The Washington Post brought its campaign against Social Security into the name-calling phase with a full page article headlined, “Social Security Is a Mess. How to Fix It.” (That is the print edition headline, the web version is slightly different.) The piece includes a standard list of revenue and spending items that could close the shortfall that is first projected to arise in 19 years.
There are a few points worth making about this piece. The first is the obvious. Name-calling doesn’t belong in a serious newspaper. The Social Security system faces problems, but so does the Justice Department and the Defense Department, or for that matter Amazon, the company controlled by Washington Post owner Jeff Bezos. It is unlikely we will ever see an article headlined “Amazon is a Mess.” The Post should try at least a little bit to separate the views of the editors/publisher from the way it presents the news. That is what serious newspapers do.
The second point is that in the scheme of things Social Security is an incredibly effective program. It has kept tens of millions of people out of poverty. It is the main source of retirement income for current retirees and will grow as a share of most workers’ retirement income in the years ahead. It has very little fraud and abuse. In fact, fraud is so rare that the Washington Post thought it was worth a front-page story to report that 0.006 percent of Social Security benefits over the prior three years had been paid out to dead people. And its administrative costs are less than one-tenth as large as those of private sector firms providing retirement accounts. If Social Security is a “mess,” then the adjectives appropriate for other large institutions could not be printed in a family paper.
The piece also wrongly asserts that the shortfall would be easier to solve if it were done sooner. That might be true if we envision that the gap would be closed entirely or in part on the benefit side. However if the gap is closed on the revenue side it doesn’t follow that there is an special advantage to having a fix implemented sooner. For example, if we raise the cap on taxable wages and raise the payroll tax beginning in 2025, it is not clear that there is any big advantage to writing that into law in 2014 as opposed to 2024. (There may be some small advantage that people can adjust their behavior, but this is a very minor issue.)
It would also have been useful to put the projected shortfall in some context. Much of the shortfall stems from the upward redistribution of income over the last three decades. This is in turn is attributable to policies like special too big to fail insurance for Wall Street banks, trade policy that was designed to put downward pressure on the wages of ordinary workers, and Federal Reserve Board policy that has deliberately kept unemployment high in order to undermine workers’ bargaining power.
This upward redistribution is important to Social Security for two reasons. First, it has shifted a large amount of wage income to workers earning above the cap. The share of wage income that has escaped taxation in this way rose from 10 percent in 1983 to 18 percent in recent years. Similarly, the shift from wage income to profits in the last 14 years has also deprived the system of revenue.
The other reason this shift is important is that it has kept wages from growing in step with productivity. If the typical worker’s wages had risen in step with productivity since 1980 they would be more than 30 percent higher today. In this context, a 2-3 percentage point rise in the payroll tax (like we saw in both the decade of the 1970s and the 1980s) would probably not seem like that big a deal. Workers care first and foremost about their after-tax wage, not the tax rate. While politicians and newspapers might focus on the latter, workers would be far better off with 30 percent more going into their paychecks, even if 2-3 percent more was coming out in taxes.
The Washington Post brought its campaign against Social Security into the name-calling phase with a full page article headlined, “Social Security Is a Mess. How to Fix It.” (That is the print edition headline, the web version is slightly different.) The piece includes a standard list of revenue and spending items that could close the shortfall that is first projected to arise in 19 years.
There are a few points worth making about this piece. The first is the obvious. Name-calling doesn’t belong in a serious newspaper. The Social Security system faces problems, but so does the Justice Department and the Defense Department, or for that matter Amazon, the company controlled by Washington Post owner Jeff Bezos. It is unlikely we will ever see an article headlined “Amazon is a Mess.” The Post should try at least a little bit to separate the views of the editors/publisher from the way it presents the news. That is what serious newspapers do.
The second point is that in the scheme of things Social Security is an incredibly effective program. It has kept tens of millions of people out of poverty. It is the main source of retirement income for current retirees and will grow as a share of most workers’ retirement income in the years ahead. It has very little fraud and abuse. In fact, fraud is so rare that the Washington Post thought it was worth a front-page story to report that 0.006 percent of Social Security benefits over the prior three years had been paid out to dead people. And its administrative costs are less than one-tenth as large as those of private sector firms providing retirement accounts. If Social Security is a “mess,” then the adjectives appropriate for other large institutions could not be printed in a family paper.
The piece also wrongly asserts that the shortfall would be easier to solve if it were done sooner. That might be true if we envision that the gap would be closed entirely or in part on the benefit side. However if the gap is closed on the revenue side it doesn’t follow that there is an special advantage to having a fix implemented sooner. For example, if we raise the cap on taxable wages and raise the payroll tax beginning in 2025, it is not clear that there is any big advantage to writing that into law in 2014 as opposed to 2024. (There may be some small advantage that people can adjust their behavior, but this is a very minor issue.)
It would also have been useful to put the projected shortfall in some context. Much of the shortfall stems from the upward redistribution of income over the last three decades. This is in turn is attributable to policies like special too big to fail insurance for Wall Street banks, trade policy that was designed to put downward pressure on the wages of ordinary workers, and Federal Reserve Board policy that has deliberately kept unemployment high in order to undermine workers’ bargaining power.
This upward redistribution is important to Social Security for two reasons. First, it has shifted a large amount of wage income to workers earning above the cap. The share of wage income that has escaped taxation in this way rose from 10 percent in 1983 to 18 percent in recent years. Similarly, the shift from wage income to profits in the last 14 years has also deprived the system of revenue.
The other reason this shift is important is that it has kept wages from growing in step with productivity. If the typical worker’s wages had risen in step with productivity since 1980 they would be more than 30 percent higher today. In this context, a 2-3 percentage point rise in the payroll tax (like we saw in both the decade of the 1970s and the 1980s) would probably not seem like that big a deal. Workers care first and foremost about their after-tax wage, not the tax rate. While politicians and newspapers might focus on the latter, workers would be far better off with 30 percent more going into their paychecks, even if 2-3 percent more was coming out in taxes.
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The Washington Post treated us to “five myths about billionaires” this morning. Incredibly, they missed the most obvious one: that billionaires know anything special about what is good for the country and the world.
Most billionaires (at least those who didn’t inherit the money) are probably smart and hard-working, but so are millions of other people. What most distinguishes someone like Bill Gates from the hundreds of thousands of other software entrepreneurs is luck and sharp elbows. Suppose IBM had refused to allow Gates to keep control of the Dos operating system? Gates might still be very rich, but certainly not the richest man in the world. Alternatively, if the government still enforced anti-trust laws Microsoft might have faced serious penalties for engaging in textbook anti-competitive practices to get and keep a near monopoly in operating systems, Gates also would not have the fortune he has today.
Anyhow, there is no reason to think that Gates’ luck and ruthlessness make him particularly competent to pass judgment on world poverty, education, or any of the other issues for which he is now viewed as an authority. The same applies to the other billionaire policy types cited in the piece. While these people obviously have the money to ensure that their views carry force in the world, there is no more reason to think that these billionaires’ judgments on public policy carry particular value than the judgments of people who win the lottery.
The Washington Post treated us to “five myths about billionaires” this morning. Incredibly, they missed the most obvious one: that billionaires know anything special about what is good for the country and the world.
Most billionaires (at least those who didn’t inherit the money) are probably smart and hard-working, but so are millions of other people. What most distinguishes someone like Bill Gates from the hundreds of thousands of other software entrepreneurs is luck and sharp elbows. Suppose IBM had refused to allow Gates to keep control of the Dos operating system? Gates might still be very rich, but certainly not the richest man in the world. Alternatively, if the government still enforced anti-trust laws Microsoft might have faced serious penalties for engaging in textbook anti-competitive practices to get and keep a near monopoly in operating systems, Gates also would not have the fortune he has today.
Anyhow, there is no reason to think that Gates’ luck and ruthlessness make him particularly competent to pass judgment on world poverty, education, or any of the other issues for which he is now viewed as an authority. The same applies to the other billionaire policy types cited in the piece. While these people obviously have the money to ensure that their views carry force in the world, there is no more reason to think that these billionaires’ judgments on public policy carry particular value than the judgments of people who win the lottery.
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Don’t worry folks, this is a family-friendly blog. The issue is that Steven Pearlstein takes great offense at the possibility that people are manipulating the stock price of a biotech company by shorting its stock on a massive basis. Pearlstein is right to be angered about stock manipulation, he is wrong to imagine it bears any direct connection to shorting stock.
The issue here is that short sellers of Northwest Biotherapeutics (people betting against the company’s stock) are supposedly spreading rumors to push down its price. This could be true, and if so, the perps should be nailed and jailed. But people often spread false stories to push up the price of stocks as well. This is every bit as pernicious. It means that suckers could pay high prices for stock that may have little or no value. This could deprive people of large portions of their savings. It also diverts capital from companies that may actually have worthwhile products to companies that don’t.
It is much easier to manipulate the stock price of a small company than a large company, but this is true on both the short and long side. Shorts can serve a valuable function. Imagine that the investment banks had been shorted in a massive way in 2004 just as the housing bubble was really going crazy. It might have stopped the bubble in its tracks. There is nothing inherently pernicious about shorts. It is wrong to make an automatic connection between shorts and stock manipulation. There is none.
Don’t worry folks, this is a family-friendly blog. The issue is that Steven Pearlstein takes great offense at the possibility that people are manipulating the stock price of a biotech company by shorting its stock on a massive basis. Pearlstein is right to be angered about stock manipulation, he is wrong to imagine it bears any direct connection to shorting stock.
The issue here is that short sellers of Northwest Biotherapeutics (people betting against the company’s stock) are supposedly spreading rumors to push down its price. This could be true, and if so, the perps should be nailed and jailed. But people often spread false stories to push up the price of stocks as well. This is every bit as pernicious. It means that suckers could pay high prices for stock that may have little or no value. This could deprive people of large portions of their savings. It also diverts capital from companies that may actually have worthwhile products to companies that don’t.
It is much easier to manipulate the stock price of a small company than a large company, but this is true on both the short and long side. Shorts can serve a valuable function. Imagine that the investment banks had been shorted in a massive way in 2004 just as the housing bubble was really going crazy. It might have stopped the bubble in its tracks. There is nothing inherently pernicious about shorts. It is wrong to make an automatic connection between shorts and stock manipulation. There is none.
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Neil Irwin has a useful piece reporting on a journal article by Pavlina Tcherneva documenting the increased share of income growth going to the top 10 percent and especially the top 1 percent. While there can be little doubt about the basic patterns, it is worth noting that the data include capital gains income. This is important because by this measure the change in income shown in any given year will be hugely influenced by the movement in stock prices in the recent past.
For example, if stock prices stay more or less at their current level for the next two years and then we compared the income growth of the top 1 percent in 2016 with the growth in 2012 (after three years of sharp price increases) our numbers would show a sharp fall in the income of the top 1 percent even if nothing else in the economy had changed. While it is worth noting changes in wealth and capital gains, it is useful to examine income with gains (or losses) excluded. If the stock market stabilizes at its current level and the pattern of income distribution has otherwise not changed, the country will not have become more equal.
Neil Irwin has a useful piece reporting on a journal article by Pavlina Tcherneva documenting the increased share of income growth going to the top 10 percent and especially the top 1 percent. While there can be little doubt about the basic patterns, it is worth noting that the data include capital gains income. This is important because by this measure the change in income shown in any given year will be hugely influenced by the movement in stock prices in the recent past.
For example, if stock prices stay more or less at their current level for the next two years and then we compared the income growth of the top 1 percent in 2016 with the growth in 2012 (after three years of sharp price increases) our numbers would show a sharp fall in the income of the top 1 percent even if nothing else in the economy had changed. While it is worth noting changes in wealth and capital gains, it is useful to examine income with gains (or losses) excluded. If the stock market stabilizes at its current level and the pattern of income distribution has otherwise not changed, the country will not have become more equal.
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Justin Wolfers is trying to sell gross domestic income (GDI) as a more accurate measure of growth than GDP. He notes that gross domestic income grew at a 2.2 percent annual rate in the first half of 2014 and says that this “more accurate” measure of the economy should be taken over the 1.2 percent annual rate shown by the more widely used GDP measure.
In principle GDI and GDP should show the same growth. GDI measures the economy by measuring the incomes generated in production (e.g. wages, profits, interest, and rents). GDP measures the economy by counting the goods and services sold (consumption, investment, government, net exports, and inventories). In principle they should show the exact same number, but due to errors in measurement they always differ and sometimes by a large amount. (The gap is defined as the statistical discrepancy, which is GDP minus GDI.)
While Wolfers tells readers that the GDI measure is more accurate the good folks at the Bureau of Economic Analysis generally say that the GDP numbers provide a better measure. The data (Table 1.17.6) show that GDI is far more erratic than GDP. For example, if we believe the GDI measure then the economy grew at a 7.2 percent annual rate in the 2nd quarter of 2012 and then slowed to a 0.6 percent rate in the third quarter. The GDI data also show the recovery barely budged in the second half of 2009 even as the stimulus kicked in, growing at just a 1.1 percent annual rate. Growth then surged to a 5.7 percent annual rate in the first quarter of 2010 before falling back to a 0.5 percent rate in the second quarter.
If that doesn’t sound like the economy you remember there is an alternative explanation for the erratic movements in GDI. David Rosnick and I did a paper regressing the changes in the statistical discrepancy against lagged measures of capital gains. We found a strong relationship with the GDI becoming a larger negative number (GDI rises relative to GDP) following periods of strong capital gains.
For this to be plausible we would need a story whereby some amount of capital gains income shows up as ordinary income. (Capital gains income is not supposed to be counting in GDI.) Since one of the sources for GDI is tax returns, this seems plausible. While long-term capital gains are taxed at a lower rate than ordinary income, short-term gains (assets held less than one year) are taxed at the same rate. This means that people filing tax returns have no particular reason to distinguish between capital gains income and ordinary income.
If we hypothesize that some amount of capital gains income always shows up as ordinary income, then we would expect that the amount of capital gains income showing up as ordinary income would be higher when people have lots of capital gains income. This means that when there is a big run-up in asset prices, we would expect the statistical discrepancy to become a larger negative number, as the data show. See, economics is simple and fun.
Justin Wolfers is trying to sell gross domestic income (GDI) as a more accurate measure of growth than GDP. He notes that gross domestic income grew at a 2.2 percent annual rate in the first half of 2014 and says that this “more accurate” measure of the economy should be taken over the 1.2 percent annual rate shown by the more widely used GDP measure.
In principle GDI and GDP should show the same growth. GDI measures the economy by measuring the incomes generated in production (e.g. wages, profits, interest, and rents). GDP measures the economy by counting the goods and services sold (consumption, investment, government, net exports, and inventories). In principle they should show the exact same number, but due to errors in measurement they always differ and sometimes by a large amount. (The gap is defined as the statistical discrepancy, which is GDP minus GDI.)
While Wolfers tells readers that the GDI measure is more accurate the good folks at the Bureau of Economic Analysis generally say that the GDP numbers provide a better measure. The data (Table 1.17.6) show that GDI is far more erratic than GDP. For example, if we believe the GDI measure then the economy grew at a 7.2 percent annual rate in the 2nd quarter of 2012 and then slowed to a 0.6 percent rate in the third quarter. The GDI data also show the recovery barely budged in the second half of 2009 even as the stimulus kicked in, growing at just a 1.1 percent annual rate. Growth then surged to a 5.7 percent annual rate in the first quarter of 2010 before falling back to a 0.5 percent rate in the second quarter.
If that doesn’t sound like the economy you remember there is an alternative explanation for the erratic movements in GDI. David Rosnick and I did a paper regressing the changes in the statistical discrepancy against lagged measures of capital gains. We found a strong relationship with the GDI becoming a larger negative number (GDI rises relative to GDP) following periods of strong capital gains.
For this to be plausible we would need a story whereby some amount of capital gains income shows up as ordinary income. (Capital gains income is not supposed to be counting in GDI.) Since one of the sources for GDI is tax returns, this seems plausible. While long-term capital gains are taxed at a lower rate than ordinary income, short-term gains (assets held less than one year) are taxed at the same rate. This means that people filing tax returns have no particular reason to distinguish between capital gains income and ordinary income.
If we hypothesize that some amount of capital gains income always shows up as ordinary income, then we would expect that the amount of capital gains income showing up as ordinary income would be higher when people have lots of capital gains income. This means that when there is a big run-up in asset prices, we would expect the statistical discrepancy to become a larger negative number, as the data show. See, economics is simple and fun.
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The NYT ran an article celebrating the recent run-up in the dollar. The headline is “buoyant dollar recovers its luster, underlines rebound in U.S. economy.” The headline could have with at least as much accuracy substituted “undermines” for “underlines.” While the piece attributes the rise in the dollar to all sorts of good things about the U.S. economy, there actually is a much simpler explanation. Interest rates are higher in the United States than elsewhere.
Relative interest rates determine where investors choose to park their money. They are not assigning gold stars to economies for good behavior. There is some relationship between interest rates and growth, but it is the former that matters for investors, not the latter.
The piece gets many other points wrong. For example, after the dollar has risen, investment in developing countries becomes more attractive, not less attractive. But the big point left out of this story is that the over-valued dollar is the main cause of what has become known as “secular stagnation.”
Fans of national income accounting everywhere (i.e. anyone who knows economics) know that a trade deficit creates a gap in demand that must be filled through some other source. Currently the trade deficit is running at more than a $500 billion annual pace or around 3.0 percent of GDP. For the economy to be at its potential, this gap in demand must be fill by higher consumption, investment, housing, or government spending.
The reason the economy is still more than $600 billion below its potential level of output is that it doesn’t have a source of demand to fill this gap. It is not easy to make any of the other components of GDP rise, with the exception of government spending, but that is ruled out for political reasons. We could do it with a stock or housing bubble, but those stories don’t have happy endings.
So the rise in the dollar translates into slower growth and fewer jobs. Goldman Sachs estimates that the 3.0 percent rise in the dollar we have seen to date will shave 0.1 to 0.15 percentage points off GDP growth in each of the next two years (sorry, no link). That is a pretty good size hit in an economy that is only growing at a 2.0 percent annual rate.
It also translates into lost jobs. If the economy is 0.25 percent smaller in 2016 due to the higher dollar that would imply a loss of roughly 350,000 jobs. So, does the NYT have any more good news for us today?
The NYT ran an article celebrating the recent run-up in the dollar. The headline is “buoyant dollar recovers its luster, underlines rebound in U.S. economy.” The headline could have with at least as much accuracy substituted “undermines” for “underlines.” While the piece attributes the rise in the dollar to all sorts of good things about the U.S. economy, there actually is a much simpler explanation. Interest rates are higher in the United States than elsewhere.
Relative interest rates determine where investors choose to park their money. They are not assigning gold stars to economies for good behavior. There is some relationship between interest rates and growth, but it is the former that matters for investors, not the latter.
The piece gets many other points wrong. For example, after the dollar has risen, investment in developing countries becomes more attractive, not less attractive. But the big point left out of this story is that the over-valued dollar is the main cause of what has become known as “secular stagnation.”
Fans of national income accounting everywhere (i.e. anyone who knows economics) know that a trade deficit creates a gap in demand that must be filled through some other source. Currently the trade deficit is running at more than a $500 billion annual pace or around 3.0 percent of GDP. For the economy to be at its potential, this gap in demand must be fill by higher consumption, investment, housing, or government spending.
The reason the economy is still more than $600 billion below its potential level of output is that it doesn’t have a source of demand to fill this gap. It is not easy to make any of the other components of GDP rise, with the exception of government spending, but that is ruled out for political reasons. We could do it with a stock or housing bubble, but those stories don’t have happy endings.
So the rise in the dollar translates into slower growth and fewer jobs. Goldman Sachs estimates that the 3.0 percent rise in the dollar we have seen to date will shave 0.1 to 0.15 percentage points off GDP growth in each of the next two years (sorry, no link). That is a pretty good size hit in an economy that is only growing at a 2.0 percent annual rate.
It also translates into lost jobs. If the economy is 0.25 percent smaller in 2016 due to the higher dollar that would imply a loss of roughly 350,000 jobs. So, does the NYT have any more good news for us today?
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The NYT had a fascinating article on innovations in the financial sector. The piece reports on devices installed in cars purchased with subprime loans that will block a car from starting. According to the piece lenders often block a car from starting after borrowers are just a few days late on their payments. It also reports on cases where borrowers claim they were current on their loans when their cars were blocked from starting. Apparently state rules regulating repossessions, such as providing notice, do not apply to this technology, which largely has the same effect as repossessing a car.
The NYT had a fascinating article on innovations in the financial sector. The piece reports on devices installed in cars purchased with subprime loans that will block a car from starting. According to the piece lenders often block a car from starting after borrowers are just a few days late on their payments. It also reports on cases where borrowers claim they were current on their loans when their cars were blocked from starting. Apparently state rules regulating repossessions, such as providing notice, do not apply to this technology, which largely has the same effect as repossessing a car.
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The NYT had a bizarre article on India’s projected path of greenhouse gas emissions, noting that its emissions are likely to continue to rise at least through 2030. The piece notes that India is likely to pass both the United States and China as the world’s leading emitter of greenhouse gases. The piece presents India’s situation as providing a real moral dilemma since the country still has so many people living in poverty and it needs to increase energy production to sustain its growth and lift people out of poverty.
The moral dilemma is actually much simpler than the piece implies. The comments reported as assertions by Indian political figures happen to be true. Global warming would not be a problem if the United States and other rich countries had not been spewing large amounts of greenhouse gases into the atmosphere for many decades. For this reason, asking India to reduce its greenhouse gas emissions when they are still less than one quarter as high on a per capita basis as U.S. emissions (a fact that was not mentioned in the piece) might not seem terribly fair.
The obvious way around this problem is to have the United States and other rich countries pay poor countries like India to reduce their emissions. This is actually a very simple thing to do. In fact, given the weakness of demand in the U.S. and Europe, paying these countries to reduce emissions would actually increase employment and growth in the wealthy countries.
It might be hard for politicians to suggest something like making payments to poor countries to ensure that our children live on a decent planet, just like many politicians find it difficult to say they believe in evolution, but it really shouldn’t be difficult for a newspaper to discuss these issues in a serious manner.
The NYT had a bizarre article on India’s projected path of greenhouse gas emissions, noting that its emissions are likely to continue to rise at least through 2030. The piece notes that India is likely to pass both the United States and China as the world’s leading emitter of greenhouse gases. The piece presents India’s situation as providing a real moral dilemma since the country still has so many people living in poverty and it needs to increase energy production to sustain its growth and lift people out of poverty.
The moral dilemma is actually much simpler than the piece implies. The comments reported as assertions by Indian political figures happen to be true. Global warming would not be a problem if the United States and other rich countries had not been spewing large amounts of greenhouse gases into the atmosphere for many decades. For this reason, asking India to reduce its greenhouse gas emissions when they are still less than one quarter as high on a per capita basis as U.S. emissions (a fact that was not mentioned in the piece) might not seem terribly fair.
The obvious way around this problem is to have the United States and other rich countries pay poor countries like India to reduce their emissions. This is actually a very simple thing to do. In fact, given the weakness of demand in the U.S. and Europe, paying these countries to reduce emissions would actually increase employment and growth in the wealthy countries.
It might be hard for politicians to suggest something like making payments to poor countries to ensure that our children live on a decent planet, just like many politicians find it difficult to say they believe in evolution, but it really shouldn’t be difficult for a newspaper to discuss these issues in a serious manner.
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It’s often said that the economy is far too simple for economists to understand. There is probably no better example of this problem that the invention of the “balance sheet” recession. The story is that because households have large amount of debt (generally mortgage debt), they cut back on consumption, thereby reducing demand and growth. In Wonkblog today, Matt O’Brien tells us that falling house prices in China may cause the country to face such a balance sheet recession.
The problem with the debt issue is largely secondary. The point is that people cut back consumption because they lose wealth. This is a straightforward, and old, economic concept.
To see the point, imagine someone has a home on which they owe $200,000 and is worth $250,000. Imagine that it rises in value to $350,000. We would typically expect that people would spend more money based on this additional wealth. The usual estimates on the size of this effect are on the order of 5-7 cents on the dollar, implying that this homeowner would spent an additional $5,000 to $7,000 a year based on her increased wealth. Now if the house price plunged back to $250,000 we would expect to see spending to fall back by roughly this amount.
Now let’s do this with debt. Suppose the person borrows an additional $100,000 when the house price goes up to $350,000. They would then owe $300,000 on the house. When the price plunges, she would then owe $50,000 more than the value of the house. In this case we would also expect to see a drop in her annual consumption of $5,000 to $7,000. We could blame debt (she owes $50,000 more than the value of the house), but the main point is that she lost the wealth that was driving her consumption, not the fact that she is now in debt. Focusing on the debt in this story is simply an unnecessary complication.
Of course people are not identical. Many people will not increase their spending at all as a result of the increase in their housing wealth. These people will then not reduce their consumption when their house price falls. The people who did increase their consumption are the ones most likely to find themselves in debt, but that doesn’t change the fact that the story is really one of a wealth effect, not debt.
This point can be easily seen if we look at the macro data. The consumption share of disposable income is actually quite high now, contrary to what is often reported. In other words, given their income levels, people are spending more on average than they did at any point in the post-war period, except the peaks of the stock and housing bubbles. This means that debt is not keeping people in aggregate from spending more, the reduction in wealth is what is keeping people from spending at their bubble peaks.
The debt story creates an unnecessary complication. It perhaps is a useful excuse for economists who somehow missed the importance of the largest asset bubble in the history of the world, but the real story is and was very simple. Economists had all the tools needed to see the problem at the time, they were just not willing to use them.
It’s often said that the economy is far too simple for economists to understand. There is probably no better example of this problem that the invention of the “balance sheet” recession. The story is that because households have large amount of debt (generally mortgage debt), they cut back on consumption, thereby reducing demand and growth. In Wonkblog today, Matt O’Brien tells us that falling house prices in China may cause the country to face such a balance sheet recession.
The problem with the debt issue is largely secondary. The point is that people cut back consumption because they lose wealth. This is a straightforward, and old, economic concept.
To see the point, imagine someone has a home on which they owe $200,000 and is worth $250,000. Imagine that it rises in value to $350,000. We would typically expect that people would spend more money based on this additional wealth. The usual estimates on the size of this effect are on the order of 5-7 cents on the dollar, implying that this homeowner would spent an additional $5,000 to $7,000 a year based on her increased wealth. Now if the house price plunged back to $250,000 we would expect to see spending to fall back by roughly this amount.
Now let’s do this with debt. Suppose the person borrows an additional $100,000 when the house price goes up to $350,000. They would then owe $300,000 on the house. When the price plunges, she would then owe $50,000 more than the value of the house. In this case we would also expect to see a drop in her annual consumption of $5,000 to $7,000. We could blame debt (she owes $50,000 more than the value of the house), but the main point is that she lost the wealth that was driving her consumption, not the fact that she is now in debt. Focusing on the debt in this story is simply an unnecessary complication.
Of course people are not identical. Many people will not increase their spending at all as a result of the increase in their housing wealth. These people will then not reduce their consumption when their house price falls. The people who did increase their consumption are the ones most likely to find themselves in debt, but that doesn’t change the fact that the story is really one of a wealth effect, not debt.
This point can be easily seen if we look at the macro data. The consumption share of disposable income is actually quite high now, contrary to what is often reported. In other words, given their income levels, people are spending more on average than they did at any point in the post-war period, except the peaks of the stock and housing bubbles. This means that debt is not keeping people in aggregate from spending more, the reduction in wealth is what is keeping people from spending at their bubble peaks.
The debt story creates an unnecessary complication. It perhaps is a useful excuse for economists who somehow missed the importance of the largest asset bubble in the history of the world, but the real story is and was very simple. Economists had all the tools needed to see the problem at the time, they were just not willing to use them.
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