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Bubbles Are Not Funny

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Saturday, 16 November 2013 17:31

Paul Krugman tells us that Larry Summers joined the camp concerned about secular stagnation in his I.M.F. talk last week, something that I had not picked up from prior coverage of the session. This is good news, but I would qualify a few of the points that Krugman makes in his elaboration of Summers' remarks.

First, while the economy may presently need asset bubbles to maintain full employment (a point I made in Plunder and Blunder: The Rise and Fall of the Bubble Economy), it doesn't follow that we should not be concerned about asset bubbles. The problem with bubbles is that their inflation and inevitable deflation lead to massive redistribution of wealth.

In the case of the housing bubble in particular we saw millions of people lose much or all of their wealth from buying homes at bubble-inflated prices. The loss of housing wealth is especially devastating because housing is a highly leveraged asset even in normal times and it is an asset often held by middle and moderate income households. It was great that the bubble was able to spur growth and get the economy close to full employment, however the subsequent crash was pretty awful. It would be incredibly irresponsible to go through another round like this.

The second qualification is that it is reasonable to believe that aggregate consumption levels will depend at least in part on the distribution of income. The upward redistribution in the last three decades, from middle and lower end wage earners to the high end wage earners in the 80s and 90s, and to corporate profits in the last decade, likely had an effect in depressing consumption. The question here is whether the marginal propensity to consume out of income is higher for a retail clerk or factory worker than a doctor or CEO. I would be willing to argue that it is, which means that the upward redistribution of income over this period had a depressing effect on consumption. (As a practical matter, this depressing effect was offset by the asset bubbles in the 1990s and 2000s.)

The third qualification is that Summers and Krugman seem to be leaving net exports out of the picture. In the old textbooks, rich countries like the United States were supposed to be net exporters of capital to developing countries. This implies that instead of running trade deficits we should be running surpluses This would both mean a higher return on capital in rich countries and more rapid growth in developing countries, which would be able to use imported goods and services to build up their capital stock even as they sustained a decent level of consumption for their populations.

The real world never followed the textbook story very closely, but it followed especially badly in the years following the 1997 East Asian financial crisis. The harsh terms of the bailout (led in part by Larry Summers) led to a situation in which developing countries began to accumulate massive amounts of reserves to protect themselves from ever being dictated to by the IMF in the same way. Instead of being importers of capital from rich countries developing countries became huge exporters of capital. This meant that the United States in particular had a huge trade deficit that created a huge drag on demand.

Finally, as an alternative to trying to increase demand to deal with secular stagnation, countries could try to reduce supply. This should not sound too crazy. Western Europeans work on average 20 percent fewer hours a year than do people in the United States. These countries mandate paid vacation (at least four weeks a year), paid sick days, paid parental leave and other forms of paid time off. France has a 35-hour work week. Remember, the problem is too much supply not too little. Reduced work hours (i.e. more leisure) is an easy way to deal with this "problem."

The long and short of the matter is that secular stagnation is really a story of too much wealth. It is absurd that this ends up impoverishing countries and leading to mass suffering. Keynes taught us how to deal with this problem almost 80 years ago. We know how to prevent the suffering; we just lack the political force to stop it.

Comments (12)Add Comment
Gotcha
written by Robert Waldmann, November 16, 2013 5:26
Over at Krugman's blog I predicted you would make the point about the US trade deficit. I also noted the probable effect of inequality (but rats didn't predict you would -- no reason you wouldn't except to keep the post short and snappy).
...
written by AlanInAZ, November 16, 2013 6:05
The marginal propensity to consume (mpc) varies with wealth but it also depends on age. As society ages the average mpc will decline. My own spending has declined significantly over the last two decades. I have a home filled with stuff and little need to replace much of it. When we do buy stuff it is often at estate sales that are plentiful. We as a society do not need as much new stuff today and that which we need can be produced with far less labor input than in the past. I should note that my reduced consumption does not signal a reduced standard of living.

Cure for Secular Stagnation: Spread the Wealth You Have
written by Last Mover, November 16, 2013 6:41
The long and short of the matter is that secular stagnation is really a story of too much wealth.


Wait till Very Serious Persons see this one and start howling this is what socialists really want and Dean Baker finally admits it up front ... First they want massive government spending to rescue the economy ... now they want to shrink the economic pie due to "too much supply" ... so there's more wealth to go around ... snicker ...
The problem with bubbles is that their inflation and inevitable deflation lead to massive redistribution of wealth.


The mechanism of how this happens should be rubbed into the face of every Very Serious Person yelling incessantly about government debt now, instead of yelling about the private debt created in the shadow banking sector that fueled the bubble in the first place.

Specifically this Great Recession is a double hit on losers from wealth redistribution upwards. The loss of housing wealth at the micro level and the loss of income earned at the macro level, the latter due to the trillion dollar output gap with nothing to fill the huge hole in demand.

Secular stagnation? So America is stuck at a new low potential output level? And the way out is to shrink supply?

Time for a new book from the father of capitalism, Adam Smith: The Excess Wealth of Nations and Why It Declines

Oh wait. Dean Baker already wrote it.
...
written by watermelonpunch, November 16, 2013 7:57
written by AlanInAZ, November 16, 2013 7:05
The marginal propensity to consume (mpc) varies with wealth but it also depends on age. As society ages the average mpc will decline. My own spending has declined significantly over the last two decades. I have a home filled with stuff and little need to replace much of it. When we do buy stuff it is often at estate sales that are plentiful. We as a society do not need as much new stuff today and that which we need can be produced with far less labor input than in the past. I should note that my reduced consumption does not signal a reduced standard of living.


I'm not disputing your general point here.

But I have noticed that a lot of younger people do NOT buy quality items that last & don't need to be replaced as rapidly as accumulation in the first place.
I notice a lot more of the buy lots of junk, and replace that junk often going on.

It certainly doesn't need to be that way. And that is certainly not confined to youths - I see middle aged & elderly people doing the same thing (though less so).
And it of course doesn't apply to everyone, because I'm more of the "less sturdy stuff" kind of person.

Point being, this may have been true of older people in the past... but will it remain so?
...
written by Blissex, November 17, 2013 8:00
n the case of the housing bubble in particular we saw millions of people lose much or all of their wealth from buying homes at bubble-inflated prices. The loss of housing wealth is especially devastating because housing is a highly leveraged asset even in normal times and it is an asset often held by middle and moderate income households.

But necessarily the same number of middle and moderate income households made a lot of money fast in tax-free capital gains by selling homes at bubble-inflated prices.

Because asset price bubbles are purely redistributive, and a loss of "wealth" for one is necessarily a gain of "wealth" for someone else.

It was great that the bubble was able to spur growth and get the economy close to full employment, however the subsequent crash was pretty awful.


But it was higher employment paid for with colossal waste. There are plenty of non-renewable resources that have been destroyed forever in that bubble.

It would be incredibly irresponsible to go through another round like this.


For most voters and in particular for big property owners it would be irresponsible to stop having bubbles. Because most voters implicitly and big property owners know they can become rich with asset stripping, and bubbles are fantastic opportunities for pump-and-dump style asset stripping.

The difference is of course is that most voters want badly to asset strip themselves, rather cleverly, while big property owners want to asset strip everybody else...
We want to encourage consumption of labor but not of more goods
written by John Wright, November 17, 2013 8:16
If we accept that climate change is occurring and largely caused by human (economic) activity, we should be encouraging lower production of carbon dioxide.

Blindly encouraging consumption appears to be ultimately self defeating unless one believes it will lead to technology that can counter climate change.

Perhaps we are in a world where economic activity will need to be discouraged to keep climate change effects tolerable.

Simply following the current economic game plan of increasing the pie (consumption)should be re-thought.

To me this seems we need to move to a lower consumption, repair/reuse/recycle society, at least in the USA.

This may lead to new employment opportunities, but is not a good political messaged as it is making "more with less".
...
written by A Populist, November 17, 2013 8:54
Paul Krugman's suggested problem / solutions:

"Of course, the underlying problem in all of this is simply that real interest rates are too high. But, you say, they’re negative – zero nominal rates minus at least some expected inflation. To which the answer is, so? If the market wants a strongly negative real interest rate, we’ll have persistent problems until we find a way to deliver such a rate.

One way to get there would be to reconstruct our whole monetary system – say, eliminate paper money and pay negative interest rates on deposits. Another way would be to take advantage of the next boom – whether it’s a bubble or driven by expansionary fiscal policy – to push inflation substantially higher, and keep it there. Or maybe, possibly, we could go the Krugman 1998/Abe 2013 route of pushing up inflation through the sheer power of self-fulfilling expectations."

PK has an implicit *assumption* that "investment first" is the answer, yet dismisses the idea that inequality is the cause of imbalance, because he dare not make *that* assumption - and instead makes the "default" assumption that inequality is *not* the problem.

He is willing to entertain all kinds of complicated schemes to force-feed the economy with investment, yet doesn't seem willing to entertain a higher minimum wage, and/or incentives to spread labor and wages more evenly - which is clearly the biggest problem facing the economy.

Trying to force people to choose to invest in extra unneeded capacity as an alternative to losing money rapidly via inflation or taxation is dysfunctional - a solution which presumes that "investors" should drive the consumption mix of the economy at large. Instead, Demand (consumption) should "pull" the economy along - sending price signals of where to invest. The deification of the entrepreneur and investor, blinds people to the fact that (absent key supply constraints) it is *consumption* which determines the pattern of investment. (A person buys a car, the OEM buys from Tier 1,2,3 etc - the *customer* being the driver in every case). Forced investment is akin to dysfunctional central planning.

More bubbles and instability would be the obvious result of a "negative interest" scheme, as people would be frantically shifting their money, in a vain attempt to outguess the crowd in finding a store of value - and workers would be terrified of ever retiring, as they could never be sure that their savings would be sufficient to avoid future financial ruin.

Massive government spending is not a good long term solution to the demand deficit either - this does not allow for consumption to level off, and for those wishing to "purchase leisure" to be able to afford to do so.

The key imbalance in the economy is the imbalance in the labor market. Is that not clear? If the labor market were in balance, wages could rise, and workers could afford to each work less.
As Dean Baker constantly reminds us, consumption rate is high not low
written by A Greek Bearing Facts, November 17, 2013 10:22
Neither Larry Summers nor Paul Krugman is worried much about a bubble-fueled consumption binge in our immediate future. The real economic crisis at the moment, as Larry clearly pointed out in his IMF remarks, is the inability of most rich countries to generate enough job vacancies to usefully employ millions of citizens who want and need jobs.

The theory that the upward redistribution of income has lowered the aggregate propensity of Americans to consume out of their current incomes does not seem to fit the facts. The upward redistribution of income began in earnest in the 1980s. The fraction of current income that is consumed also began to shift *upward* (not down) in the second half of the 1980s. As Dean Baker frequently reminds us, even though the private savings rate increased in and after the Great Recession, it still remains well below its average level from the end of World War II through the early 1980s (you can look it up). So far as I know, everyone agrees that U.S. incomes were significantly more equal between 1945 and 1979 than they have been since. Am I missing something?

Collectively, consumers, investors, and the government are not spending enough in the rich countries to generate full employment. Both Larry Summers and Paul Krugman proposed useful ways to nudge zero-lower-bound economies toward. I am not sure how harping on IMF / U.S. Treasury policies during the Asian crisis of the late 1990s brings us closer to fixing the crisis rich countries face in 2013. (By the way, unless my memory is way off, I think Paul Krugman actually argued against some of those IMF / Treasury policies.)
Bubbles and such
written by ReturnFreeRisk, November 17, 2013 10:50
1) It is frightful to see Fed governors like Dr. Kocherlakota and now Dr. Krugman draw the conclusion that bubbles are acceptable as a means to fuller employment. Whatever one says, the last two bubbles have hardly done any good. It is when asset prices is most of the harm done, although the consequences are visible only when prices come down.

2) The diagnosis that there was NO over consumption during the bubble years is unbelievably wrong. When US is borrowing 80% of world's capital to finance its trade account deficit, it is overconsumption that could not be met by domestic production. During the two bubbles, unemployment was LOW, so no, we could not have produced 5-6% of GDP more.

3) NO. absence of high inflation does NOT prove there was no over consumption. When one country like china keeps its currency low to sell us cheap goods, it is their fault. BUT when we are sucking in 80% of world's excess savings when we are 5% of the population, it is OUR FAULT. Blaming Germany now and moralizing that Krugman is doing is plain silly.

4) Bubbles are good? They should be encouraged to generate employment? wow. Please keep your voice up against this deviant line of thinking.
Faring Well
written by MissingThePoint, November 18, 2013 4:04
One of PK's best rules of thumb goes along the lines of "if you think other smart people are missing something basic—reconsider your position; it's probably you".

With that in mind, please disabuse me of my folly.

If
1)secular stagnation and
2) not everyone enjoys an optimal minimum living standard (food/housing/medical/education, etc.) and
3)there is still (technological) capacity for growth in aggregate production (and lets not even discuss the coming 2nd wave of automation), how can any remotely moral solution deviate from an increasingly redistributive economic model / universal welfare state?

In other words: Isn't the suggestion to enforce leisure starkly immoral compared to universal welfare, in light of the fact that a significant percentage of society is still living in steerage? We could just take a "wait and see" approach to positive demand effects due to redistribution.

I live in Germany, and basic welfare is modern-subsistence at best. But by doubling per capita GDP and more redistribution, things would be much more comfortable for the median, and still great for the "haves".

And those uninterested in traditional "production" (that great bugaboo the "takers") are merely doing their part to the proposed increase in leisure. And let's be honest: that small subset of folks aren't producing so much value today, anyway. QED
Reduce supply of what?
written by jonny bakho, November 18, 2013 8:15
There is plenty of unmet demand for goods and services. More grocery store jobs could be created by more money in food stamps and other support programs. Establish universal preschool which leads to better education results. There are plenty of people who could move up from lower wage jobs to do this. Repair of dilapidated housing. Improvements to public transit. Sidewalk repair. More bike lanes. During the Depression, we built wonderful recreation facilities that are still in use today.

Almost every city and county in America has dozens of useful projects that go undone because of lack of funds. The money is there. The Excess labor is available. We lack political will.
Krugman & Co.—totally flabbergasting neoclassical apologetics-professor Lars Pålsson Syll
written by Jan , November 18, 2013 5:48
Krugman & Co.—totally flabbergasting neoclassical apologetics-professor Lars Pålsson Syll at Malmö University.
http://larspsyll.wordpress.com/2013/11/18/krugman-co-totally-flabbergasting-neoclassical-apologetics/

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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.

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