DeLong isn’t as wrong as he thinks he is
Brad Delong has a post suggesting he was wrong in 6 of 8 key areas relating to the crisis. I’d like to argue he was only wrong about 5 of 8, and hence is batting a more than respectable .375.
Here’s the mistake I don’t think he made:
I thought subprime was too small to takedown the US economy, even if the housing bubble did crash hard.
In my view the housing crash of 2006-08 did not takedown the US economy; the NGDP crash of 2008-09 took it down. One obvious response is that the housing crisis caused the financial crisis, and the financial crises threw monetary policy off course by sharply depressing the Wicksellian equilibrium nominal interest rate.
Fair enough, but I don’t think the subprime crisis even took down the US financial system. The scale of the subprime fiasco was quite clear by April 2008, and yet estimated losses to the US banking system were well under a trillion dollars. By April 2009 estimated losses were well over $2.7 trillion, which suggests that falling NGDP dramatically worsened the financial crisis by depressing the value of all sorts of assets, not just subprime housing loans.
I think the key mistake by DeLong (and I’m equally guilty here) was in assuming the following:
I thought that the Federal Reserve would make stabilizing nominal GDP growth in order to avoid prolonged high unemployment its principal priority.
Since I often bash Krugman here, perhaps I should mention that this is one he got right.
PS. Perhaps the following analogy would make my argument clearer. I didn’t think a Greek debt crisis would be big enough to cause a eurozone crisis. And it wasn’t. Only when the ECB let eurozone NGDP growth crash far more sharply than even in the US, did the crisis spread to bigger countries like Spain and Italy.
PPS. Technically I haven’t reduced the aggregate number of DeLong errors. He was right about subprime loans, but I’ve shown he was wrong in estimating that he got 6 of 8 key points wrong. So his total number errors remains unchanged.
Tags:
1. April 2013 at 10:46
Scott, separate question related somewhat to the previous post,
how much of wage stickiness is due to expectations on the part of workers of long, secular inflation? Major Freedom, no matter his other craziness, once argued that wage stickiness can be explained entirely by the Fed’s policy of 2% growth rate inflation per year. While I don’t agree that wage stickiness would disappear ENTIRELY if we were to forget about prices and focus instead on the level of NGDP-would you say that if the Fed commited itself to 1% level targeting, and the economy got used to 3% real growth per year (with 2% consisting of lower prices, of good, supply side deflation) that wage stickiness would ameliorate to a large degree?
1. April 2013 at 13:08
Edward, Wage stickiness might be reduced, but I doubt it would go away. And the low rate of NGDP growth might make the natural rate of unemployment go up, due to money illusion.
1. April 2013 at 13:35
This is phony modesty from DeLong, basically “I thought they’d do better.” All of a sudden, he’s a market monetarist? Why did he and Krugman harp on fiscal policy the whole time?
1. April 2013 at 13:59
I hate the “NGDP crash” took down the economy trope.
Of course the NGDP crash took down the economy. Decling GDP is the very definitation of a recession. It is circular logic.
Yes, it is possible to have a “stagflation” with positive NGDP and declining RGDP, however it is uncommon.
Below trend NDGP growth is a always a function of tight money is also a trope of this blog. That a monetary contraction caused the recession is a more interesting subject.
What happened in late 2008 that caused the money supply to tighten?
How is 7 maneuvers to cut the Fed Funds rate before the Fannie / Fredie / Lehman / AIG collapse, and 3 thereafter consistant with tightening money supply?
There was a financial crisis. The crisis caused the Money supply to collapse. The crisis was the money supply collapsing. Credit is Money.
How the subprime crisis which everyone in 2007 agreed was “contained” turn out to be beyond containment?
The subprime crisis exposed shoddy underwriting across MBS. It also exposed the way huge volumes of credit risk is hidden from veiw via off-balance-sheet activity. The “shadow banking system” collapsed, and brought the out-of-the-shadows banking system down with it.
Every “toxic asset” that radically fell in value created a monetary vacuum. Despite the Fed’s efforts to increase the money supply through 2008, it was not adding money as fast as the market was removing it.
1. April 2013 at 14:21
By miscounting his *errors*, DeLong made a *meta-error*!
1. April 2013 at 15:12
You sure you didn’t get suckered by an April Fools’ day joke?
1. April 2013 at 16:55
Doug, You said;
“Of course the NGDP crash took down the economy. Decling GDP is the very definitation of a recession. It is circular logic.”
How many times do I have to read this argument?!?!? No it’s real GDP, remember Zimbabwe?
You said:
“What happened in late 2008 that caused the money supply to tighten?”
Money tightened in late 2007 and early 2008 as the Fed sharply slowed the growth rate of the monetary base. It had nothing to do with the financial crisis. They started printing less money.
Neal, Yes, I’m sure.
1. April 2013 at 16:58
@Doug M
You agree that NGDP can always be determend by the fed? You agree that NGDP is a good policy?
Ok so we are almost there, whatever else happens, for whatever reasons does not actually matter that much.
Why money demand when up so sharp is a very diffrent question, and one that needs asking too. But more importently all these other problems are nowhere near as importent as the NGDP drop that was allowed by the Fed.
I fully agree that problems in the housing market and probebly banking as well would have caused a probebly a modest recession or just below trend real growth.
So to say that ‘NGDP crash’ was the problem is mostly correct. If NGDP would not have been allowed to fall the real crash would have been very soft.
1. April 2013 at 17:23
“PPS. Technically I haven’t reduced the aggregate number of DeLong errors. He was right about subprime loans, but I’ve shown he was wrong in estimating that he got 6 of 8 key points wrong. So his total number errors remains unchanged.”
That is true but by expanding the universe of “things DeLong could be wrong about” you’ve nonetheless helped reduce his error rate – he’s now batting .333 when before he was bating .250.
1. April 2013 at 17:36
how much of wage stickiness is due to expectations on the part of workers of long, secular inflation?
The major problem isn’t employees who face unemployment — a small minority of workers even when unemployment hits 10% — not being willing to take lower pay, but employers not generally lowering the wages they pay so they can hire more workers and avoid layoffs across-the-board.
As to employees, I don’t see what “expecting inflation” would have to do with it at all. If you are going to be unemployed, why won’t you take a lower wage now to keep your job? Who cares what inflation does over the next 10 years. You need to pay your rent *now*.
Back to employers, there are various factors at play, e.g.:
1) Call it “the union effect”. In a simpler world a company with a revenue shortfall might impose say a 8% pay cut on everyone and keep the business going whole. But a unionized work force will never accept that. The union will have a vote, “an 8% cut for all versus the 10% lowest-seniority being laid off and 90% of us keeping 100% of our pay and benefits and raises”. Guess which outcome wins by a vote of about 90%-10%?
Look at FRED’s data on public sector wages and you’ll see ’em going straight up as before through 2008,9,10, for all the political talk everywhere about “we need stimulus funds to end the savage layoffs of school teachers and public servants.” Precious few stimulus payments to the states were conditioned on wage-benefit freezes for their employees.
But not to over-beat on unions…
2) In the non-union private sector the same pressures are felt through a “competitive effect”. Your company takes a revenue hit so you want to impose an 8% pay cut on everybody. But even in a bad recession only some businesses are hurting, others are OK or many even thriving. So if you impose a pay cut on everybody all your employees will be unhappy and some will bail out on you to go to other healthy businesses, even to your direct competitors.
Which employees will leave? Your **best** employees, who are in most demand. You’ll be left with your worst, who know they couldn’t get another job if they tried.
Thus, instead of saving that 8% by making everybody feel insecure and demoralized and worried about the company going under, and losing your best workers, you are better off doing it by keeping everybody’s pay up high, firing the least valuable employees you choose to lose, and keeping your surviving workforce secure and happy.
Believe me, this is a *very* real deal for private businesses. Labor economists call this the “morale effect” but it really is a competitive effect. IBM got hammered by the loss of a flood out of its very best employees back during its big shakeout when it tried to limit wages and offered “voluntary buyouts”. A textbook business school lesson ever since.
On other fronts…
3) Yes, as per Mulligan, increased govt benefits to “cushion” unemployment and financial hardship make it easier to lay off workers and slow the return of former workers to employment. But this is a marginal effect, it certainly doesn’t cause a big drop in employment at one time or drive the business cycle.
4) On the largest scale, in a rich society it’s a lot easier for employees to decline wage cuts, take some time off with a high reservation wage, and for employers to lay off such workers. We all bemoan how rough we have it, but compared to 1921 we all live like kings: savings, houses, retirement funds, well off families and relatives, govt unemployment and support programs, medical care — such as none of which existed back then. Unemployment ain’t what it was back then, when it could be life and death for many, creating much greater pressure for immediate wage reductions all around.
Major Freedom, no matter his other craziness, once argued that wage stickiness can be explained entirely by the Fed’s policy of 2% growth rate inflation per year.
Yes, of course he did — as he kept insisting they didn’t have that problem in Japan because of its deflation-fueled strong growth of the last 15 years, putting it at the healthy top of the OECD pack… 🙂
1. April 2013 at 17:46
Well, Scott, neither you nor Krugman nor DeLong should feel too badly, since most people still haven’t figured out the Fed should have stabilized the NGDP growth path.
🙂
1. April 2013 at 21:13
Delong never talked about NGDP until Scott came around. Don’t let him distort history to make himself look better and plagiarize your position at the same time.
1. April 2013 at 23:39
Awesome new article by Matthew O’Brien:
“Why the Euro Is Doomed in 4 Steps”
http://www.theatlantic.com/business/archive/2013/03/why-the-euro-is-doomed-in-4-steps/274470
He says the Euro is “the gold standard minus the shiny rocks.”
1. April 2013 at 23:45
What is the consensus Market Monetarist position on what would happen if the Eurozone broke up completely? Would it be an enormous problem or a tiny problem?
Wouldn’t a bunch of the former Eurozone countries experience currency devaluation, which would boost their NGDP growth rates for many years?
Should owners of U.S. equities with European exposure advocate a total breakup of the Eurozone?
2. April 2013 at 00:14
“You agree that NGDP can always be determend by the fed?”
Actually, no.
2. April 2013 at 00:23
“Money tightened in late 2007 and early 2008 as the Fed sharply slowed the growth rate of the monetary base. It had nothing to do with the financial crisis. They started printing less money.”
What is your data here? Because, I can’t find it.
2. April 2013 at 01:26
TravisV: Thomas Sargent explained how the euro is an artificial gold standard back in August 2010. Reading that interview made both the eurozone and the various goldzone crises make much more sense.
2. April 2013 at 04:26
Squarely, Good point.
TravisV, I’m not sure there is a consensus opinion. I don’t know what would happen, because I’m not sure what policies would follow. My best guess is a very messy situation for about a year, then faster growth. Something like Argentina.
Doug, The St Louis Fred has data on the monetary base.
2. April 2013 at 07:20
Scott,
Here’s an interview with David Stockman. I don’t know what he believes in… Fed bashing, perhaps.
http://www.theatlantic.com/politics/archive/2013/04/were-going-to-have-a-crisis-david-stockmans-stark-warning-for-america/274554/
2. April 2013 at 12:22
“St Louis Fred has data on the monetary base.”
St Louis Fred shows Mb increasing at a pretty steady pace from 2003-2008 and exploding in late 2008.
3. April 2013 at 16:42
Chuck, life’s too short . . .
Doug, The base grew at about a 5% rate until roughly July 2007, then leveled off for about 9 months, triggering a recession. Then exploded with IOR and near-zero rates boosting demand for ERs.