Is modern macro to blame?
There are some recent posts by David Andolfatto, Mark Thoma and Noah Smith, discussing whether modern macro failed us in 2008. I don’t disagree with claims that we should not have been expected to predict the financial crisis (if these crises were predictable then they would not occur.) Rather I’d like to approach the issue from a different perspective. When economists discuss the state of macroeconomics circa 2008, they generally take one of two positions:
1. Macro is fine, it’s not our fault.
2. Macro screwed up because they didn’t pay enough attention to ________, where the missing name is the person judging the condition of macro.
I’m sort of in the second group. But I’ll make things a tad more interesting by claiming that they didn’t just ignore my advice; macroeconomists ignored their own theories. Here are some parts of mainstream macro, circa 2007, that were almost totally ignored a year later:
1. Monetary policy continues to be highly effective at the zero bound.
2. Interest rates and/or the money supply are not good indicators of the stance of monetary policy.
3. The Great Depression was caused by tight money, not banking distress.
4. Fiscal stimulus is mostly ineffective due to monetary offset.
5. Extended unemployment benefits raise the unemployment rate.
If economists had kept believing in 2008 what they believed in 2007, the Great Recession would have been the little recession. In Europe it was even worse, as economists didn’t even seem to recognize that Great Recessions are caused by adverse demand shocks. On the other hand European economists seemed to be a bit more skeptical about fiscal stimulus, AFAIK.
PS. I have a post over at Econlog looking at the question of whether the Fed is allowed to create NGDP futures markets, a question recently raised by David Andolfatto.
HT: Gordon
Tags:
15. April 2015 at 13:10
“3. The Great Depression was caused by tight money, not banking distress.”
What’s the difference?
15. April 2015 at 13:21
@Britonomist
Depression does not mean banking distress in all cases, see canada in the GD.
Banking distress does not mean depression see pre Fed US banking.
15. April 2015 at 13:49
Greece is in as much deep sh.. as the US was in early 1933. If that[s not because of monetary policy, what is?
https://thefaintofheart.wordpress.com/2015/04/15/continued-negation-of-monetary-policy-imf-version/
PS @Britonomist
The banking distress then, as in 2008 (Lehman) was to a large extent due to mon. policy disfunction
15. April 2015 at 13:52
I think the failure is the illusion that the economy is stable.
There is nothing to economic theory that says that the economy must be stable. And Chaos theory says, that really it should not be.
Chaos is real. Sh!t happens. Economies crash.
The focus of the for the economics profession should not be predicting crashes or preventing crashes. Perhaps picking up the pieces afterwards.
regarding #2, how about “more sophisticated” measures of rates, real rates, or the shape of the curve.
#5 I don’t know if I would go so far as to say increase the unemployment rate. That suggests a higher rate at the trough. I think that extended benefits slow the reduction in the unemployment rate and cause a more sluggish recovery.
15. April 2015 at 14:00
Monetary policy is effective, but on which scale? See yin wen (2014) from minnesota fed.
Also, when inflation is lower than the target, there is no monetary offset. Furthermore, with sticky prices, the monetary offset is only partial in the short-run.
And about the banking crisis, if the banking sector is not operative, it limits the transmission of monetary policy.
15. April 2015 at 14:25
Scott, any thoughts on Bernanke’s latest post, in which he says:
“…a principal motivation that proponents offer for changing the monetary policy target is to deal more effectively with the zero lower bound on interest rates. But economically, it would be preferable to have more proactive fiscal policies and a more balanced monetary-fiscal mix when interest rates are close to zero. Greater reliance on fiscal policy would probably give better results, and would certainly be easier to explain, than changing the target for monetary policy. I think though that the probability of getting Congress to accept larger automatic stabilizers and the probability of their endorsing an alternative intermediate target for monetary policy are equally low.”
http://t.co/dOUe8aFah8
Seems like Bernanke 2015 is closer to Bernanke 2008-9 than Bernanke 1998-2003.
15. April 2015 at 14:43
You keep making these claims as if the Fed can just wave a magic wand and expand the money supply. How is that supposed to happen at the ZLB without fiscal policy?
15. April 2015 at 15:18
“are caused by adverse demand shocks.”
-I think the “are” should be replaced with “can be” to avoid ambiguity.
15. April 2015 at 15:25
@Jon P
-Same as the Weimar Republic did it. Foreign currency purchases. And have you never heard of a little something called “Large Scale Asset Purchases”? Also known as “Quantitative Easing?
15. April 2015 at 15:30
@Doug M
“The focus of the for the economics profession should not be predicting crashes or preventing crashes. Perhaps picking up the pieces afterwards.”
-So the Fed shouldn’t have attempted to stop the demand shock associated with the Great Depression?
@Nick Zbinden
-Interestingly, had Canada attempted to keep NGDP stable, they would have ended up with a larger-scale version of the present-day Russian recession. Though employment would not have been hit nearly as hard as it actually was.
15. April 2015 at 15:39
Dr. Sumner,
Lots of people foresaw the Housing Bubble bursting and imagined the broader consequences.
April 2006, CBS News
“Countless articles in the financial and popular press have now been devoted to the question of whether we are in a housing ‘bubble.’ It is a favorite topic of many liberal economists, columnists, and bloggers, who argue that President Bush’s tax cuts and other policies have created a hollow and unsustainable economy. They are laying the groundwork to hang a housing bust around the necks of President Bush and congressional Republicans.”[1]
May 2002, Los Angeles Times
“After all the rhapsody about the digital age, it was skyrocketing home prices and sales that finally shook the U.S. economy out of its doldrums this year. While stock markets languished, mortgage refinancing pumped more than $1 trillion into consumers’ pockets. Nationally, average home prices rose above the $200,000 mark for the first time ever. But rather than signal prosperity, the housing boom may be largely driven by the financial maneuvers of wealthier Americans. Housing, in fact, has become part of the bubble economy, with potential consequences more serious than the stock market fiasco.”[2]
September 3, 2001
“The downside to easy credit: overleverage. Most households have either no mortgages or very manageable ones. But there are enough people stretching their budgets to have caused a key debt-burden ratio to hit an alltime high. The ratio of mortgage debt service to total disposable income climbed to 6.46% in the fourth quarter of 2000, surpassing a 6.35% record set during the first quarter of 1991 in the depth of the last recession. Collective owners’ equity in the U.S., as a percentage of the real estate’s value, sank to 55% in the first quarter of this year, the lowest level ever and down from 70% in 1982. ‘Leverage against an asset that can deflate in value is a recipe for disaster,’ says economist Charles W. Peabody of Mitchell Securities in Manhattan.”[3]
Anyone who *wanted* to see the problems, saw them. Those who did not see the crash coming, did not want to see it coming. The problem was that too many people had a vested interest in not seeing the problem. It was not a theoretical or analytical problem but a political problem.
[1] http://cbsn.ws/12A5bLP
[2] http://lat.ms/Y1suwe
[3] http://onforb.es/Y1ssVb
15. April 2015 at 16:08
@David de los Ãngeles BuendÃa
-I don’t like how Sumner deals with stuff like this, either. Though I have to admit, the huge difference in the fates of housing prices in the U.S. v. those in Canada after 2006 should make anyone pause. What factors would make one correctly predict a housing bust for the U.S., but no housing bust for its neighbor to the North?
BTW, both had remarkably similar RGDP fates:
http://newmonetarism.blogspot.com/2014/03/why-are-canadians-working-so-much-more.html
15. April 2015 at 16:30
http://www.brookings.edu/blogs/ben-bernanke/posts/2015/04/15-monetary-policy-in-the-future
Ben says, Now you see it;
‘Suggestions that have been made include raising the inflation target, targeting the price level, or targeting some function of nominal GDP.’
Then makes NGDP targeting disappear;
‘Some of these approaches have the advantage of helping deal with the zero-lower-bound problem, at least in principle. My colleagues at the Fed and I spent a good deal of time during the period after the financial crisis considering these and other alternatives, and I think I am familiar with the relevant theoretical arguments. Although we did not adopt one of these alternatives, I will say that I don’t see anything magical about targeting two percent inflation.’
Now You don’t!
15. April 2015 at 16:45
David, I agree that by 2005/6 it may have been obvious to many that housing was ridiculously over priced. But 2001? Please, there was really no reason to think house prices were in a bubble in 2001, most people agreed the bubble started in 2002 and peaked at 2005/6. A few years ago I did an econometric study on this, and prices only seemed to deviate from what explanatory variables like housing costs, population density, interest rates etc.. would predict house prices should be based on an econometric model, at around 2002/2003. There’s nothing unusual about someone predicting a huge downturn in any asset price, 99% of the time they’re wrong, but even a stopped clock is right now and again. If you want to see a problem, you can see *any* problem, just google any possible problem and you’re guaranteed to see someone making that bet. It’s immensely difficult separating actually good forecasters from phony chartists which most of them are.
15. April 2015 at 17:23
“If economists had kept believing in 2008 what they believed in 2007, the Great Recession would have been the little recession.”
And then AFTER that, there would have been an even more painful correction.
But because money was tighter than that looser standard, we had a less painful correction.
There is no such thing as a free lunch in socialism, especially socialist money. The reason why money tightened across the economy is because the market was telling us too much money was issued prior.
But the market is wrong isn’t it, when it comes to your socialist plan. It is always right otherwise. The universe has a cosmic kink whereby the market is right for everything except that one thing that just so happens to not have a market.
Haha
15. April 2015 at 17:40
Britonomist, The difference? Here’s an example. From October 1929 to October 1930 the Fed reduced the base by about 7%. The WPI and industrial production indices both plunged sharply lower. So did NGDP.
There was no banking distress. They often overlap, but not always.
Someone also mentioned Canada, which avoided bank failures, but not the Great Depression.
Marcus, Partly money and partly bad supply-side policies. Double-whammy.
Doug, There will always be real instability, as you say, but let’s not make it worse by adding nominal instability.
MB, No, we saw complete monetary offset in 2013, despite inflation being below target. And banking problems do not limit the effectiveness of monetary stimulus, as we saw in 1933.
Rajat, The Fed doesn’t need Congress’s permission to do NGDPLT. Raising the inflation target is not the only option, or the best option.
Jon, You said:
“You keep making these claims as if the Fed can just wave a magic wand and expand the money supply.”
No I don’t, I never make those claims. Read my older posts.
E. Harding, Yes, “can” be.
David, John Paulson got really rich, not many others did. If government policymakers or academic economists were able to reliably predict crises as well as Paulson they wouldn’t happen. This one happened because the vast majority did not predict it. Ex ante you can always find a few people that got the financial predictions right, that proves NOTHING.
The very first time I played blackjack I won by first 12 hands in a row. Does that prove I was an expert at Blackjack?
BTW, I plan to move to LA soon. Please find me some nice properties in West LA at 2001 prices, now that the “bubble” has burst and they are no longer at “bubble” levels. I’m willing to pay those 2001 “bubble” prices, I’ve got my checkbook out right now.
E. Harding, Canada, Australia, New Zealand, Britain—none of their bubbles crashed. Why only the US and Ireland? In continental Europe why did Spain crash but not most of the others. Why didn’t the East Asian bubbles burst? This is all Monday morning quarterbacking.
15. April 2015 at 18:45
Oddly enough, about the only investment I can think of that can be truly classified as sometimes being in a bubble is…gold.
15. April 2015 at 19:24
I don’t quite agree with 3., because in 1931 companies defaulted after they saw their earnings fall and their costs rise, ok, but nobody knows if had NGDP been kept at higher levels, the money would flow to those specific companies. Possibly the depression would not happen, ok, but I don’t think things would have been a walk in the park.
The main reason I like market monetarism is that if implemented as prescribed in this blog and others, noboday will ever again complain about demand side macro management, and the “real stuff” will surface …
15. April 2015 at 20:59
David, home prices after the bust never dropped below 2003 levels and are currently back up to around 2005 levels. This rise has happened with zero mortgage growth. At this point, it should not seem reasonable to claim 2001 and 2002 were bubbles funded by unsustainable mortgage debt.
16. April 2015 at 05:15
Jose, Keep in mind that the economy did not have many “real” problems in 1929. It was the nominal shock that caused the big rise in defaults.
Kevin, Good point.
16. April 2015 at 05:50
@Scott
I get your point, but we can’t know that for sure. There are analysis of that period that point to the tentative by most corporations to sustain nominal wages as a cause of rising costs and declining profits for corporations. Even if we reason that should NGDP have been sustained by monetary policy revenues would not have fallen significantly, ok, but there is no way we can know if corporations would have kept their profits going as in the 20’s in a seamless fashion. Don’t get me wrong, I believe thing could have been a lot better should NGDP have not fallen. But if I had to bet, I would bet on a scenario where profits would have fallen less than they did, economy would have had slower real growth than the preceding years, and we would have more inflation. Not a walk in the park, but perhaps something not so catastrophic.
16. April 2015 at 06:13
Scott, you are making an impact. Bernanke: “Suggestions that have been made include…targeting some function of nominal GDP…My colleagues at the Fed and I spent a good deal of time during the period after the financial crisis considering these and other alternatives,”
A journey of a thousand miles…
16. April 2015 at 07:53
Hello Britonomist,
My point is broader than merely the Housing Bubble bursting but the impact that the bust would have on the stock market and the broader economy. What Mr. Fitch and Dr. Friedman discuss is how a bursting Housing Bubble will drag down the stock market and investment in general. Housing bubbles have been around since the 1870’s but they were regionalized and had no impact on the economy of the United States nationally. What both of these pieces draw out is that Housing Bubble was a symptom of a much larger problem which the Housing Bubble and the preceding Dot.Com Bubble were masking. The U.S. economy was suffering from a lack of profitable investment opportunities and so too much capital was chasing too little opportunity and bubbles were formed.
Those who paid attention to this dynamic could see that when the Housing Bubble burst, the impacts would much broader than just the housing industry.
16. April 2015 at 08:10
Mr. Erdmann,
My point was not about the Housing Bubble per se or housing prices. My point was that Macro-Economics did not “fail”, those who applied it correctly did indeed foresee that when the Housing Bubble burst, which many could easily see, that there would a much broader impact to economy of the United States including the stock market.
I linked a piece in the Los Angeles Times by Dr. David Friedman who makes a very cogent argument as to why the Housing Bubble was masking a serious underlying economic problem and when the bubble would burst, that problem would become very apparent.
Marco-economics worked.
16. April 2015 at 08:27
Dr. Sumner,
1) I do not know who John Paulson is and I did not cite him in my posting. So I do not understand the relevance of this to what I wrote.
2) The point that I was making was not that one person or another accurately predicted that the Housing Bubble would burst, that was not a difficult call to make, but rather that the writers in question correct saw that the bursting of the Housing Bubble would have much broader macro-economic impacts. Dr. Friedman and Mr. Fitch, both writing years before the Crash of 2008, rightly laid out arguments as to why the Housing Bubble was a *symptom* of a weak and narrow economy in the Untied States and the bubble was masking these fundamental problems. They both argued that once the bubble burst, there would be significant negative economic impacts.
Using the science marco-economics, these two individuals succeeded in assessing that potential for a broader economic contraction initiated by the Housing Bubble bursting. As applied by those who paid attention, the science of marco-economics “worked”, it was only individual macro-economists who failed.
3) The relative pricing of housing in various cities in the United States currently is not the issue at hand but rather the ability of people using marco-economics to assess the impact of over investment in the housing industry on a weak and narrow economy.
4) Contrary to what you may believe, I do not live in the capital city of BÃo BÃo Provence in the Republic of Chile.
16. April 2015 at 08:35
E. Harding
“So the Fed shouldn’t have attempted to stop the demand shock associated with the Great Depression?”
I don’t think the central bank could have prevented the ’29 crash or the demand shock that followed, nor should they have tried. The Fed (assisted by DC) took on some atrocious policy which extended the depression for longer than it needed to be.
16. April 2015 at 08:55
@David: “the bursting of the Housing Bubble would have much broader macro-economic impacts”
We know that housing prices crashed, and we know that an economy-wide recession followed. And you’re pointing us to people that predicted that sequence, as evidence of good macroeconomic theory.
But there’s an alternative interpretation. Which is that EVEN IF a housing “bubble” bursts, that doesn’t necessarily require a subsequent recession (e.g., if the central bank keeps NGDP on target). So the people you cite are doubly wrong: their theories not only incorrectly assumed a necessary connection between housing and the broader economy, but they also missed the actual cause of the recession (namely, a negative nominal shock).
“the science of marco-economics “worked””
Nope, macro is even worse than you believe, because those macro theories that you are lauding, that predicted “a weak and narrow economy” in the US in 2008, were incorrect. The US economy in 2008 was broad and diverse and strong. The recession happened anyway, but not because of economic fragility, and not because of the housing crash. (The cause was the Fed failing to meet its own nominal targets.)
16. April 2015 at 09:47
Did macro fail in 2008? Of course it did as things change as we face new issues. Just think of all the changes from 1960 of the US economy: High Labor Force Participation with Gender & Race Equality, Massive Globalization, Falling birth rates and the end of the cold war. The economy moved accordingly.
In thinking about the three biggest financial crisis, (US- 1929-33, Japan-90-98, US-01-08), I find the ironic part is all three economies were incredibly productive before the crisis. In all cases, it felt each economy had proven to different this time. There was no economy as productive as the US during the Roaring 20s and it was inspiring to watch Japan Inc. during the 70s and 80s. And the whole new dotcom and internet brought about The Information Age. Each instance the economies were incredibly productive and led to a huge crisis.
I still say China has devised a different and productive society and give macroeconomics a new angle in 2022.
16. April 2015 at 17:08
“I don’t think the central bank could have prevented the ’29 crash or the demand shock that followed, nor should they have tried.”
-Why? You mean they couldn’t have even made the Great Depression into a Russian 1990s?
“The Fed (assisted by DC) took on some atrocious policy which extended the depression for longer than it needed to be.”
-I agree that the Great Depression probably would not have happened without the Fed. But, given the nature of the banking system at the time, either Congress or the Fed should have used a few select varieties of stabilization policy to stop the nominal income contraction. Unlike the Great Recession, the Great Depression was in every conceivable way a classical demand shock.
16. April 2015 at 17:20
@ssumner
Which had the better policy response to RGDP collapse: U.S. in the early 1930s or Russia in the early 1990s?
17. April 2015 at 06:32
Jose, If NGDP is steady and profits fall, then wages increase–>no recession!
17. April 2015 at 06:37
Lately I think people just prefer “bubbles” to “prices rise and fall” because the former craves both explanation and expiation while the latter just nods gently at a natural phenomenon.
17. April 2015 at 06:43
Thanks Todd.
David, You did not address any of the points I made in my response. Simply saying a couple people guess right on a bubble bursting, or its aftereffects, means nothing. Why would I even care?
Doug, You said:
“I don’t think the central bank could have prevented the ’29 crash or the demand shock that followed, nor should they have tried.”
This isn’t even the right question. The Fed clearly caused the demand shock that created the Depression, not just by my policy indicators (NGDP) but even by the conventional ones (the base, interest rates, etc.) Indeed they were explicitly trying to create a negative demand shock to pop the stock market bubble. That was their explicit goal.
E. Harding, I don’t recall exactly what Russia did in the early 1990s, but I think it’s fair to say both countries did pretty poorly.
17. April 2015 at 06:43
Talldave, Good observation.
17. April 2015 at 14:27
Hello Don Geddis,
1) Dr. Friedman and Mr. Fitch did not write that *every* real estate bubble bursting would always result in a major economic contraction. They both wrote that in *this particular* real estate bubble, when it would eventually burst, there would be a very serious economic negative impact.
2) I must disagree, the economy of the United States following the Dot.Com Bubble was driven almost entirely by the Housing Bubble. The telling point is that as “hot” as the US economy was, there were no inflationary pressures, prices remained stable. Without the Housing Bubble, there would been no growth at all.
17. April 2015 at 14:45
Dr. Sumner,
The writers in question did not “guess”, they examined the data available and applied macro-economic principles and drew the correct conclusions. It does indeed prove that Macro-Economics was not deficient, that at least some individuls could effectively apply it to draw meaningful conclusions. The argument that is made is that Marco-economics was inadequate to predict the Real Estate Bubble would burst and bring down the economy with it. I only need one example to prove that theory wrong and provided three.
18. April 2015 at 10:18
David, If they beat the market then it was just a lucky guess–the fact that they had their reasons is irrelevant. Those reasons would also imply the other housing bubbles should have burst, but they did not.
Also note that the recession was not caused by a collapse in housing, indeed the economy continued to grow between January 2006 and April 2008, even as housing construction collapsed.
18. April 2015 at 12:17
“David, If they beat the market then it was just a lucky guess-the fact that they had their reasons is irrelevant. Those reasons would also imply the other housing bubbles should have burst, but they did not.”
So much wrong is only two sentences.
1. Beating the market is not always luck. There can be no good excuse in repeating this same fallacy this often given that it has been explained many times why it is wrong on this blog.
As already explained, it is not the case that our only choice is to either find a mathematical formula the use of which always enables an individual to beat the market, or else beating the market is necessarily always luck. There is another choice that you are blind to because your a priori theory blocks it out. The other choice is having a historically contingent set of superior knowledge and skill. This means that while there is no end all and be all mathematical formula that spits out above average return stock picks, there is nevertheless a resetting of relative skills and abilities being unequal among the populace that investors take advantage of when participating in the market.
It is irrelevant that some investors who thought they had superior skills, end up not beating the market. The market is the judge, but we cannot always know whether the market is judging a gain or loss because of luck, or because of knowledge and skill.
The theory of EMH cannot cope with changes and relative differences in knowledge and skill. It effectively assumes a giant eye in the sky that can’t beat itself. Well sure, it is impossible for anything to beat itself, but that is not what is happening when investors beat the market. It is not the market beating itself, it is some investors beating other investors, either by luck or by skill.
It is possible Warren Buffet got lucky for 20 years in a row. This possibility is jumped on by sloppy and hasty EMH theorists as just another thing to be expected with EMH being true. Yet it is also possible he had superior skills and abilities, which again are historically contingent and need not repeat ad infinitum because of an actual relative depreciation of those skills and abilities. For the failing to beat the market time periods, it is possible that either his skills absolutely decreased, or other investors increased their skills more than he did.
In any event, the market is telling us without a doubt that beating the market is not always luck. If every investor did what the theory of EMH suggests is the best approach, which is to be a massive investor in index linked funds, then the capital markets would collapse. They would cease to exist. There can be no market activity if every investor acted in accordance with “I will only buy index linked funds”.
No theory that is claimed to accurately describe an activity would if accepted result in a destruction of that activity.
EMH is the destroyer of healthy markets. It is a good thing we have investors who reject that naiveté and go on about their business, or else we wouldn’t have a capital market.
It is precisely because EMH is false that we have a market at all that EMH theorists claim can only be beaten with luck.
EMH theory is at root a theory for losers who have difficulty accepting the truth that some investors have superior abilities than other investors, including of course EMH theorists.
2. It is not true that the reasons given for any one housing bubble will burst must always “imply” every other housing bubble must burst in the same exact way. Ceteris is not paribus. It is possible for a housing bubble to be delayed from correcting by more intense inflation and regulation, or by way of a change in psychology. If I saw a house builder building a house that needed more bricks than he had on hand, then me thinking that at some point his errors are going to be revealed, does not imply that every other home builder in the same situation will always go through the same exact history.
Housing bubbles are NOT price trends. They have almost always been associated with price trends, for example in the sense that some respond to an already formed price trend by involving themselves positively in housing construction demand and thus maintain or accelerate that trend, but the prices themselves are not “the” bubble. Never reason from price changes.
A housing bubble is actually a phenomena of real resources and labor. If more resources are pulled into housing than what consumers are actually willing to tolerate, given their saving and consumption preferences, then THAT is “the” bubble. How can that happen? It happens when the communication signal between real investment and real saving is jammed. Market jamming occurs when there is anti-market activity taking place.
Sumner accepts this, he just accepts the sole cause being the Congress with its anti-market, pro-housing law enforcement. He does not understand, either because he is unwilling or because his livelihood depends on him not promoting it or believing it, that another cause is the socialist Federal Reserve System.
How in the world can investors and savers effectively communicate (by way of interest rates), when we don’t even have market determined interest rates due to the existence of Fed activity (which Ben Bernanke explained in his first blog post)?
The answer is of course we cannot. What monetary policy really does is distort and then allow the market to correct, or distort more in order to prevent correction now and thus bring about a bigger correction later on.
I know we are in the mother of all bubbles because we are living in a time of the mother of all activist central banking the world over. Never before 1971 was the whole world put under the guillotine of socialist money. All the errors are now international, and the world is the biggest market, capable of absorbing an almost unfathomable amount of errors and distortions before physical reality asserts itself.
Naive extrapolations from the past easily and very seductively allow us to think certain things like NGDP being stable is the key, totally missing the crucial fact that stable NGDP brought about by a healthier market without fiat money is categorically different from stable NGDP being brought about by a sicker market with fiat money. Never reason from a spending change.
18. April 2015 at 12:19
“Also note that the recession was not caused by a collapse in housing, indeed the economy continued to grow between January 2006 and April 2008, even as housing construction collapsed.”
More wrong here too.
Economies contuing to “grow” does not mean the economy is growing on a healthy sustainable path. Growth for its own sake leads to some people harming other people.
18. April 2015 at 12:20
The recession was caused by the same thing that caused the housing bubble:
Socialist money, the IMF, the BIS, the Fed, they are the root of social economic evil.
18. April 2015 at 13:06
“money, the IMF, the BIS, the Fed, they are the root of social economic evil.”
You left out the Rothschilds, Gettys, Queen Elizabeth and Colonel Sanders.
18. April 2015 at 14:12
@MF: “I know we are in the mother of all bubbles because … Never before 1971 was the whole world put under the guillotine of socialist money.”
LOL. I love the examples you pick to “support” your points. 1980-2005 (roughly) had the greatest real wealth creation over a quarter century period that has ever happened in all of human history. Whatever caused it, we should do more of that! It was “socialist money”, you say? Please, then, bring on more “socialist” money!
P.S. Re: your theory about currently living in “the mother of all bubbles” … Is this theory of yours falsifiable? Is there any future economic history that could possibly unfold, that would lead you to admit, “no, sorry, I was wrong about that”? Or do you somehow just “know” you’re right, from some a priori gut feeling? Or do you think you’ve deduced that conclusion, using only pure logic, starting only from the axiom “humans act”? (If so, please outline the steps in the logic proof.)
18. April 2015 at 16:48
Anthony:
Nice good sheep.
Don Geddis:
I love it how the example you picked in your response “supports” your points.
If we had a free market in money 1980-2005, then growth would have been even higher, and it would have been more sustainable.
Your theory is warped. Correlation is not causation.
I understand your feathers get all frazzled when your faith is questioned. Really, I get it.
And don’t lie, you don’t actually want me to lay out any deductions here. What you want is for me to say I prefer not, so that you can go back to your religious pracising in psychological peace.
It doesn’t matter to you if the argument we are in the mother of all bubbles is falsifiable through experience or if it is a priori synthetic. For no matter what happens, your faith in socialism is not to be shaken. You’ll blame insufficient devotion to the hegemony. You’ll blame the symptomatic degradation of whatever can serve as the excuse of the day.
You are neither honest nor informed enough to hold an intelligent discussion on these matters. You are too emotional to think clearly.
18. April 2015 at 16:48
Everything you asked about has already been written, which you refuse to read.
19. April 2015 at 09:19
Major,
The Pentaverate knows what you did. You better keep quiet.
https://www.youtube.com/watch?v=FveBzGMD6zw
19. April 2015 at 09:28
Anthony,
Video is not available. Do you have a mirror so that I can watch a non-burning burn sometime today? I was feeling a little too mature today.
19. April 2015 at 12:14
@MF: “Correlation is not causation.”
If you say so. Remind me again: what is causation, exactly (according to you)?
“What you want is for me to say I prefer not”
Which is apparently exactly what you then did. So I “win”?
If you don’t want to even attempt to justify your ranting claims, I guess nobody can make you.
19. April 2015 at 20:29
Dr. Sumner,
I did not write that either Dr. Friedman or Mr. Fitch “beat the market”. Neither offered investment any advise nor did they make any comparisons between how they invested money versus how others invested money. What they both did was suggest that there was a Housing Bubble which was facilitated by easy money policies and because of the narrowness of the growth, when that bubble burst, it would have very serious negative economic impacts to economy as a whole and the stock market in particular. They were entirely correct and no guessing was involved. “Luck” had nothing to do with what they wrote.
20. April 2015 at 05:51
David, You said:
“when that bubble burst, it would have very serious negative economic impacts to economy as a whole and the stock market in particular.”
And that proved false, as the economy and stocks did fine in 2006 and 2007, when most of the decline in housing occurred. It was falling NGDP in 2008 that hurt the economy and stocks, and that reflected tight money.
20. April 2015 at 15:04
” It was falling NGDP in 2008 that hurt the economy and stocks, and that reflected tight money.”
No, it reflected a decline in safe assets for the private sector, a loss in confidence in bank dent, leading to a credit squeeze:
http://www.cnbc.com/id/101327578
That’s the fundamental cause. Just because (as you claim) monetary policy could have corrected it doesn’t make it “the” fundamental cause, just like a surgeon not being good enough during an operation to revive someone doesn’t mean the reason they died wasn’t cardiac arrest.
20. April 2015 at 15:06
I mean this is insane, how could you POSSIBLY say the bursting of the housing bubble did not have any negative consequences for the economy. How could you POSSIBLY say that “12 of the 13 most important financial institutions in the U.S. were near failure” is not a drastically negative outcome.
20. April 2015 at 16:32
Britonomist, the drop in safe assets shown in your article began in 3Q 2007. At that time, delinquencies on real estate loans were 3% (not out of range of other recent downturns). Currency in circulation was growing at less than 2.5% (and falling), the yield curve had been inverted for a year, and the Fed Funds Rate was still above 5%. How can you say monetary policy wasn’t to blame?
20. April 2015 at 18:22
@Britonomist: “How could you POSSIBLY say that “12 of the 13 most important financial institutions in the U.S. were near failure” is not a drastically negative outcome.”
Change happens in the economy all the time. The US labor force went from 90+% agriculture to about 3% in a century or two. Auto manufacturing was huge in Detroit for decades … and then its importance collapsed dramatically. The stock market crashed in 1987. The entire dot-com industry crashed in 2000.
But none of these events were a “drastically negative outcome” for the overall US economy. They didn’t significantly affect trend RGDP growth, nor did they cause a major rise in overall unemployment.
An industry-specific crisis can be a big deal, for those in that industry. Having it spread to the entire huge and diversified US economy, for years, is a different story.
“12 of the 13 most important financial institutions in the U.S. were near failure”, if the rest of the economy remains unaffected, is only a local industry-specific problem. And thus it is not a “drastically negative outcome” for the US as a whole.
You’re missing what a very special thing it is, for unemployment to jump from 5% to 10% in a short period of time, and remain there for a long period of time. That rarely happens in the US, and needs a deeper causal explanation than “some financial institutions were in trouble”.
20. April 2015 at 19:04
“At that time, delinquencies on real estate loans were 3% (not out of range of other recent downturns).”
Explain to me what caused the financial industry to explode and necessitate a bailout (although some institutions weren’t so lucky to even get bailed out e.g. Lehman, Bear Stearns etc..), are you really going to make the preposterous claim that the highly leveraged housing bubble wasn’t to blame? Or do you think like Don that finance ‘is just another industry’ and that it doesn’t matter?
20. April 2015 at 19:17
“An industry-specific crisis can be a big deal, for those in that industry. Having it spread to the entire huge and diversified US economy, for years, is a different story.”
It’s not just any industry, it’s a central industry that provides essential liquidity and financial capital to /all other industries in the US/. In fact it’s such a significant industry that it’s failure spread to other countries, like my home country of Britain, and caused serious weakness. If it was a simple secular unrelated in recession in the US it wouldn’t have propagated across the Atlantic to Europe and elsewhere. Do you really think that the US, most of Europe and the UK all just decided to experience a severe but standard secular recession at exactly the same time? You honestly don’t think that the /global/ financial crisis had global consequences?
Regarding the dot com crash, it had a much lesser impact because there are actually strict rules in place regarding how leveraged financial institutions’ positions could be in the stock market, thus its collapse had much less ramifications for the financial sector as a whole. There were very little limitations on how leveraged their positions on housing could be however, and were clearly overleveraged causing serious issues.
“needs a deeper causal explanation than “some financial institutions were in trouble”.”
It wasn’t just ‘some financial institutions’, it was the financial sector as a whole that was going haywire, there was extreme panic and loss of faith – it wasn’t called ‘the credit crunch’ for nothing. How on earth could a shock to the supply of credit, on a credit based economy, not have drastic consequences? There’s really no arguing that this didn’t cause a major demand shock, you can /maybe/ argue over why the demand shock had such a persistent effect on the economy, but you cannot argue that it initially had no effect.
20. April 2015 at 19:36
My claim and some of the evidence is in the comment you responded to. Practically everyone agrees with you. That’s fine. I’ll live. But getting the vapors isn’t an argument.
20. April 2015 at 19:56
Sorry if I come of as angry, I just trying to emphasize how extreme or contrarian some of these beliefs appear to me.
20. April 2015 at 20:38
No problem. You don’t seem angry. I know it’s contrarian.
21. April 2015 at 06:02
Britonomist, You need a theory of the stance of monetary policy, and you don’t have one. If you are going to argue that tight money did not cause the recession, you’ll have to tell us how one identifies tight money.
The financial crisis was mostly caused by the fall in NGDP, which was caused by tight money.
21. April 2015 at 06:29
Why did NGDP fall? What about all the other countries that suffered, did they just happen to suffer a fall in NGDP at around exactly the same time? How are you establishing causality from a fall of NGDP to financial crisis rather than financial crisis to fall in NGDP?
Also I didn’t say monetary policy couldn’t have helped or even mitigated things, but it’s ridiculous to attribute that as a fundamental cause. In the same way, if a robber shoots a bank manager while a police officer is present, nobody would EVER say the policeman ’caused the bank managers death’, even though theoretically the policeman could have rushed in and saved him if he was extremely quick. What you seem to be doing is just flat out ignoring the fact that a robber was shooting someone, treating that as irrelevant, when in fact it’s absolutely fundamental as to why the bank manager died.
21. April 2015 at 07:25
Britonomist,
“Explain to me what caused the financial industry to explode and necessitate a bailout (although some institutions weren’t so lucky to even get bailed out e.g. Lehman, Bear Stearns etc..), are you really going to make the preposterous claim that the highly leveraged housing bubble wasn’t to blame?”
The amount of leverage was a component of it, yes. The banks balance sheets did not have a lot of residual capital to cushion any unexpected market losses. The Basel rules said that banks didn’t need to carry much, if any, capital for AAA rated mortgage backed securities, so they were very highly leveraged. Property values started to decline, and that posed a problem for many of the variable ARM loans in those MBS’. Then to add insult to injury the Fed raised rates to combat mystery inflation. This made many of those variable ARMs increase making them more vulnerable. The valuations on the MBS started to fall. The banks had to mark to market the valuation of these MBS’ and CDOs which meant they had less capital. Capital they didn’t have due to the rules stated earlier. Banks desperately need to preserve capital which meant lots of normal activities were suspended, cut or halted altogether. On top of this was the recession starting to hit and very tight liquidity markets. Banks reduced lending to each other due to uncertainty over balance sheets and an effort to preserve capital and liquidity. The market for securities like MBS and CDOs dried up which led to their values plummeting. This hit their balance sheets even more…..wash, rinse, repeat.
The valuations of these securities fell well below the present value of their expected future cash flows. The reasons for this were a combination of very tight monetary conditions, the recession, and under capitalized balance sheets. The mark to market rules meant that banks had too little capital even though there wasn’t a true market for much of anything due to extremely tight liquidity and credit markets. The banks had to be recapitalized.
21. April 2015 at 07:44
Even if we allow for the idea that the recession (or mild fall in NGDP growth) came first, then that caused the financial crisis, were it not for the financial crisis I’m sure it would have been a mild recession at worst, or at best just a slowing of growth. The fact that it caused financial crisis created a huge feedback effect that massively exacerbated the downturn and caused a very deep recession. How do we know this? We don’t even need to look at the data, standard models TELL US this is what will happen. Look at the work of Bernanke & co on the financial accelerator, or just look at the Kiyotaki-Moore model. Credit crunches cause large output fluctuations, the literature is extremely supportive of this.
21. April 2015 at 08:56
Brit,
“Credit crunches cause large output fluctuations, the literature is extremely supportive of this.”
Yes, I’m sure you’re familiar with the work Reinhart & Rogoff did about financial recessions versus non-financial ones. Things are playing out pretty much the way they said 5 years ago. And it certainly makes sense. The balance sheets of Americans was and still is out of whack. There are reportedly millions still underwater on their mortgages. Until our balance sheets get corrected (something easy money could help with greatly) we will not get back to “normal.”
21. April 2015 at 09:25
@Britonomist: “Credit crunches cause large output fluctuations, the literature is extremely supportive of this.”
But credit crunches are highly correlated with NGDP crashes. So this doesn’t help you distinguish causality.
The Market Monetarists are claiming: if NGDP stayed on trend, then not only would the financial crisis have been less severe (because part of an NGDP crash is an increase in the real burden of debt), but also whatever remaining instability there was in the financial sector, would not have spread so strongly to the rest of the economy.
You can’t resolve this causality conflict, by pointing to historical examples where central banks did not keep NGDP on trend. We need to debate the hypothetical case of a “credit crunch” without a decline in aggregate demand. Does that still cause a large output fluctuation? You seem to think it would, but I doubt you have strong evidence for that conclusion.
21. April 2015 at 09:41
Don, but that doesn’t allow anyone to say the housing bubble bursting wouldn’t have had serious economic impacts. Do you recognize the difference between saying “the housing crisis would not cause a serious impact IF the central bank managed to keep NGDP on trend” and “the housing crisis did not cause a serious impact”? Those are actually very different statements. One is basically saying that the demand shock could have been offset by central bank policy, the latter implies it didn’t even cause a demand shock.
21. April 2015 at 10:31
Brit,
If you read Kevin Erdmann’s thorough examination of housing data, you will find it difficult to argue that “the housing bubble” is the cause of the recession. I think he has proved that sub-prime loans were not the cause.
21. April 2015 at 12:05
Don,
“The Market Monetarists are claiming: if NGDP stayed on trend, then not only would the financial crisis have been less severe (because part of an NGDP crash is an increase in the real burden of debt), but also whatever remaining instability there was in the financial sector, would not have spread so strongly to the rest of the economy.”
I’m not an economist, so I can’t speak directly to that. However I do know banking, and the crisis might not have been a crisis with additional liquidity. I think if the expectations had been “the Fed will make sure there is more than adequate liquidity” the problem would not have been nearly as severe.
21. April 2015 at 14:01
@Britonomist: “Do you recognize the difference between saying “… IF the central bank managed to keep NGDP on trend””
Oh, sure! I’ll totally grant you that the housing crisis exerted pressure on NGDP. But no real-world pressure can possibly compete with the ability of a central bank to hit a nominal target using fiat currency.
The whole point is that the Fed is supposed to act like a thermostat, to hit a target. There are all sorts of things in the economy that exert “pressure” on NGDP, either up or down. That’s the nature of a control system. The stock market crash in 1987 exerted pressure, the dot com crash in 2000 exerted pressure. As did the housing crash in 2006.
But none of these affected the larger economy, outside of those narrow industries, until the Fed allowed NGDP to plummet from trend. The economy-wide macro effects (reduced RGDP, elevated unemployment) came from the decline in NGDP, not from the specific industries of housing or finance.
You’ve got a thermostat with an infinitely powerful air conditioner and furnace. Somebody starts a log fire in the fireplace. Later, there are complains that the whole house is too hot. Is the “cause” the log fire? Not really. Why didn’t the thermostat just turn on the AC and hit its temperature target? There’s no reason that a log fire needs to cause the whole house to be excessively warm, when there’s a running thermostat with infinite heat control.
23. April 2015 at 17:37
Britonomist, You may not know this, but the standard view among economists is that tight money caused the Great Depression of the 1930s. But I guess you also think that theory is ridiculous.
23. April 2015 at 17:41
I don’t think that’s ridiculous actually Scott, one of my modules during my masters was economic history, and the great depression was well covered. I agree with people like Irwin & Eichengreen regarding the causes. But we’re not talking about the great depression, and I believe the causes of the recent recession differ.