Archive for the Category Crisis of 2008


Kocherlakota edges ever closer to market monetarism

TravisV directed me to Narayana Kocherlakota’s newest Bloomberg essay:

What drove this increase in inequality? It wasn’t the result of the Fed propping up housing or stock markets, which declined sharply from 2007 to 2010. Rather, it seems that the poor would have been better off if the Fed had done more to support asset prices — and particularly home prices. In other words, inequality rose because monetary policy was too tight, not because it was too easy.

There are two ways to read this.  If Kocherlakota means the Fed should target house prices, then I obviously disagree.  I think a more plausible reading is that Kocherlakota thinks money was too tight during 2007-10, and that excessive tightness had many side effects including declining asset prices.

Of course that’s “the real problem is nominal” story I’ve been peddling since 2009.  In early 2009, most people thought I was crazy.  Money was clearly “extraordinary accommodative” or so I was told.  And even if if was tight, the fall in home prices was “obviously due to factors unrelated to tight money”.  And now we have a former member of the FOMC espousing a very market monetarist view of the Great Recession.

We’re winning.


Market monetarism is on the march

Cardiff Garcia quotes from a recent report by James Sweeney at Credit Suisse:

Many commentators point to high debt levels as a major driver of the [2008] crisis. However, high debt levels signal vulnerability, not imminent crisis. Crisis occurs when highly leveraged entities suddenly cannot service their debts. This is most likely when nominal growth suddenly slumps, or when asset prices fall sharply.

Of course, those two things often happen together. And what’s most likely before a sharp decline in nominal growth and asset prices is a boom in both.  .  .  .

We believe policymakers are so scarred by the events of 2008 that they live in constant fear of anything resembling a recurrence. The simplest way to prevent recurrence has little to do with achieving 2% inflation and much to do with minimizing the variance of nominal growth, preferably while maintaining full employment.

Macroprudential policy and financial stability monitoring may help with these goals, but ultimately monetary policy is the tool most likely to prevent large cyclical swings in nominal growth.

We’re winning.

My new article in Foreign Affairs

When I was young, I noticed that Foreign Affairs was the classiest looking publication on most newstands.  The kind of outlet where you’d read something by Henry Kissinger, or Zbigniew Brzezinski.  Thus I’m pleased that their new issue has an article by me, discussing the role of monetary policy in the Great Recession:

Here’s the intro, the only part not gated:

Today, there is essentially one accepted narrative of the economic crisis that began in late 2007. Overly optimistic homebuyers and reckless lenders in the United States created a housing price bubble. Regulators were asleep at the switch. When the bubble inevitably popped, the government had to bail out the banks, and the United States suffered its deepest and longest slump since the 1930s. For anyone who has seen or read The Big Short, this story will be familiar.

Yet it is also wrong. The real cause of the Great Recession lay not in the housing market but in the misguided monetary policy of the Federal Reserve. As the economy began to collapse in 2008, the Fed focused on solving the housing crisis. Yet the housing crisis was a distraction. On its own, it might have caused a weak recession, but little more. As the Fed bailed out the banks at risk from innumerable bad mortgages, it ignored the root cause of serious recessions: a fall in nominal GDP, or NGDP, which counts the total value of all goods and services produced in the United States, not adjusted for inflation. Such a fall began unimpeded in mid-2008, and once that happened, much of the damage had been done.

PS.  Sad to hear about Prince.  For me, he was the high point of 1980s pop, which I think of as the age of MTV.  Younger people might be surprised to know that during the golden age of rock music (mid-60s through early 1970s) the major rock bands rarely appeared on TV.  And of course there was no internet.  Unless you saw them live, you didn’t know what they looked like performing.  MTV changed music, made it more TV-oriented.  I can’t even imagine Led Zeppelin on TV.

MM goes mainstream

I was listening to some speakers on Bloomberg discussing the Malaysian and Chinese credit markets, and this comment (by David Stubbs) caught my attention:

Default cycles tend to come when you get that weaker nominal GDP and certainly when expectations of nominal GDP are not met—indeed the expectations that were embedded in the lending contracts themselves, which drove the credit expansion.

Bank in 2009, this argument was viewed as borderline “crackpot”.  I was told that it was “obvious” that the debt problems were due to reckless subprime mortgages, highly leveraged banks like Lehman and irresponsible Greek deficit spending, and that falling nominal GDP was the result.  Now the heterodox (market monetarist) view seems to be going mainstream.


Are we again misdiagnosing the problem?

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

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

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

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

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

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

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

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

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

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

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

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