Wednesday, February 15, 2012

JW Mason: Fisher Dynamics in Household Debt

At the Slack Wire, JW Mason introduces his and Arjun Jayadev's new study of debt, a 31 page PDF.

From the Abstract:

Specifically, if average rates of growth, inflation and interest remained the same after 1980 as before 1980, household debt burdens in 2011 would have been roughly the same as they were in the early 1950s, despite the sharp increase in borrowing in the early 2000s.

Unfortunately, the costs of debt led to inflation in the 1960s and '70s, which led to the suppression of growth since the 1980s. (Through the whole period, of course, debt burdens continued to increase and were encouraged by policy to increase.) The deleterious effects of debt on prices and on aggregate demand made it impossible for "average rates of growth, inflation and interest [to remain] the same after 1980 as before 1980".

That's my story, and I'm sticking with it.

From the Abstract:

If lower private leverage is a condition of acceptable growth, then in the absence of a substantial fall in interest rates relative to growth rates, large-scale debt forgiveness of some form may be unavoidable.

Yes. We have to to something like that. I still say print money and use it to pay off debt. Pay off private sector debt so the private sector can grow, so the economy can grow. Let us reduce financial costs and turn the difference into increased wages and profits. Oh, and let us use our increased income for growth, instead of using so much debt. Because if the private sector resumes the increase of debt, then we have not really solved the problem.

Page 2:

when the motivation is concern over credit constraints, liquidity, or financial fragility, it is also important to consider the evolution of debt in isolation from assets.

The quote above is a call for economists to stop ignoring private debt. It is the next necessary step after Keen's observation that

Non-economists might expect professional economists to pay great heed to these indicators—after all, surely private debt affects the economy? However, the dominant approach to economics—known as “Neoclassical Economics” —ignores them completely, on the a priori grounds that the aggregate level of private debt doesn’t matter: only its distribution can have macroeconomic impacts.

Page 2:

While outside the scope of this paper, it seems clear that it was only the massive increase in federal borrowing that allowed the private sector to deleverage successfully in the 1940s.

Mmmm. I'd like to see more on that. I get it. I got it from MMT I think. But I don't have it. I need to keep kicking it around until it makes sense to me the way DPD makes sense to me. I'll get there eventually.

Meanwhile, let me point out that if the problem is excessive debt and the need to deleverage, then the solution ought to be neither another world war nor another massive expansion of the role of government in society. All we need is to pay down the debt. We could do it with Congress and the Treasury, but they'd be likely to bicker forever and to expand the role of government anyway.

I'd rather have the Federal Reserve stand up and say: Oops, we made a mistake. We thought it would be okay to let the accumulation of debt grow faster than the quantity of base money and M1 and unencumbered forms of money, but we were wrong. Now we see we are wrong, and we wish to set things right. We will make an adjustment. We will print money and use it to pay off debt and thus remove the liabilities from the private sector, and rescue creditors as an accidental byproduct of our efforts. We will no longer print money and use it to buy up risky assets, rescuing creditors but leaving debtors to hang, leaving the economy in tatters. Please note that this is a temporary, emergency measure, and that our policy will change again as debt falls to a level that enables economic recovery and growth.

Page 3:

JW Mason's Figure 1: Non financial Leverage, 1929-2011

Figure 1 suggests that policymakers have good reason to be concerned with rising leverage; but also suggests that private leverage should be at least as much a focus of discussion as public leverage.


Page 3 (bottom):

between 1980 and 2000 households reduced their borrowing compared with the prior two decades, but saw a rise in their debt burden.

Mason follows that observation by returning to his focus:

The increase in household leverage over this period is fully explained by Fisher dynamics -- that is by the increased burden of existing debt in an environment of higher nominal interest rates and lower inflation. This is in sharp contrast with the usual story of rising household borrowing after 1980...

But let me stick to my focus and point out that it makes perfect sense that "between 1980 and 2000 households reduced their borrowing compared with the prior two decades" because growth was slower after 1980 than before. It's like confirming what I thought I knew.

And yes, a rise in the debt burden would be a consequence of, for example, lower inflation and higher interest rates. But don't forget that the policies that led to lower inflation and higher interest rates were created consciously and on purpose, to fight a prior problem: the inflation of the 1970s.

And I return again to the notion that when the inflation arose in the '70s it came not in tradeoff with unemployment, but as a complement to unemployment. The "stagflation" of the 1970s was a new and different problem, and it could not be solved by people who were used to thinking of a tradeoff between inflation and unemployment.

Like Solomon, then, policymakers split the stagflation problem in two. They took a "both" problem and dealt with it as two separate problems. They would fight inflation with monetary policy; and they would invent new tales of government and regulation to deal with unemployment and growth.

And as with Solomon, splitting this baby was not the answer.

1 comment:

JW Mason said...

Wow, Arthur, these are great comments. Will have substantive responses shortly, I hope.