Archive for the Category Great Recession


Today’s stock market decline

Stocks dropped sharply this morning.

In don’t view today’s decline in stock prices as being important.  In recent years, stocks have often plunged for a few days, and then recovered.  I put more weight on the level of stock prices, which is still quite high.  Thus I believe the macroeconomy is still in very good shape.

But there’s also something more interesting going on—bond prices have also been falling (i.e. higher yields):

“It’s always hard to judge at what point you hit an inflection point where the correlation between yields and stocks goes into reverse,” says Liz Ann Sonders, chief investment strategist at Charles Schwab & Co. “One of the markers to when that happens is typically when you move from a deflationary era or at least a deflationary mindset to more of an inflationary mindset.”

It’s potentially a big deal.

An enduring rupture in positive correlations — yields moving up along with stocks — would signal a break in the weak-growth, low-interest regime seen over much of the past decade. Markets driven by negative tandem moves — yields up, shares down — have tended to be in the grip of inflationary pressure or potential economic over-heating.

David Glasner did a very important study that found stock prices became positively correlated with TIPS spreads (inflation expectations) during the Great Recession, but not before.  This may have reflected the fact that market participants thought the US economy would benefit from a more expansionary monetary policy during the period of high unemployment and near-zero interest rates.  That assumption was correct in my view. If long-term bond yields and TIPS spreads start becoming negatively correlated with stocks, then presumably excessively tight money is no longer much of a problem.

That doesn’t mean money is now too easy.  In my view we are so close to optimal that it’s hard to be sure whether policy is appropriate or a tad too expansionary.  We’ll know better in a few years.  But certainly most of the data looks pretty good from a dual mandate perspective.

I’d encourage people not to think in terms of binaries, rather shades of grey.  Monetary policy has been gradually moving from much too tight, to slightly too tight, to about right.  We don’t know precisely where we are on the spectrum, but the trend it clear.  It’s also clear that current monetary policy is far more appropriate than policy in 2009, or 1979, or 1930.

How likely is another Great Recession?

If you only have time for one post today, make it David Beckworth’s very important post showing that the Fed is edging in the direction of level targeting, indeed something not too far away from NGDPLT.

Tyler Cowen recently linked to my previous post:

5. Is another Great Recession just around the corner?  Well, is it?

I’m not sure what qualifies as a “Great Recession”.  I suppose 1893-97, the 1930s, the 1980-82 double dip, and 2007-09 are the most plausible candidates, at least since 1860.  So perhaps once every 40 years or so.

So let’s suppose I’m right that the “housing bubble” did not cause the Great Recession.  In that case, the fact that we are having another housing price boom is not particularly worrisome.  It doesn’t increase the odds of another Great Recession.  So let’s say the odds are roughly 1 in 10 that another Great Recession will occur in the next 4 years, based on past performance.

Can’t we forecast better?  I’m not sure, as the additional information we have cuts both ways.

1. Perhaps the slowness of the recovery makes it more likely that the expansion has more room to run.  Or perhaps we’ve learned something from the previous debacle.  Australia hasn’t had a recession in 27 years; no reason we can’t beat the record of the previous US expansion, which was 10 years.

2.  On the other hand, big recessions are more likely at the zero bound and we are likely to hit the zero bound again in the next recession.  So perhaps another Great Recession is now more likely than usual.

If I had to guess, I’d say point #1 is slightly more persuasive than point #2, but I don’t have a high degree of confidence.  Where I am confident is in stating that the housing bubble did not cause the Great Recession, and thus the current housing price boom (very similar to 2001-06), does not make another Great Recession highly likely in the near future.  Unless I’m mistaken, the bubble-mongers should be predicting another Great Recession in the near future.

PS.  I am amused to see commenters say, “it wasn’t the price bubble, it was blah, blah, blah.”  Deep down they know that the bubble theory is wrong, and they are looking for a way out.  Unfortunately, that’s rewriting history.  At the time, people were saying the problem was the price bubble.  They were saying that those prices were obviously unsustainable.  (Even though Canada, Australia, Britain, New Zealand, etc., did sustain them.) Kevin Erdmann has convincingly shown this “unsustainable” view is wrong, and more importantly he did so long before prices had recovered.  I’d have more sympathy for the other side if in 2012 they had not said “prices were obviously crazy in 2006”, but rather had said, “prices in 2006 might be rational at a given interest rate, and hence if rates stay low and rents keep rising I would expect prices get right back up to bubble levels.”

PPS.  My opponents are like astrologers.  When I say to an astrologer, “OK, lets take data on a million people, based on the sign they were born under, and correlate it with personality data.  It’s an easy test.”  They respond. “It’s more complicated than that, there’s all sorts of other factors to consider.”  Well I’m a Libra, and we don’t believe in those sorts of excuses.

Did the Great Recession reduce the US birth rate?

A few years ago it was conventional wisdom that the Great Recession reduced America’s birth rate.  That’s possible, but it’s striking how little evidence there is for that claim.  It’s true that the birth rate declined between 2007 and 2010, but we all know that correlation doesn’t prove causation.  And there’s a lot of evidence pointing in the opposite direction.  Here’s one popular measure of the birth rate:

Now let’s consider all of the evidence against the claim that the Great Recession reduced America’s birth rate:

1. Rich countries tend to have much lower birth rates than poor countries.  So poverty doesn’t seem to reduce birth rates.

2.  If you prefer time series evidence; the US birth rate has trended down for 100 years, even as we’ve become much richer.

3.  It’s true that the birth rate fell during the 1930s, but it fell much faster during the booming 1920s.  It fell especially sharply during 1955-73, one of the very best periods ever for having big nuclear families with stay at home moms.  The birth rate was flat during the bad period of 1979-83, when unemployment soared to 10.8%, but fell during the booming 1990s.  Go figure.

4.  In 2016, the birth rate declined in 2016 to the lowest rate ever, despite one of the fastest 2-year growth spurts in real median household income ever seen in US data:

There may be a slight lag in the impact of the economy on the birth rate, but if we don’t see a sharp rise in the birth rate in 2017, then we may need to revise the conventional wisdom on the Great Recession.

5.  The birth rate decline has been far sharper for teens than for other groups:

In the United States, teen-aged moms are increasingly rare. In 2016, the teen birth rate dropped 9% compared to the previous year, a new government report published Friday found. This record low for teens having babies continues a long-term trend.

The birth rate among teen girls has dropped 67% since 1991, according to the National Center for Health Statistics, which presented preliminary data for 2016 based on a majority (99.9%) of births.

In 2016, the number of US births totaled 3,941,109, a decline of 1% compared to 2015. The fertility rate of 62 births per 1,000 women is a record low for the nation.

The teen rate is a “phenomenal decline,” said Dr. Elise Berlan, a physician in the section of adolescent medicine at Nationwide Children’s Hospital.

Interestingly, this sharp decline in teen births occurred during a period when teens are increasingly delaying the adoption of adult-like behavior.  The share of teens that date, have sex, drive cars, drink alcohol, smoke, work on jobs, and other similar activities is falling sharply.  I doubt the Great Recession caused teens to not want to date, drink, or get a drivers license.  More likely, we are seeing a longer term cultural change, driven by factors unrelated to the business cycle.  (Also note that the really sharp decline in teen births began with the Great Recession, and has continued right up until the present time.)

One thing I can’t stand about cultural conservatives is that they are always pessimistic about the younger generation.  I recall back in 1991 that America’s cultural conservatives were wringing their hands at how the high teenage birth rate and crack cocaine addiction was going to lead to a generation of dysfunctional children.  Since then, we’ve seen a massive decline in teen births, and also a huge decline in crime, divorce, and lots of other metrics of social distress.  America’s teens are behaving amazing responsibly, (maybe too responsibly, IMHO).

So are the social conservatives trumpeting this wonderful turnaround?  No.  Instead of celebrating this cultural trend they find new things to worry about—rising use of opioids, single moms, or the fears that immigration will bring in low IQ people that dilute our gene pool.

I really, really wish that cultural conservatives would just cheer up.  (Or light up a joint in one of the states where it’s now legal, and chill.)

Mike Konczal on 2008

Mike Konczal has a new post criticizing the recent NYT piece by Beckworth and Ponnuru.  He makes four points.  The first is that Senator Cruz’s views on money are not always consistent.  Even if true, that has no bearing on the Beckworth/Ponnuru argument.  Here’s the second:

A lot depends on what we mean by “cause.” Google “define:cause” and I get “make (something, typically something bad) happen.” But the authors really mean “didn’t prevent” here. There is a fascinating Myth of Ownership/”you didn’t build that” element here – where is the line between the market and the state that structures it? But the story is simple: there was an aggregate demand shortfall from the housing collapse, and the government didn’t step in to fix it.

In that same exact way, the stimulus not being large enough also caused the Great Recession. Sure, but I doubt Ted Cruz would agree with that statement.

This is a completely meaningless distinction, when it comes to monetary policy.  As Nick Rowe points out there is no meaningful distinction between the Fed acting and not acting.  Monetary policy can be described along many dimensions, including interest rates, the base, M2, exchange rate, and NGDP expectations.  Acting in one dimension might mean not acting in terms of another.  And this isn’t even one of those “Keynesian vs. Monetarist” things where no one can say who’s right. Konczal’s fellow Keynesian Paul Krugman frequently describes Fed action/inaction in terms of changes in the base, whereas Konczal considers action in terms of changes in interest rates.  The growth rate of the base slowed sharply in late 2007 and early 2008, so using Krugman’s criterion Fed “acted” to make policy tighter right before the recession.  Under Konczal’s the Fed “acted” to make it easier.  (Of course later the base soared, so by Krugman’s criterion money became much looser.)

In my view neither the base nor the level of interest rates are good indicators of what the Fed “is doing”, and I’m pretty sure that Beckworth and Ponnuru agree. We evaluate Fed policy in terms of changes in NGDP, or expected NGDP growth. By that criterion, policy got more contractionary.  Konczal may not like this view, but it’s basically the view of Ben Bernanke before he became Fed chair, so no one can claim we are trying to come up with some whacky new way of describing the stance of monetary policy.

As for the housing “collapse”, it had almost no impact on unemployment.  Housing construction plunged by more than 50% between January 2006 and April 2008, and unemployment merely edged up from 4.7% to 5.0%, so Konczal is flat out wrong in claiming that AD plunged due to a housing collapse.  AD plunged due to a tight money policy from April 2008 to October 2009, which caused unemployment to soar from 5% to 10%.  Jobs were lost in many industries, not just housing construction.

Konczal continues:

I think a lot of people’s frustrations with the article – see Barry Ritholtz at Bloomberg here – is the authors slipping between many possible interpretations. Here’s the three that I could read them making, though these aren’t actual quotes from the piece:

(a) “The Federal Reserve could have stopped the panic in the financial markets with more easing.”

There’s nothing in the Valukas bankruptcy report on Lehman, or any of the numerous other reports that have since come out, that leads me to believe Lehman wouldn’t have failed if the short-term interest rate was lowered.

I’m no expert on Lehman, but the financial crisis as a whole would have been far milder if the Fed had kept NGDP growing at roughly 5%/year.  And the reason is simple; at that growth rate the asset markets would have been far stronger, and the crash in asset prices severely impacted the balance sheets of many banks, including Lehman.  Keep in mind that the subprime crash was not big enough to bring down the banking system.  Rather when NGDP growth expectations plunged, the prices of homes in the (non-bubble) heartland states, as well as commercial property, began falling.  This is what turned a manageable financial crisis into a major crisis.  But even with a major crisis, the Fed was quite capable of boosting NGDP sharply.  They showed this in 1933, when NGDP rose strongly despite one of the most severe banking crises in American history, which shut down 1000s of banks for many months.

(b) “The Federal Reserve could have helped the recovery by acting earlier in 2008. Unemployment would have peaked at, say, 9.5 percent, instead of 10 percent.”

That would have been good! I would have been a fan of that outcome, and I’m willing to believe it.

Talk about damning with faint praise!  If the Fed had kept NGDP growing at 5% then obviously unemployment would not have risen to 9.5%, a figure like 6% is more plausible.  So is Konczal claiming that the Fed would have been unable to boost NGDP?  Why?  And why did they succeed in 1933?  Devaluation?  Then do the modern equivalent—level targeting.

Is the argument that we’d somehow avoid the zero-lower bound? Ben Bernanke recently showed that interest rates would have had to go to about -4 percent to offset the Great Recession at the time. Hitting the zero-lower bound earlier than later is good policy, but it’s still there.

There are lots of problems here.  The Bernanke claim was that the Taylor rule implied a minus 4%, but that’s in 2009, not 2008. And that distinction really matters!  The graph Konczal shows has the Taylor Rule suggesting an interest rate in positive territory in 2008.  In any case, the Bernanke article Konczal links to is critical of the Taylor Rule, so it cannot possibly be used as evidence that Bernanke thought a negative 4% interest rate was appropriate in 2008, or even 2009.  If he had thought that, why would the Fed have set rates at positive 2% in mid-2008? Sure, there are data lags but not 600 basis points worth of them.  The fact of the matter is that the Fed didn’t cut rates more aggressively because at the time they thought it would lead to excessive inflation.  It’s pretty hard to now claim that our wonderful economic models somehow show that even far lower interest rates could not possibly have prevented deflation and deep recession in 2009.  If our models were that accurate we never would have had a Great Recession.

As an analogy, it would be like claiming that a small adjustment in steering by a bus driver could not possibly have prevented a bus from going over a cliff further on, because 100 yards further down the road even a big adjustment in steering would not have been enough.

A lot of the “expectations” stuff has a magic and tautological quality to it once it leaves the models and enters the policy discussion, but the idea that a random speech about inflation worries could have shifted the Taylor Rule 4 percent seems really off base. Why doesn’t it go haywire all the time, since people are always giving speeches?

I’m tempted to say that one needs to first understand “stuff” like rational expectations models, before dismissing them. Speeches only matter when they provide new information that causes markets to change their views as to the expected future path of monetary policy.  Very few speeches do that.

And couldn’t it be just as likely that since the Fed was so confident about inflation in mid-2008 it boosted nominal income, by giving people a higher level of inflation expectations than they’d have otherwise? Given the failure of the Evans Rule and QE3 to stabilize inflation (or even prevent it from collapsing) in 2013, I imagine transporting them back to 2008 would haven’t fundamentally changed the game.

Inflation “collapsing” in 2013?  I don’t think Mike Konczal wants to go there.

If your mental model is that the Federal Reserve delaying something three months is capable of throwing 8.7 million people out of work, you should probably want to have much more shovel-ready construction and automatic stabilizers, the second of which kicked in right away without delay, as part of your agenda. It seems odd to put all the eggs in this basket if you also believe that even the most minor of mistakes are capable of devastating the economy so greatly.

No, if these three-month errors are so consequential then you want to shift to a monetary regime where they are not so consequential, like NGDP level targeting. With that regime a three month miss would not cause asset prices to collapse.


Monomaniacal . . . but in a good way

Ezra Klein recently included this blog in his annual awards:

Most influential-yet-obscure economic blogger: Scott Sumner. Be honest, how many people had even heard of Nominal GDP level targeting before this year? No one. But as the economy stagnated, and policymakers seemed increasingly incapable of mitigating the pain, many analysts started reading Sumner’s blog with interest. So far, the Federal Reserve has rejected his idea for NGDP target””under which the Fed would essentially target a combination of real output plus inflation rather than focus on curbing inflation alone””but the notion has attracted support from everyone from Paul Krugman to Tyler Cowen to Goldman Sachs. And much of that has to do with Sumner’s near-monomaniacal focus on the topic.

Klein presumably included the term “near” as a courtesy; I’m obsessively monomaniacal about NGDP.

Back around 2007 the US had lots of problems; income inequality, a rapidly declining home building sector, and according to some we were already well into The Great Stagnation.  But one problem we didn’t have is high unemployment.  Indeed unemployment was still only 4.9% in April 2008, by which time the great home building crash was already 70% over.

In the long run NGDP is of no importance at all; Japan’s NGDP is nearly 40 times larger than America’s.  But sudden unexpected changes in NGDP matter a lot.  Because nominal wages are sticky, a sudden downshift in NGDP growth will cause fewer hours worked and (except in Germany) a sudden upswing in the unemployment rate.  More than enough reason for me to be monomaniacal about NGDP.

But there’s more, debt contracts are also denominated in nominal terms.  During most recessions that’s not a big problem.  However this time around there were two factors that made the NGDP downshift have a much bigger impact than usual.  First, the decline in NGDP growth was unusually large.  And second, both debtors and financial institutions were already greatly stressed by the sub-prime fiasco, even before the NGDP crash occurred.  The NGDP crash then made the debt crisis much worse.

When I made this argument in early 2009 I don’t recall finding many takers.  It seemed obvious that “the” debt problem was due to reckless practices of US banks and GSEs.  But then the crisis spread out of the sub-prime ghetto and engulfed other types of real estate debt.  Then municipal debt came under stress.  And now we have the euro-debt crisis.  Is it just a coincidence that all these separate debt crises flared up at about the same time?  Is it just coincidence that they all occurred just after the biggest drop in NGDP since the Great Depression?  Given that economic theory predicts that a sudden drop in NGDP growth will make it much harder to repay loans, my monomaniacal focus on NGDP doesn’t seem quite as crazy as in early 2009.

HT:  Tyler Cowen, David Levey, Christopher Mahoney