Brad DeLong asks questions about the financial panic of 2007-2009 and our current macroeconomic predicament
by Robert Waldmann
Answering Brad DeLong’s questions
There are a large number of serious and, so far, unanswered questions about the financial panic of 2007-2009 and our current macroeconomic predicament. Among them are:
1)Why is housing investment still so far depressed below any definition of normal?
2)Why has labor-force participation collapsed so severely?
3) Why the very large spread between yields on safe nominal assets like Treasuries and yields on riskier assets like equities?
4) Why didn’t the housing bubble of the mid-2000s produce a high-pressure economy and rising inflation?
5) To what extent was the collapse of demand in 2008-2009 the result of the financial crisis and to what extent a simple consequence of the collapse of household wealth?
6) Why has fiscal policy been so inept and counterproductive in the aftermath of 2008-9?
7) Why hasn’t more been done to clean up housing finance (in America) and banking finance in Europe)?
I will try to answer
1. Housing. My guess is that trends were and are being chased. I think that the once normal level of housing investment was caused by irrationally high expected returns based on the false belief that the ratio of the price of a house to the CPI typically increased quite rapidly over time. Efforts to deal with this assume that the bubble began some time in the 21st century. The belief was strong in the late 20th. Current housing investment could be the new normal (I mean US houses are huge). I would guess also that people consider houses to be terrible investments now. Here I am thinking mostly of the perceived risk of a house as an investment.
2. Not much on labor force participation. I’d mostly guess this is the result of prolonged high unemployment. Also maybe higher than previously guessed elasticity of labor supply by people who are in their 50s and whose children are grown up and financially independent (last qualifier meaning not people like us whose children study on and on).
3) As usual, I reject the premise of your third question.
“Why the very large spread between yields on safe nominal assets like Treasuries and yields on riskier assets like equities?” Hmm it used to be that the alternative to safe nominal assets wich you considered were mortgage backed bonds and low rated corporate bonds. I think what we have here is a determination to defende the shortage of safe assets hypothesis from the data. I note that the S&P dividend yield is extraordinarily low http://www.multpl.com/s-p-500-dividend-yield/ there is no sign of extreme reluctance to buy equities.
Rather the data show that there *was* an extraordinary desire for safety back in 2008-9 causing extremely low stock prices which have since returned to normal. You can identify the return on stock with the required return only if you assume perfect foresight (that is that stock isn’t risky at all).
I would conclude that Mill did not diagnose the US economy’s current illness in 1828.
4) This is the tough one and the one most relevant to the post. I’d say that just NIP accounting says it was the trade deficit (so the *global* savings glut).
5) This is a pretty simple empirical question. Baker has a strong argument that forecasts of effects of reduced house prices based on pre-2006 data work well so there is nothing else. But Lehman. I tend to find Baker convincing on this one (which is boring).
6) That is politics not economics and, clearly, it comes down to the usual question: are Republicans more stupid of more evil.
7) I really hope that the answer to 7a is “Edward De Marco” but I fear that the problem is broader and not resolved. I’d say more generally terror of moral hazard if anyone but a banker is bailed out plus the bankers own Washington so will not be forced to take a haircut for their bad underwriting (even though the haircut could be in their collective interest as the problem is trying to free ride on the reduction someone else’s principal).
7b is bankers don’t like to be cleaned up and they are powerful in Europe too.
cross posted with Robert’s Stochastic Thouights
update: redundancy removed.
A couple of observations wrt questions 1 & 2, hoping to hear your thoughts.
At least in the major metro areas, house pricing is very inflated still. CAP rates are far too low to recycle properties into the rental market. Hence, seeing a home as an investment option is depressed. Rental prices are on the hairy edge of affordable for young workers. Wrt more rural properties in these areas, unless the area is attractive for retirement, uncertainty about future employment options is high.
With respect to labor force, this one is challenging. Viewing the situation from the tech field, I see this getting worse. Simply, jobs are being automated away. As the current lower skilled administrative and aging workforce retires, jobs are not being replaced. I can’t tell you how many organizations I see that are bloated with under skilled “white collar” workers. Even in the information technology area, too few people are developing the skills that will last even 1/3 of a career.
Can’t remember where I saw it, but an analysis of future job prospects are poor in many many labor categories. Automation, self service, continue to erode administrative and bureaucratic jobs. It seems that the excess of labor capacity and production efficiencies are driving craft-centered local economies.
As to labor participation, much of that is on the young end with more students not able to find work and not working and extending their education further as the opportunity cost of not working is rather low these days, with parents remaining in the workforce longer to support them. Over 50 and unemployed is likely much more marginal with high unemployment, age and income discrimination, and the large wage cuts necessary to obtain work in the low wage areas that are growing. This also impairs housing as those of house buying age are not as ready or have bad credit, there probably isn’t much of a move up market since those may be underwater or at breakeven, and without the security and growth to make a larger commitment.
I agree that question 6 as phrased should be directed to political scientists, but it subsumes a challenging one for economists. That is, why did most economists recommend an insufficient stimulus in 2009 and then, beginning in 2010, support and not oppose fiscal austerity? Or, turning this on its head, why didn’t most economists forcefully recommend a much larger and longer-lasting (or repeated) fiscal stimulus? This question presupposes that there was/is something wrong in the economics discipline and/or profession, and it’s not helpful to point to notable exceptions–or place all blame on politics.