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Eight reasons why we are in a depression
1. We have zombie banks.
2. There is considerable regulatory uncertainty in banking and finance.
3. There is a negative wealth effect from lower home and asset prices.
4. There is a big sectoral shift out of real estate, luxury goods, and debt-financed consumption.
5. Some of the automakers are finally meeting their end, or would meet their end without government aid.
6. Fear and uncertainty are high, in part because they should be high and in part because Bush and Paulson spooked everyone.
7. International factors are strongly negative.
8. There is a decline in aggregate demand, resulting from some mix of 1-7.
I have two simple points, First, a large fiscal stimulus addresses factor #8 but fares poorly in alleviating the other problems. Of course it may give a band-aid for #5 or #6 and you can tell other stories but we are in a multi-factor depression.
Second, forecasting will prove very difficult. These factors interacted with each other in a unique manner on the way down and they may well interact in an unpredictable manner on the way back up, whenever that comes. Just for a start, who has a good model of #1, #2, or #6? Right now we're seeing a lot of good faith efforts to develop forecasts, but I say don't believe any of them, whether they support your point of view or not.
Posted by Tyler Cowen on January 11, 2009 at 08:03 AM in Economics | Permalink
Comments
1. Nationalize the zombies, clean up the balance sheets, IPO them back to public ownership. Often referenced as the Swedish approach.
2. New administration to announce regulations
3. This will take time
4. Similar to 3
5. The problem is more about transitional employment and confidence. Someone will make enough cars
6. Obama is not Bush and Obama's team is not Paulson. Competence may help here. The new admin is likely to do better on the animal spirits front (YMMV).
7. true
8. With luck, government spending and policy will increase demand. Fixing one problem is better than fixing none.
Forecasting is always difficult and everyone has a terrible track record.
Posted by: fusion at Jan 11, 2009 8:15:31 AM
I think I remember a post from some time back about "are we in a recession?" I mention it because I think I've noticed economists were resistant to take each step in public pessimism, basically from 2005 to now. As I think I've mentioned, the rekindling of the New Deal conflict was a warning of what economists were thinking, if not quite yet saying.
And so I take this post as very bad news. If economists are a lagging indicator, then yes we must be (if not "there") in a tight spot.
Posted by: odograph at Jan 11, 2009 8:39:33 AM
That's a good list, and I particularly agree about the difficulty of forecasting. If these factors interact in a unique and unpredictable manner, we don't even know if a range of forecasts spans the space of the possible outcomes. Like always, we will have to keep our eyes and ears open, and remain alert to a wide range of variables as events unfold. Maybe the forecasting problem is even worse. For example, we ought to remain alert to the impact of the downturn on other economies and societies, each with its own set of problems, and to how they react in terms of trade barriers, currency policies, etc that feed back to impact on the rest of the world economy.
Posted by: David Thompson at Jan 11, 2009 8:50:19 AM
I agree that government intervention spasms make forecasting difficult, but here's one forecast that seems easy to make.
There will be a huge food fight over investment dollars as practically every nation on Earth tries to borrow and spend at the same time. Over at the UK Housing Bubble blog, I read that government borrowing is supposed to triple globally in 2009 over 2008. Good luck finding all that money. It's going to be like a game of musical chairs and one by one, countries are going to find themselves without investors for their bonds.
What will be the effect of that?
Posted by: K T Cat at Jan 11, 2009 9:06:16 AM
Number 2 should be uncertainty about the Obama administration; specifically the future of spending, taxes and regulation in a Federal government dominated by Democrats
Posted by: DanC at Jan 11, 2009 9:15:55 AM
Number 2 should be uncertainty about the Obama administration; specifically the future of spending, taxes and regulation in a Federal government dominated by Democrats
Posted by: DanC at Jan 11, 2009 9:17:55 AM
Basically, we turned out to be not as rich as we thought we were.
The fundamental question is whether demographic change -- the decline in average human capital from importing tens of millions of people with grade school educations -- means that we aren't going to get back to that level of per capita wealth the markets thought we had on 7/1/07.
California appears to be finally sinking toward the level of wealth that its paltry per capita human capital suggests (California is down at the bottom of the NAEP school test scores, just above Mississippi, largely because of its huge number of Hispanic students).
Will the rest of America follow?
Posted by: Steve Sailer at Jan 11, 2009 10:28:43 AM
You don't count unemployment?
Posted by: Buce at Jan 11, 2009 10:32:08 AM
The Census Bureau recently forecasted that America will add about 100 million Hispanics to its population from 2000 to 2050. A massive study by sociologists at the UCLA Chicano Studies program of Mexican-Americans in Los Angeles and San Antonio in both 1965 and their children in 2000 found that fourth generation American-born Mexican-Americans have a college graduation rate of 6% versus 35% for non-Hispanic whites. Hispanic households average about one-tenth as much net worth as non-Hispanic white households.
This long term decline in median human capital in the U.S. due to massive Hispanic immigration was not being included in economic forecasts up through 2007 due to political correctness. If we start to be realistic about the demographic impact of illegal immigration and higher Hispanic birthrates, it may start to look like what we are seeing is not a shorterm blip but a permanent correction as the markets become more realistic about how much the American population of the future can actually produce.
Posted by: Steve Sailer at Jan 11, 2009 10:36:21 AM
The thing that bothers me is that this whole mess really needn't be such a big deal. Assume the US economy contracts 10% from peak to trough (which is very pessimistic). That gives you a PPP GDP per capita of around $40,000 a year rather than the $45,000 you have now. I live in Finland and we have a PPP GDP of $35,000. It's a failure of organisation if anyone in the US is miserable because of this.
Posted by: Finnsense at Jan 11, 2009 10:52:04 AM
Steve,
Assuming we take all that as a granted, that wouldn't mean that we need an economic correction of any kind. At most it would mean that the rate of expansion per capita would decrease.
Posted by: at Jan 11, 2009 10:58:51 AM
K T Cat makes a very good point.
The whole stimulus debate seems to missing a key point. Krugman and others are insisting that a truly enormous stimulus will be effective, without even once pausing to wonder whether it will even be possible.
Posted by: at Jan 11, 2009 11:05:43 AM
#3: a negative wealth effect should lead to a boom, not a recession. labor supply goes up.
#6: there is some work trying to model the effect of uncertainty on the economy. see the herding literature, gale-chamley, and the paper by bloom.
Posted by: aaa at Jan 11, 2009 11:57:45 AM
I think Tyler may be omitting something, mainly the confidence shock resulting from the Lehman bankruptcy; that and the resulting crash in the financial markets. At that point businesses, even ones not themselves affected by the credit crunch (and it is said the cash position of corporations as a whole was good) concluded that a much more severe recession/depression was in the offing and began laying off workers. In other words there was the kind of crisis of confidence that became a self-fulfilling prophecy. The 1929 stock market crash probably had a similar effect. I guess what I'm saying is that Tyler may be overestimating the influence of "fundamental" causes, not those weren't serious too.
Posted by: Phil P at Jan 11, 2009 12:08:55 PM
I agree with Phil P., altho' to Tyler's credit, the Lehman situation may be encapsulated in #2 & 6. Paulson et al, not subtle thinkers, engaged in brinkmanship with the market and lost.
The Doomsday Device detonated and as we are seeing, the assured destruction is deeply mutual with lots of side fallout to boot.
The government can toss rainbows with pots of gold at both ends into the maws of the market now for little effect - cash alone doesn't restore confidence that the government isn't crazy.
Obama may be able to change the situation via offering new confidence, just enough to kick things on a slowly-grinding upward, but still upward!, path. In fact this may the entire value of his presidency.
Posted by: StreetWalker at Jan 11, 2009 12:32:31 PM
Depression? Unemployment, growth and inflation is no worse than it was during the early 1990's and the 70's. Don't be a drama queen. This is just another bust cycle caused by fed pumping, it will soon pass into an inflationary pseudo expansion and we will be on our way to the next boom cycle.
Posted by: Mick at Jan 11, 2009 12:32:45 PM
I can't believe I'm defending Bush, but #6 seemed unfair. Bush and Paulson spooked everyone, but did so to raise enough capital to stabilize the banking system, which softened #1 and #2.
Remember the post-Lehman situation? That wasn't just a public perception problem; the banks had negative balance sheets a year ago if you exclude bad accounting and people were just starting to realize it.
Posted by: Jeremy at Jan 11, 2009 12:38:55 PM
"I can't believe I'm defending Bush, but #6 seemed unfair. Bush and Paulson spooked everyone, but did so to raise enough capital to stabilize the banking system, which softened #1 and #2."
And it's not as though Obama and Biden - the "hope" that everyone has been paying attention to for the last few months - not to mention the Democratic leadership as a whole, haven't spent the last few months scaring the bejeezus out of everyone. Or that the talking heads haven't done it. Or columnists. Or bloggers.
Posted by: MM at Jan 11, 2009 12:43:13 PM
"I think Tyler may be omitting something, mainly the confidence shock resulting from the Lehman bankruptcy; that and the resulting crash in the financial markets. At that point businesses, even ones not themselves affected by the credit crunch (and it is said the cash position of corporations as a whole was good) concluded that a much more severe recession/depression was in the offing and began laying off workers."
IMHO, this "balloon prick" had to happen otherwise the shadow banking system (Ponzi derivativitization) would have kept on rolling along leading to a potentially larger disaster down the road (how much larger is anyone's guess). If Lehman would have been "covered up", very few people would realize/believe the severity of the depths of stupidity in the global financial markets. Anyway, if it wasn't Lehman it would have been someone else a few months later. "This" is not one that can be mopped under the rug . . . .
Posted by: alpha at Jan 11, 2009 12:44:26 PM
fusion,
It is remarkable just how simple and "liberal" those solutions to problems are at this point.
Plus, I disagree with us being less wealthy than we were a few months ago. Our money is just worth more than it used to be. Measuring absolute wealth with money, a relative value indicating tool, is not wise.
Posted by: mickslam at Jan 11, 2009 12:56:32 PM
Another way to phrase uncertainty is "nobody knows the rules".
If you are a large business right now (or university or local government) would you put $10 mm into improving the business in an uncertain business climate, or $10 mm into lobbying to get your share of the Washington spoils?
Yet (a) it's hard to argue lobbying is a net positive investment for the economy, although there's probably somebody who's done that, and (b) the possibilities for corruption are very high.
Posted by: at Jan 11, 2009 12:58:18 PM
9. George Bush over the last 8 years did everything in his power to ruin the economy through deregulation.
Posted by: Jay at Jan 11, 2009 1:14:17 PM
Maybe I'm naively optimistic, but my contrarian point of view is that things are actually going fairly well, considering where we started. I think we're well on our way to working through our wealth effect, and lower consumption is necessarily part of that. A large part of the housing and finance imbalance has already been worked off. Zombie banks are of course a very sticky problem, as we saw in Japan, but at least short-term credit indicators are slowly trending towards normalcy. Once we really get past the credit crunch, my forecast is for a "normal" recession of maybe 2 years. If I have to put a date on a return to consistently positive growth, I will say start of 2010. I'll also keep my fingers crossed for nice rebound growth for a while at that point. As to why, keep in mind that the economy is much more flexible than it was 60 years ago, and that our policy response, while still muddled, is also better. Just the fact that Obama is talking tax cuts and actually useful infrastructure is pretty positive.
Maybe now would be a good time to come up with a definition of depression. Or is it solely intended for economic ghost stories around the campfire?
Posted by: Greg at Jan 11, 2009 1:14:23 PM
For the people who criticize Paulsen and valorize Obama, I have two questions: (i) what objective reason is there for me to believe that you are smarter or more knowledgeable than the CEO of Goldman Sachs? and (ii) is it your suggestion that Tim Geithner and Ben Bernanke have been kicking and screaming under the Paulsen yoke, and have a wildly different set of policies to implement? Because things will not improve otherwise.
Let me note that 2 is not really true, 3 has not in fact been important, 6 is poorly stated (see Brad DeLong for a better elucidation), but is actually the most important item, and 7 is stated so broadly as to be meaningless.
Posted by: y81 at Jan 11, 2009 1:27:03 PM
y81, I don't fall into your category, but let me tell you my point of view.
In the first, I doubt that I'm smarter and I'm certainly less knowledgeable (if I am, we're all hurting badly...), but my outlook is that this is the fox guarding the hen house. Paulsen should have immediately resigned. Period. He is part of the problem, and while he may have some insight, that's not going to solve the problem either. The immediacy of getting a solution to the problems either means he wasn't paying attention or he was trying to stave things off for the other administration, certainly at least past the elections. Does anybody really think that the election would have been that close with all that crap out before the election?
To the second, I'm not sure that anything or anybody can really make a difference. While I'm glad that we will be shortly taking a different path from what we had been taking, the next presidency is probably doomed to failure regardless of who won.
As to the rest, I have to agree.
Posted by: Bryan Price at Jan 11, 2009 2:08:22 PM
