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Article Artículo

Getting Serious About Debt and Deficits: The Deficit Hawks Did Enormous Harm to Our Kids

I have pasted below a post from Patreon page. I had planned to wait a little longer, but this NYT piece convinced me to post it now.

Debt and Deficits, Again

With the possibility that the Democrats will retake Congress and press demands for increased spending in areas like health care, education, and child care, the deficit hawks (DH) are getting prepared to awaken from their dormant state. We can expect major news outlets to be filled with stories on how the United States is on its way to becoming the next Greece or Zimbabwe. For this reason, it is worth taking a few moments to reorient ourselves on the topic.

First, we need some basic context. The DH will inevitably point to the fact that deficits are at historically high levels for an economy that is near full employment. They will also point to a rapidly rising debt-to-GDP ratio. Both complaints are correct, the question is whether there is a reason for anyone to care.

Just to remind everyone, the classic story of deficits being bad is that they crowd out investment and net exports, which makes us poorer in the future than we would otherwise be. The reason is that less investment means less productivity growth, which means that people will have lower income five or ten years in the future than if we had smaller budget deficits. Lower net exports mean that foreigners are accumulating US assets, which will give them a claim on our future income.

Debt is bad because it means a larger portion of future income will go to people who own the debt. This means that the government has to use up a larger share of the money it raises in taxes to pay interest on the debt rather than for services like health care and education. Or, to put it in a more Keynesian context, there will be more demand coming from people who own the debt, which means the government would need higher taxesnto support the same level of spending than would otherwise be the case.

There is an important intermediate step in the deficit-crowding out story that is worth stating explicitly. The Federal Reserve Board could opt to keep interest rates low by buying up debt directly. The assumption in the crowding out story is that the Fed allows interest rates to rise or even deliberately raises them, presumably because it is concerned about inflation.

If there is no basis for inflationary concerns, there is no reason that the Fed could not simply keep interest rates low in spite of a large deficit, and therefore prevent any crowding out. The question then is whether a budget deficit is pushing the economy up against its limits, leading to inflationary pressures. When we look at the various sources of demand in the economy, there are two reasons for thinking that a larger budget deficit would be needed today to sustain something close to full employment than would have been true four decades ago.

CEPR / September 26, 2018

Article Artículo

Response to Bernanke On the Bubble Versus Financial Crisis Story of the Great Recession

Ben Bernanke responded to Paul Krugman's post last week, which agreed with my argument that the main cause of the Great Recession was the collapse of the housing bubble rather than the financial crisis. Essentially, Bernanke repeats his argument in the earlier paper that the collapse of Lehman and the resulting financial crisis led to a sharp downturn in non-residential investment, residential investment, and consumption. I'll let Krugman speak for himself, but I see this as not really answering the key questions.

I certainly would not dispute that the financial crisis hastened the decline in house prices, which was already well underway by September of 2008. It also hastened the end of the housing bubble-led consumption boom, which again was in the process of ending already as the housing wealth that drove it was disappearing.

I'll come back to these points in a moment, but I want to focus on an issue that Bernanke highlights, the drop in non-residential investment following the collapse of Lehman. What Bernanke seemed to have both missed at the time, and continues to miss now, is that there was a bubble in non-residential construction. This bubble essentially grew in the wake of the collapsing housing bubble.

Prices of non-residential structures increased by roughly 50 percent between 2004 and 2008 (see Figure 5 here). This run-up in prices was associated with an increase in investment in non-residential structures from 2.5 percent of GDP in 2004 to 4.0 percent of GDP in 2008 (see Figure 4).

This bubble burst following the collapse of Lehman, with prices falling back to their pre-bubble level. Investment in non-residential structures fell back to 2.5 percent in GDP. This drop explains the overwhelming majority of the fall in non-residential investment in 2009. There was only a modest decline in the other categories of non-residential investment.

CEPR / September 22, 2018

Article Artículo

The Bubble and the Great Recession: The Need for Denial

(This post originally appeared on my Patreon page.)

The tenth anniversary of the collapse of Lehman brought a flood of news stories on the financial crisis. The housing bubble, whose collapse precipitated the crisis, was only mentioned in the background if at all.

In keeping with the general tenor of the commentary, Brookings brought in former Fed chair Ben Bernanke to present a paper saying the story of the Great Recession really was the financial crisis. To my knowledge, they did not have anyone making the case for the bubble.

I won’t go through the whole story here since I just did a paper on the topic. (I’m happy to say Paul Krugman largely agrees with me.) Rather I will say why I think there is such an aversion to acknowledging the importance of the housing bubble to the Great Recession.

The first reason to discount the bubble is that acknowledging its importance in the Great Recession highlights the immense failure of public policy that led to this disaster. The point is that the bubbles, and especially bubbles that drive the economy, are easy to see.

After largely tracking the overall rate of inflation for 100 years, house prices began to hugely outstrip inflation in 1996. This run-up in house prices should have been hard to miss. It was reported in government data that were published quarterly. The fact that there was no corresponding increase in rents and that vacancy rates were rising through the bubble years should have been a serious warning that something wasn’t right in the housing market. The deterioration of mortgage quality in the later years of the bubble was a widespread joke among people in the real estate business.

It should also have been easy to see that the bubble was driving the economy. Residential investment went from an average of less than 4.5 percent of GDP in the prior two decades to a peak of 6.8 percent of GDP in 2005. This is the GDP data that are published quarterly. How does an economist not notice this?

CEPR / September 21, 2018