old beat up 1970s VW van? Do they become a capitalist?
What about a homeless person’s cardboard box and sleeping bag? Are they capital goods?
Are you saying hotels are not capital goods?
No. A hotel is a capital good if the expenditures to build it and/or buy it once completed, is for the purposes of making subsequent sales, for example charging room rates to guests, or charging a whole new buyer of the hotel.
If however a hotel is bought for the purposes of some crazy person’s residency, if he bought the hotel NOT for the purposes of making subsequent sales, then he is the owner of a consumer good. He isn’t capitalizing it and deducting it from any sales revenues in order to calculate profits.