Okay, so it took eight months to get around to this.

Back in February, in a PDF titled Inflation Targeting in the USA, James Bullard of the St. Louis Fed wrote:

A better interpretation of the behavior of U.S. real GDP over the last five years may be that the economy was disrupted by a permanent, one-time shock to wealth.⁴  In particular, the perceived value of U.S. real estate fell substantially with the 30 percent decline in housing prices after 2006. This shaved trillions of dollars off of the wealth of the nation. Since housing prices are not expected to rebound to the previous peak anytime soon, that wealth is simply gone for now. This has lowered consumption and output, and lower levels of production have caused a significant disruption in U.S. labor markets.

Bullard's footnote 4:

Macroeconomists like me often use the word “permanent,” even though nothing is really permanent. Think of permanent as “exceptionally persistent.”

Paul Krugman responded, suggesting that Bullard was

confusing supply with demand... But Bullard goes even further, seeming to say that a drop in asset prices is itself a destruction of output capacity. What?

I remember, because Krugman's critique impressed me. I wrote of it at the time.

But I didn't go back and check what Bullard had said, the excerpt above. Until now.

Here's what I think.

In the footnote, Bullard says he uses the word "permanent" to mean "exceptionally persistent". If you know that meaning, the word is reasonable, surely. If you don't know that meaning, the word "permanent" could make you doubt the statement.

The writer depends on the reader to make the effort to understand.

In the main excerpt, Bullard says housing prices fell, and are not expected to rebound soon. "This has lowered consumption and output," he says, increasing unemployment.

Let's just say that it "lowered consumption". Because with consumption down, output will fall and unemployment will rise. Conceptually, it's all one piece.

So, why is consumption down? Housing prices fell. Bullard says, "that wealth is simply gone for now".

A lot of people took that statement and turned it into a "wealth effect" story. Tim Duy, for example:

Simply put, Bullard simply moves from the wealth effect to a drop in consumption

But what was happening, really?

People were buying houses and "flipping" them, and making some money by it. That's income, not wealth. There may have been wealth effects, too, based on confidence and expectations and "perceived" wealth rather than on reality. That can't be helped. But the real part of it all -- the effectual part, as Adam Smith would say -- was the actual income generated within the bubble.

That's why it was a bubble: Because there was more actual income being generated. Otherwise, there would be nothing to inflate the bubble.

So I think that when Jim Bullard said all that about the disappearance of wealth as the cause of reduced consumption and reduced output and reduced employment, I think he was saying that falling housing prices made it impossible for people to continue gaining income by flipping houses.¹  That deflated the income bubble, which reduced consumption and output and employment.

But, saying it in fewer words, Bullard said something that got misinterpreted as a "wealth effect" story.

Maybe he should have clarified it in a footnote.

Note 1: The building of new homes suffered the same squeeze as flipping homes.


Interestingly, Bullard does not use the phrase "wealth effect" in the PDF. Nor did he use it in his response to Tim Duy.

The writer depends on the reader to make the effort to understand.