Scooped by Nick Bunker! Well, that post can now go in the trash!

Nick Bunker: Are Recoveries from Financial Crises Always Slow?: “A form of conventional wisdom has developed in the years since the beginning of the Great Recession about financial crises…

…When economies go through major systemic failures of their financial systems the ensuing economic recoveries will invariably be tepid and prolonged. This view is based primarily on research by economists Carmen Reinhart and Kenneth Rogoff…. Christina D. Romer and David H. Romer… is a refinement of those analyses… focused specifically on financial crises in rich economies in the latter half of the 20th century…. Very large financial crises… Sometimes, as in the case of Japan, the crisis leads to significant recessions and slow recoveries. And sometimes, such as with Norway in the early 1990s, the effect was pretty much non-existent…. A large financial crisis doesn’t necessarily mean a large economic downturn has to happen. Economic events aren’t forces that sweep over us, but things that we can react to and very possibly control.

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Paul Krugman (January 2008): Deep? Maybe. Long? Probably: “The last two recessions were… followed by prolonged ‘jobless recoveries’ that felt like continuing recessions….

…There’s every reason to think that the same thing will happen this time…. The 1990-91 recession was brought on by a credit crunch, the 2001 recession by overinvestment; this time we’ve got both. I guess we’ll see. In any case, whatever happens will probably last quite a while.

Christina Romer and David Romer: New Evidence on the Impact of Financial Crises in Advanced Countries: “In the four decades before the Great Recession… financial distress in 24 OECD countries for the period 1967–2007….

…based on assessments of the health of countries’ financial systems from a consistent, real-time narrative source…. We find that output declines following financial crises in modern advanced countries are highly variable, on average only moderate, and often temporary. One important driver of the variation in outcomes across crises appears to be the severity and persistence of the financial distress itself.

Carmen Reinhart and Kenneth Rogoff: Recovery from Financial Crises: Evidence from 100 Episodes: “100 systemic banking crises [since 1857] reveals that a significant part of the costs of these crises lies in the protracted and halting nature of the recovery….

…Five to six years after the onset of the current crisis only Germany and the United States… have reached their 2007–2008 peaks in per capita income…. The sub-prime crisis is not an anomaly in the context of the pre-WWII era. Postwar business cycles are not the right comparator for the severe crises that have swept advanced economies in recent years….

Even after one of the most severe multi-year crises on record in the advanced economies, the received wisdom in policy circles clings to the notion that high-income countries are completely different from their emerging-market counterparts… growth, financial stability, and debt sustainability can be achieved through a mix of austerity and forbearance (and some reform). The claim is that advanced countries do not need to resort to the more eclectic policies of… debt restructurings and con- versions, higher inflation, capital controls, and other forms of financial repression.

Now entering the sixth or seventh year (depending on the country) of crisis, output remains well below its pre-crisis peak in ten of the twelve crisis countries. The gap with potential output is even greater. Delays in accepting that desperate times call for desperate measures keeps raising the odds that, as documented here, this crisis may in the end surpass in severity the depression of the 1930s in a large number of countries.

Òscar Jordà, Moritz Schularick, Alan M. Taylor: The Great Mortgaging: Housing Finance, Crises, and Business Cycles: “The share of mortgages on banks’ balance sheets doubled in the course of the 20th century….

…Financial stability risks have been increasingly linked to real estate lending booms which are typically followed by deeper recessions and slower recoveries.” |

Sovereigns versus Banks: Credit, Crises, and Consequences: In advanced countries since 1870… significant financial stability risks have mostly come from private sector credit booms rather than from the expansion of public debt. However… high levels of public debt have tended to exacerbate the effects of private sector deleveraging after crises…. (i) In a normal recession and recovery real GDP per capita falls by 1.5 percent and takes only 2 years to regain its previous peak, but in a financial crisis recession the drop is typically 5 percent and it takes over 5 years to regain the previous peak; (ii) the output drop is even worse and recovery even slower when the crisis is preceded by a credit boom; and (iii) the path of recovery is worse still when a credit-fueled crisis coincides with elevated public debt levels…. Fiscal space appears to be a constraint in the aftermath of a crisis, then and now.”

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Betting the House: “loose monetary conditions, credit growth, house price booms, and financial instability? This paper analyzes the role of interest rates and credit in driving house price booms and busts with data spanning 140 years of modern economic history in the advanced economies. We exploit the implications of the macroeconomic policy trilemma to identify exogenous variation in monetary conditions: countries with fixed exchange regimes often see fluctuations in short-term interest rates unrelated to home economic conditions. We use novel instrumental variable local projection methods to demonstrate that loose monetary conditions lead to booms in real estate lending and house prices bubbles; these, in turn, materially heighten the risk of financial crises. Both effects have become stronger in the postwar era.

Today’s Must-Must Read: Alice Rivlin: Thoughts about Monetary and Fiscal Policy in a Post-Inflation World: “I perceive… a cultural lag in thinking about the objectives of economic policy. Why are we still so focused on fighting inflation?…

…When politicians and financial journalists ask me earnestly, as they do, whether the Federal Reserve isn’t risking devastating ‘run-away’ inflation by buying all those bonds, I suspect cultural lag. What Inflation? We should be so lucky! Central banks have amply proved that they know how to stop inflation—Paul Volcker showed that. They have been much less successful in getting little inflation going…. The last time the core PCE hit 3.0 percent was 1992….

Yet many economists worry about that elusive animal, the NAIRU. The rhetoric of many politicians and much the financial press implies that we face a dangerous inflation-prone world…. In this new world the top-of the-list threats to prosperity in large advance economies are financial instability, slow growth with tendencies to deflation, and the concentration of income, wealth and political power in the hands of a small number of people….

I see four major challenges to current thinking: (1) We have to recognize that the main job of central banks is avoiding financial crisis. (2) We will have to get used to central banks operating at quite low interest rates much of the time and managing big balance sheets without apologies. (3) We have to rehabilitate [expansionary] budget policy to make it useable again and move to a sustainable debt track at the same time. (4) We have to find constitutional ways of reducing the power of big money in politics and economic policy—or change the Constitution…

Ah. But, Mark, what real-world questions were DSGE models built to answer? I cannot think of any…

Mark Thoma: On Paul Krugman’s: ‘John and Maynard’s Excellent Adventure’: “Models are built to answer specific questions…

…IS-LM models were built to answer exactly the kinds of questions we encountered during the Great Recession and… provided good answers…. DSGE models were built to address other issues, and it’s not surprising they didn’t do very well when they were pushed to address questions they weren’t designed to answer…

Danielle Paquette: Survival of the Fittest Might Have Actually Been Survival of the Richest​: “Roughly 12,000 years ago, humans started farming commercially. Those with fruitful harvests discovered what it meant to be wealthy…

…And wealthy men apparently fathered way more babies, according to a new study… a sharp decline in genetic diversity in male lineages across the world during the Stone Age…. 456 men living in seven regions across Africa, Asia and Europe… Y chromosome… passed down through the male lineage, and the mitochondria… from an offspring’s genetic mother…. Two ancient ‘bottlenecks’…. Migration from Africa drove the first…. The rise of agriculture… likely drove the second. For every 17 women who passed on their DNA, researchers could find genetic evidence of only one male whose lineage stretched to modern times.

Alicia Munnell et al.: Are Retirees Falling Short?: “Data from the Survey of Consumer Finances and studies using target income replacement rates indicate a widespread shortfall….

…Researchers using a life-cycle model… conclude that most pre-retirees have an optimal level of wealth…. The comforting results of the optimal savings research depend crucially on two as- sumptions–that households’ consumption declines when the kids leave home and that households plan on declining consumption in retirement…. The target replacement rate analysis assumes that consumption does not decline when the kids leave
home and that retirees plan on level consumption in retirement. The question is which view best reflects the real world.

J. Bradford DeLong :: U.C. Berkeley and NBER :: delong@econ.berkeley.edu

For BPEA Spring 2015 8:30 AM March 20, 2015

Let me thank Matt for doing some very serious and thoughtful digging. The upshot is that I am in an ideal position for a discussant: There are very interesting and important numbers that have not been put together before, and there is an author who is wise enough not to believe he has with the numbers mean nailed.

Thus I am in an excellent position to, if not add intellectual value, share lavishly in intellectual rents.

I was weaned on the explanation of recent trends in US inequality set out by the very sharp Claudia Goldin, Larry Katz, and company. It was skilled-biased technical change, coupled with the end of the era that had begun in 1636 of making increasing educational levels a priority. That combination greatly raised the return to education-based skills. That was the principal driver of rising income inequality.

But, recently, reality does not seem to agree.

To get large swings in the income distribution out of small changes in the relative supply of educated workers seems to require less substitutability between formal college and other factors of production then seemed reasonable. Higher experience-skill premiums and sharply higher education-skill premiums, yes. But the action seems to be far, far out in the upper tail.

A little family history: My Grandfather Bill was in not just the 1% or the 0.1% but the 0.01% back in the days before the rise in inequality. He sold his chemical construction company to the IMF conglomerate and retired back in 1968.

One of his other grandsons, my first cousin Phil Lord, might have a chance of making it into the same financial range–if he can make the transition from co-director to “producer” and “created by” credits–but if he does he will still be breathing much less rarified relative air.

Relative to 1968 you need 3.5 times the wealth now in the U.S. and 8 times the wealth worldwide. That is an income and wealth an order of magnitude higher than my grandfather ever did.

It is simply not possible to see such an extreme concentration of benefits as in any way a return to a factor of production obtained as the product of “hours spent studying” times “brainpower”.

Thomas Piketty has a guess.

He guesses that the real explanation is that 1914-1980 is the anomaly. Without great political disturbances, wealth accumulates, concentrates, and dominates.

What about what John Maynard Keynes called the “euthanasia of the rentier”? As accumulation proceeds the relative fall in the rate of profit exceeding the relative rise in concentrated wealth? Piketty points to remarkable constancy in the rate of profit at between 4% and 5% per year, but is agnostic as to whether the cause is easy capital-labor substitution, rent-seeking by the rich, or social structure that sets that as the “fair” rate of profit.

And this is why it is truly excellent that Matt Rognlie brings well-ordered and insightfully-organized data to these questions.

Matt’s focus on the net capital share is surely right.

I never understood why, in the Solow model, gross savings was supposed to be a function of gross output anyway. There are the big worries over the data.1 Let me skip those.

As Matt stressed, the big news in the post-World War II net capital share is the surge in housing: from 3% to 8% of private domestic value added.

How much of this is a real increase in housing intensity? How much reflects congestion driven by exhaustion of the low-hanging superhighways? How much is rent-extraction via NIMBYism? How much trust do we give to these “imputed rent” imputations anyway?

And what hat does this mean, anyway?

There has always been a problem with using our GDP estimates as social accounts. In GDP, we measure each unit’s contribution to production at the final unit’s marginal cost and each unit’s contribution to societal well-being at the final unit’s money-metric marginal utility. In the presence of anything like near-satiation in consumption, or of near-exhaustion in productive capacity, this does not convey a true picture.

Hard questions. No very good answers.

The fact that the big news since World War II is a rise in housing as a share of value added raises the question of whether this surge may be in significant part the reversal of story from a century ago–now the rise of valuable urban housing, then the decline of valuable Western European rural farmland.2

To the extent that land is the driver of shifts in our capital share, this is clear a problem to the extent that it is driven by NIMBYism. But is it a problem otherwise?

And as Matt also stressed, the secondary big news in his numbers is the pre-1990 fall in the net capital share, a fall driven by a very real rise in depreciation is real. Our capital stock has seen the replacement of long-lasting machines to perform Wellman-Lord desulfurization reactions with video editing machines rapidly obsoleted by Moore’s Law.

But it is puzzling that the pre-1990 fall in the net capital share not matched by a decline in the relative capitalization of the corporate sector. Matt points out a steady rise in capitalization up to the late 1960s, followed in the 1970s by a “negative bubble”–truly absurdly high earnings yields on equities–that lasts well into the 1980s. Then we see a bubbly rise in the relative capitalization of the corporate sector since the start of the 1990s–a rise that persists in spite of sub-par business-cycle performance. Very puzzling.

Let me end by strongly endorsing what I take to be Matt Rognlie’s bottom line. I take it to be that post-WWII variation in the observed net capital share is not explainable

via returns on the underlying assets. Instead, the decomposition in section 3 attributes most of the variation to pure profits, or markups…

Accumulation and returns play, outside of housing, a distinctly secondary role, if they play any role at all. But it is equally hard to find any role for the race between education and technology, and there should be if we think the factors of production are labor, education skills, and machines.

Likewise, variation in income inequality, is hard to attribute to wealth ownership or to human capital investment or to differential shifts in rewards to factors like raw labor, experience-skills, education-skills, and machines. Matt thus concludes that:

Concern about inequality should be shifted away from the split between capital and labor, and toward other aspects of distribution, such as the within-labor distribution of income.

The nly caveat I wish to make is: This is true now. This may not be true in 50 years, if Piketty is right

And Matt’s conclusion is bad news for us economists, for it leaves us in the same position as those trying to explain an earlier large puzzle in the production function, the twentieth-century retardation of the British economy.

It was Robert Solow who said:

Every discussion among economists of the relatively slow growth of the British economy compared with the Continental economies ends up in a blaze of amateur sociology…

I really would like for us to be able to do better.

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Notes:

[1] These big worries are:

• Worries about depreciation allowances in these accounts. Mine are perhaps bigger than most.

• Worries about how much of the value that comes from installing capital comes from (local) learning about how to handle the technology, and is something that does not depreciate from the point of view of the individual firm. That is not captured.

• Worries about, from the societal point of view, how much of the value that comes from installing capital comes from global learning about how to handle the technology.

• Perennial worries about what in high-end labor incomes are really incomes earned by raw labor and human capital, and what are rent-extraction and thus sharing in the returns to capital.

[2] In America things are different: the frontier. But in Western Europe one thing going on at the end of the Belle Époque is the collapse in the value of rents on absentee-owned European farmland.

Downton Abbey–Highclear–was supportable on its entailed rents a generation before World War I. It was not so afterwards. Some of this was taxes. But there was also a steep relative fall in prices of staple foodstuffs. Not just Iowa and Kansas, but Odessa and New Zealand came online.

Western European farmland lost its value as a factor of production at the end of the nineteenth century. To what extent was that it? And to what extent is “it now the rise of housing prices in London, Paris, Rome, Milan, etc.? My teacher the late David Landes, a CUNY graduate, simply bought a Paris apartment as a postdoc post-WWII. Those of our postdocs who could not afford to go to private colleges do not pick up Paris apartments casually in the course of a research trip to take a look at bank records.

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1509 words

Must- and Shall-Reads:

• Today’s Must-Must-Read: Lars E.O. Svennson: “Riksbank Deputy Governor Jansson Again Tries to Defend the Indefensible,
• Nighttime Must-Read: Grégory Claeys et al.: European Central Bank Quantitative Easing: The Detailed Manual
• Today’s Must-Must-Read: Matt O’Brien: What People Talk About When They Talk About Zero Interest Rates
• Peter Gosselin and Jennifer Oldham: If Economists Were Right, You Would Have a Raise by Now
• Paul Krugman: “The way to deal with secular stagnation… is to raise the long-run neutral interest rate above zero. If we can do this via structural reform and/or self-financing infrastructure investment, fine. If not, raise the inflation target…. If you’re really worried about secular stagnation, you should advocate a combination of a raised inflation target and a burst of fiscal stimulus to help the central bank get there…”
• Afternoon Must-Read: Jared Bernstein: The U.K. vs. the U.S. Minimum-Wage Debate
• Matthew Zeitlin: Blog Fight! War Of Words Breaks Out In A Multi-Trillion Dollar Industry
• Afternoon Must-Read: Helaine Olen: Poor Stories from [David] Brooks and [Ross] Douthat
• Tim Duy: The End of “Patient” and Questions for Yellen
• Nighttime Must-Read: Nick Bunker: One Slack Measure to Rule Them All?
• Nighttime Must-Read: Simon Wren-Lewis: Eurozone Fiscal Policy
• Lunchtime Must-Read: Paul Krugman**: A Whiff of Stagflation

Should Be Aware of:

• Michael McAuliff: “When aliens didn’t arrive in spaceships to save Keech and her followers on Dec. 21, 1954, as she predicted, it did not, at least as far as Keech’s followers were concerned, reveal her as a fraud…. When Congress debated and passed the Patient Protection and Affordable Care Act in 2009 and 2010, opponents were nearly unified in offering grim Keech-like predictions…. The dour prognostications are starting to look like Keech’s flying saucers…. [But] that won’t matter, and… Americans can expect a continued drumbeat of doom, even as the prophecies fail…”
• Glenn Fleishman: I, for One, Welcome Our New Newsletter and Podcast Overlords
• Mark Zandi: U.S. Macro Outlook: A Long Expansion
• Michael Wolf: Gigaom: The Life and Death of a Venture-Funded Media Startup

Today’s Must-Must-Read: Lars E.O. Svennson: “Riksbank Deputy Governor Jansson Again Tries to Defend the Indefensible, the Riksbank’s sharp tightening of monetary policy in the summer of 2010…from 0.25 percent to 2 percent…

…There were really, in real time, no comments suggesting that it would be a stupid idea to increase the interest rate.

But in real time, the Riksbank’s inflation forecast was below the inflation target and unemployment and the unemployment forecast were far above the Riksbank’s estimate of a long-run sustainable rate…. My colleague in the Execeutive Board, Karolina Ekholm, and I indeed dissented from this tightening policy with very clear and logical arguments, namely that easier policy would in this situation lead to better target achievement…. Riksbank and the Fed FOMC forecasts for inflation and unemployment were very similar at the time. Given these similar forecasts, the Fed obviously did the right thing, keeping the policy rate very low and starting to prepare for QE2, whereas the Riksbank did the wrong thing, tightening. Or is Jansson suggesting that the Fed should have followed the Riksbank example?
 
Jansson refers to high GDP growth as a reason for tightening in the summer of 2010. But as Paul Krugman says… Jansson seems to make “a fundamental error, confusing levels with rates of change.”… Jansson… suggests that Krugman should look at the facts before criticizing the Riksbank. It seems that it is Jansson that should look at the facts. Jansson’s previous attempts to defend Riksbank policy, including his strange suggestion that the tightening was not motived by concerns about household debt and housing prices, have been discussed here, here, and here. The cost and benefit of the Riksbank’s leaning against the wind because of concerns about household debt are examined here (with the use of the Riksbank’s own estimates, the cost can be shown to be about 250 times the benefit).

The continued refusal by policymakers in 2008-2012 to admit any error whatsoever is what seems to me the most remarkable feature of the situation. It’s not just Jansson. Consider Tim Geithner, for example: the paragraphs in his book expressing regrets about policy choices were, when he was asked about them on his book tour, taken as opportunities to try to walk back the regrets–for, Geithner said at some length, the alternative policies really would not have done any good. The only first-rank policymaker I have seen in person clearly and visibly regret his overoptimism and his failure to grasp the reality of the situation was Ben Bernanke.

Karl Whelan sends me to Grégory Claeys et al.: European Central Bank Quantitative Easing: The Detailed Manual: “The… Public Sector Purchase Programme (PSPP), started on 9 March 2015 and will last at least until September 2016…

…Purchases will be composed of sovereign bonds and securities from European institutions and national agencies. The ECB Governing Council imposed limits to ensure that the Eurosystem will not breach the prohibition on monetary financing. However, these limits will constrain the size and duration of the programme…. The PSPP profits that will ultimately be repatriated to national treasuries will be small. This was to be expected, given current very low yields…