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What Economists Call a "Balance Sheet" Recession Used to Be Called a "Wealth Effect" Recession Print
Thursday, 25 September 2014 04:58

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.


The U.S. Could Pay India Not to Emit Greenhouse Gases Print
Thursday, 25 September 2014 04:36

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.


More Lawlessness From Lenders Print
Thursday, 25 September 2014 04:30

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.

China's Per Capita Emissions are One Third Those of the U.S. Print
Wednesday, 24 September 2014 04:40

This point would have been worth including in a discussion of President Obama's effort to get China to agree to emission reductions. China remains much poorer than the United States, even though it has surpassed the United States in GDP, because it has four times the population.

Furthermore, many of its emissions are associated with goods that are produced for export to the United States and other countries. In that sense, the United States has effectively exported emissions connected to its own consumption to China. Also, the problem of global warming is associated with the accumulation of carbon dioxide over time. The United States and other wealthy countries have been contributing to this buildup on a large scale for more than a century. If they had not put so much carbon dioxide in the atmosphere, global warming would not be a problem today. China has far to go before it catches up to the United States in total carbon dioxide emissions over time.


Median Household Income Began to Stagnate in 1980, not 2000 Print
Wednesday, 24 September 2014 04:10

Thomas Edsall has a good discussion of the shift of income from labor to capital in the years since 2000. His piece puts the blame largely on the way the United States has structured global trade to put downward pressure on the wages of ordinary workers.

While Edsall's discussion of the period since 2000 is largely on target (it does miss the impact of macroeconomic fluctuations and the fact that we have been well below full employment for most of this period), it errs in telling readers:

"Until 1999, median household income (as distinct from wealth) rose in tandem with national economic growth. That year, household income abruptly stopped keeping pace with economic growth and has fallen steadily behind then."

While median household income did keep pace with economic growth from 1993 to 1999, it actually lagged far behind in the years from 1978 to 1993. Over this period real per capital income rose by 30.0 percent, while median household income barely changed. This divergence of median income from growth was associated with an upward redistribution of wage income, with high end earners (e.g. Wall Street types, CEOs, and doctors) gaining at the expense of most workers.

In this period, most college graduates (@ 25 percent of the workforce at the time) were among the winners. By contrast, in the period since 2000 only workers at the very top of the income distribution and owners of capital have been winners.

It's Best to Use Good Math (or Logic) When Picking on Paul Ryan's Bad Math Print
Tuesday, 23 September 2014 19:26

Jonathan Chait took a few swipes at Paul Ryan for his budget work and economic forecasts in a piece headlined "Paul Ryan Declares War Against Math." Most of Chait's shots are well-deserved, for example he notes Ryan's claims that the Obama deficits would lead to a surge in inflation and that Obamacare would cause health care costs to soar.

However one of the Chait's shots is definitely in the cheap seats. He tells readers:

"'Reality' [a sarcastic reference to Ryan's world view] is Ryan’s description for a world in which Bill Clinton’s punishing tax hikes on the rich hindered the economy, which was restored to health when George W. Bush cut taxes."

Actually in the reality where most of us reside, George W. Bush's tax cuts almost certainly did provide a boost to the economy. At the time the economy was experiencing a recession due to the collapse of the stock bubble (the cause of the Clinton budget surpluses). The economy desperately needed a source of demand to replace the demand generated by the collapse of the stock bubble. This is a point that is now acknowledged even by Larry Summers, President Clinton's last Treasury Secretary. The Fed was approaching the zero lower bound with its interest rate policy, as the federal funds rate was lowered to 1.0 percent in the summer of 2002.

This meant that fiscal policy was badly needed to provide a boost to the economy. In that context, the Bush tax cuts were almost certainly a positive for the economy, leading to more consumption and therefore more demand and employment than if there had been no expansionary fiscal policy. Of course the same amount of money would have provided more stimulus if it had gone to support infrastructure, education, or other forms of spending. It would have also given the economy more of a boost if it was less tilted towards those at the top end of the income distribution. 

But given a choice between the Bush tax cuts and doing nothing, the Bush tax cuts were almost certainly the better way to go. They may not have been sufficient to offset the damage caused by the collapse of the stock bubble, but they were a step in the right direction.


Note: Jonathan Chait's name was originally misspelled as "Chiat."


Total Home Sales Are At or Above Trend Print
Tuesday, 23 September 2014 04:57

The Washington Post gave us the ostensibly bad news that home sales were down slightly in August. It later uses as a point of reference the number of mortgages issued in 2001. The housing market had already entered its bubble phase in 2001 with house prices running well above trend levels. If we compare total sales (new and existing homes) with sales in the pre-bubble years 1993-1995, they would actually be somewhat higher today, even after adjusting for population growth.

While there may be an issue of many people being unable to qualify for mortgages because of their credit history, this does not appear to be having a negative effect on the state of market. Prices are already about 20 percent above their trend levels.

It also is not clear that all of the people being denied mortgages are being harmed. Because of the weak labor market, workers often have to move to find or keep jobs. There are large transactions costs associated with buying and selling a home. These average around 10 percent of the purchase price. If a person can't expect to stay in a home for at least five years they will likely lose by buying rather than renting. it is especially likely they will lose in a context where higher future interest rates, which are almost universally predicted, will put downward pressure on house prices. It is worth noting that many of the people pushing homeownership today were also pushing it as the housing bubble was reaching its peaks in the years 2005-2007.

If Children Are Being Crowded Out, It is Being Done by Rich People Print
Monday, 22 September 2014 20:19

There is a well-funded effort (think Fix the Debt and the Peter G. Peterson Foundation) to distract people from the upward redistribution to the rich through claims that the problem is really the elderly living high on Social Security and Medicare. Catherine Rampell contributed to this effort with a column warning the spending on the elderly threatens to crowd out spending on our children. Just about every claim in the column is either seriously misleading or outright wrong.

To begin with we get these two paragraphs:

"Spending on kids as a share of the budget is projected to decline dramatically in the coming decade — to just 7.8 percent by 2024. If you exclude health spending, spending on children falls in raw, inflation-adjusted dollars, too, not just as a percentage of total spending.

"'Kids’ share of federal spending isn’t tumbling because children are suddenly becoming a smaller fraction of the population. Nor is this happening because we live in an “age of austerity”; the sizes of both the economy and tax revenue are at all-time highs, after accounting for inflation, and are expected to keep growing. Federal spending overall is likewise projected to swell in coming years."

Okay, why would we exclude spending on health care for kids, unless we are trying to deceive readers? After all, the piece doesn't exclude spending on health care when it discusses spending on the elderly. Also, we know that the main avenue for spending on kids is education. This is done primarily at the state and local level. Rampell acknowledges this point later in the piece, but then why the histrionics over the age composition of federal spending?

Also saying that we are not in an age of austerity is bizarre. Tax revenues as a share of GDP have fallen to levels not seen since the 1950s. Yes, the economy is growing and the budget is growing along with it, but what matters are the shares of the GDP going to tax revenue.

Then we are told:

"Entitlements that benefit older Americans increasingly dominate the U.S. budget, and not just because the population of older people is increasing. We’re spending way more per elderly person, too. Per capita federal outlays on children rose by about $4,600 in the last half-century (from $270 in 1960 to $4,894 in 2011, after adjusting for inflation); during the same period, per capita outlays on the elderly rose by about $24,000 (from $4,000 to $27,975).

"The chasm between per capita funding received by seniors — even after taking into account all the taxes they have paid — and children looks likely to widen substantially, given the way Social Security, Medicare and child program benefits are structured."

The numbers for spending on seniors might sound dramatic, but it is important to remember that they paid for their Social Security benefits in full. In fact, according to the Urban Institute, which provided much of the basis for this column, the typical senior will have paid somewhat more in taxes to Social Security over their working lifetime than what they can expect to receive back in benefits. Complaining about what seniors get paid out without noting what they paid in would be like complaining about the interest payments that rich people get on their government bonds without noting that they paid for their bonds.



Should We Worry About Economic Stagnation Due to Weak Supply? Print
Monday, 22 September 2014 04:22

Robert Samuelson devoted his column to discussing the argument of Northwestern University economist Robert Gordon, who argues that we are destined for a prolonged period of slow growth. Samuelson argues that this could lead to major conflicts over distribution since people will not be able to enjoy rising living standards due to growth.

There are several points worth noting about Gordon's argument. First our ability to predict productivity growth has been virtually zero. There was a huge slowdown in productivity growth in 1973, a pickup in 1995, and possibly another slowdown in 2005. The profession completely missed the slowdown in 1973 and even forty years later there is no universally accepted explanation of why it occurred. The 1995 speedup also caught most economists by surprise, although there is general agreement that it was due to the spread of computers and the Internet.

The 2005 slowdown is not at all universally accepted. While it could mark the end of the 1995 speedup, it could just be due to the weakness of demand following the collapse of the housing bubble. Here also, no one predicted the slowdown. Given this track record, it is reasonable to question the accuracy of Gordon's or anyone's predictions about productivity growth over the long-term future.

It is also important to point out that this view is 180 degrees at odds with the robots taking all our jobs view. The fact that both views can be taken seriously within the economics profession speaks to the state of economics. This would be like a person going to a doctor for a check-up, with the doctor concluding that the patient is seriously obese and must immediately begin a strict diet and exercise regimen. The patient then goes to another doctor for a second opinion. This doctor is concerned about the patient being too thin and prescribes a high calorie diet to allow the patient to put on weight. This is the state of economics' ability to predict productivity.

There are a few other points worth noting. First, the comparison in Samuelson's piece of projected growth rates to growth in the 1950s and 1960s is somewhat misleading. The population was growing more rapidly in the 1950s and 1960s as the country was experiencing the baby boom. It is per capita growth, not total growth that matters for living standards. If growth slows in line with slower population growth, this does not hurt living standards. In fact, slower population growth would be associated with an improvement in living standards insofar as it means less stress on the natural environment and the physical infrastructure.



NYT Passes Judgment on European Concerns on Sharing Economy Print
Monday, 22 September 2014 04:13

There are many issues raised by Uber, Airbnb, and other major companies that are part of the "sharing economy." For example Uber drivers don't have to pass the same tests, undergo the same background checks, or carry the same insurance as drivers for traditional taxis. Uber cars also don't have to meet rules about being handicap accessible.

The same sorts of issues arise with rooms rented through Airbnb. These rooms don't have to meet the safety and accessibility standards imposed on hotels. Also, many people living in apartment buildings rent out rooms, creating a nuisance for their neighbors who didn't expect to be living in a hotel.

These and other issues have been raised by people concerned about the spread of the sharing economy in both Europe and the United States. The NYT has however determined that these concerns are not real, telling readers:

"As in the United States, where tech start-ups have also faced legal challenges, the wide-ranging response in Europe often comes down to whether lawmakers view the companies as a threat to local businesses or an opportunity to improve economic growth."

Apparently the NYT believes that people who raise concerns about hotels being accessible to people with disabilities or that they should not be fire hazards are actually only interested in protecting existing businesses. That's an interesting position to express in a news article.

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About Beat the Press

Dean Baker is co-director of the Center for Economic and Policy Research in Washington, D.C. He is the author of several books, his latest being The End of Loser Liberalism: Making Markets Progressive. Read more about Dean.