Thursday, March 10, 2016

On Delong at Huffington

This is my comment on Brad DeLong's article in the Huffington Post.

I think the Huffington post editor might have cut out a key paragraph. In the article as edited there is no description of an overhang until remedies are discussed

"What we need now is 1) debt relief to unwind the overhang and 2) much tighter financial regulation to prevent the growth of new fragilities. And if those prove inconsistent with full recovery, then we need massive government spending on infrastructure and other investments financed by money printing until full employment is reattained."

It isn't clear exactly which overhang you had in mind. I assume it is household debt as you wrote somewhere that you have been convinced by Mian and Sufi.

I don't know if this is due to the ruthless Huffingediting, but I have 3 problems with your proposals.

1) I strongly object to the word "then". As written it implies that fiscal stimulus should be used only after debt relief is tried and fails. Ignoring the political impossibility of fiscal stimulus (on the grounds that debt relief is also politically impossible) I'd argue for fiscal stimulus now. Even if debt relief works, it will take time. I am ignoring politics so I assume Congress acts tomorrow, but even then (tomorrow) it will be slow and messy. Unlike bankers, ordinary people don't promptly find out about available subsidies and grab them. Relief for the banks took time. Under the most optimistic forecast there should still be slack demand (at a Federal funds rate of zero) for over a year -- time for fiscal stimulus to help.

2) We need massive government investment. It doesn't have to be financed with money printing. I think it makes almost exactly difference if it is financed with money or T-bills -- money and T-bills are still essentially perfect substitutes. I think it makes very very little difference if it is financed with money or 7 year treasury notes. I note the lack of evidece for a correctly signed effect of QE-II. Finally, I think it makes almost no difference whether it is financed with debt or taxes on capital income or high labor incomes. I note that monetized deficits are taboo and deficit spending is unpopular while higher taxes on the rich are popular (supported even by a substatial minority of self declared Republicans).

3) I am not sure what the effect of debt overhang is supposed to be. You often print your NIPA graph of components of aggregate demand and note that the shortfall is in housing investment and public consumption and investment. The abnormally low public investment tends to suggest to anyone who doesn't think it was way to high in the past, that it should be increased even if the social cost were ordinary (that is aside from your macroeconomic consideration). For public investment, the relevant debt overhang is state and local government debt. Bond markets tell us that Federal debt is a political not an economic problem.

So I guess you think that housing investment is lower than it should be due to excessive household debt. Yes that is a value judgment (your proposals must be intended to change things from the way they are to the way they should be). Your value judgment is based on the assumption that US housing invesment was the way it should be back in 2000 before the bubble. I remain unconvinced that 2000 was before the bubble. I think demand for houses back in 2000 was based on irrational beliefs about house price appreciation which couldn't last forever -- that is I think there was a housing buble back then too. I think it started in the 1970s. What if Shiller is right and there isn't a long term trend in (house prices)/(consumer price index, people have incorrectly believed for decades that there is, and people now believe there isn't ? Then it is possible that curent levels of housing investment are the new normal and other sources of aggregate demand must be found. I think it is entirely possible that housing investment in the 80s and 90s was due to a bubble which couldn't last forever, but did last an extraodrinarily long time, because the people extrapolated a trend in a relative price which they didn't observe.

I'm not convinced there is anything abnormal in US aggregate demand except for low government consumption plus investment.

This is too long already, but I note that I agree with mwilbert and dilbert dogbert (in comments here ) that there seems to be a trend in prime age labor force participation which is not just due to low aggregate demand and discouragement. I the issue is that some people who are classified as prime age don't feel that they are in their prime (increasing numbers claim to be disabled). Now this is horrible for those of us who left prime age in the past year but it's in the data. Prime aged adults are aging and labor force participation has always declined some well before people had any business thinking about retiring (stop Robert you have to actually work in, like, a real job before you can retire). There is no need to look only at such a simple statistic as the prime age employment ratio. It is possible to regress labor force participation on year dummies and a flexible function of age and look at the coefficients on the year dummies. This has been done and it makes a difference.

Also I think Krugman (as usual) shares some of the credit for getting things right. He argued that this is not our father's recession and contrasted inflation fighting and bubble bursting recessions. Your (brilliant) look at every 4th year univariate analysis of GDP didn't take into account the fact that the Fed was slamming on the brakes then on the gas in your sample. A normal recovery included a dramatic decline in the Federal Funds rate. Stiglitz wasn't the only one who noted that wasn't going to happen in 2009.

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