When I started out writing yesterday's post, I was thinking I had a petty objection to a detail in an Interfluidity post. I thought my objection was not relevant to Steve Randy Waldman's analysis, and I was prepared to present it as an objection in principle, an objection that might apply in other situations, but not to his analysis.
Writing the post made me work through a few things, and in the end I concluded that Waldman's analysis is incorrect.
Waldman took a casual look at a graph of consumer debt, and thought he saw a significant jump in the pace of borrowing. He failed to realize that the spike in the debt/GDP ratio resulted from the large drop in nominal GDP growth caused by a sharp fall of inflation.
Waldman's mistake is a common one, and obvious once you notice it. The jump in the debt/GDP ratio was the result of a big undershoot of GDP, not a sudden increase in borrowing.
There was no sudden increase in borrowing that we can point to and say it was this increase in borrowing that compensated for growing income inequality. There is a hole in Waldman's argument.
Interestingly, in remarks on yesterday's post Steve Waldman said:
It would be perfectly possible, for example, for the broad story to be true -- poorer households must increasingly borrow to maintain aggregate consumption -- and yet for aggregate borrowings to decline over the period.
Yes it would; and I make points like that occasionally, myself. But here Waldman is saying is that his evidence -- his graph showing that "beginning in the early 1980s, household borrowing began a secular rise" -- is irrelevant because it doesn't treat "distributional questions".
Maybe. But now the discussion is getting over my head. What I know for sure is, his graph does *not* show any secular rise of borrowing that begins in the early 1980s. And if it seems to show that, it's an illusion.
I've treated this issue before, in the "red herring" post. In that case it was Scott Sumner misreading a debt/GDP graph -- as it happens, the same misreading of the same debt/GDP ratio that we see in Waldman's post.
Sumner identified "three big debt surges" and analyzed the economy on the basis of those surges. As I reported in the "herring" post:
The inflation is the reason for what appears to be a flat spot on the graph. The inflation "eroded" debt.
The growth of debt continued apace.
My StepRate function, applied to annual CMDEBT numbers from FRED, shows that the compound annual debt growth rates during Sumner's three periods were:
During the famous flat spot of 1965-1983, the comparable rate of debt growth was 9.36%. That's near 90% of the growth rate for the 1952-1964 "debt surge" and it is higher than the growth rate for the third debt surge Sumner identifies.
There was no remission. Debt did not stop growing. It barely slowed.
The growth of debt continued apace.
My StepRate function, applied to annual CMDEBT numbers from FRED, shows that the compound annual debt growth rates during Sumner's three periods were:
- 1952-1964: 10.7%
- 1984-1991: 10.25%
- 2000-2008: 9.33%
During the famous flat spot of 1965-1983, the comparable rate of debt growth was 9.36%. That's near 90% of the growth rate for the 1952-1964 "debt surge" and it is higher than the growth rate for the third debt surge Sumner identifies.
There was no remission. Debt did not stop growing. It barely slowed.
What does it matter?
If you misread the graphs, you misread the economy. That's all.
Links:
- The Sumner post
- The Interfluidity post
- My Measuring the Erosion of Debt PDF
- My Debt and Inflation posts.
11 comments:
So, this is a story I think is true. You've got it right, in that the graph was a casual pull from FRED, and is less persuasive evidence than it first appeared.
That said, I think the evidence remains consistent with this story. As discussed in the post, the evidence we have suggests that the people really actually do spend greater fractions of high incomes than they do of low (you've had some interesting coverage of the issue here). So upward shifts in income are a drag on overall demand. As described in the subsequent post, although preliminary and somewhat course-grained, we do have evidence that poorer cohorts allowed their debt to grow much faster than their incomes grew while wealthier cohorts did not. I'd like to have better evidence than we do have, whether supportive of this hypothesis or not. But given the evidence we do have, and the qualitative experience of the "democratization of credit" and GDP supporting mortgage cash-out boom, the inequality and demand story remains a strong contender, the strongest for now, I think.
Thanks Steve. And I do like your story of inequality and demand. As I said yesterday: "Despite my objections to the post, Waldman's argument makes sense to me. Still makes sense to me."
But I fear bad evidence is more often used to support bad argument than good. Besides, my particular focus is built on the view that there was never any sharp and sudden increase in the reliance on credit, but rather a gradual and persistent increase from the moment (circa 1947) of its rebirth.
Emmanuel Saez shows the increase of inequality beginning in 1979. I see inequality as the result of policy changes designed to solve the economic problems of the 1970s. If this is correct, then inequality is a result, not a primary cause of the problem. I would be happy to unwind every bit of Reaganomics, but we still need to find a cause with origins farther back in time: For example, the excessive reliance on credit.
Everything turns into a sales pitch, doesn't it.
"I'd like to have better evidence than we do have, whether supportive of this hypothesis or not."
Amen to that!
I agree. I'd not have used the graph had I realized the weakness when I posted it. It was a quick rejoinder to Krugman's quick dismissal. But the broad account rests on more than one questionable graph.
We've discussed before here I think that consumer credit behavior (I think we looked at ratios of consumer credit to income or consumption, we'd find it in a long-ago comment thread) actually began to change in the mid- to late- 1960s. Ultimately the relevant question is to what degree aggregate consumption is sustainable out of continuing, current income under the present distribution. If it is not, it doesn't really matter whether people are borrowing or dissaving, eventually stuff breaks. Unfortunately, it's really hard to find good data on dissaving, or any data at all broken down distributionally. I think you are right that the causes are deeper than Reaganomics. Post-1980s financialization strikes me as a band-aid, and an anaesthetic, it papered over and rendered painless (sometimes even exuberant) cracks that had already begun to appear. I don't think we should identify those cracks with1970s stagflation, exactly, which I think was largely about demographics + women in the workforce. But these things are related: why did 2 income families start to become the norm?
What I think we really want to get at is a picture of how a growing minority of American households found they couldn't support what they considered ordinary lives out of current income, and how they responded, by adding second earners, by dissaving (their own or their parents' accumulated wealth), by participating in asset booms, and/or by borrowing. If all those tactics become exhausted (not a foregone conclusion -- we can return to loose credit or goosed assets), and we don't invent something new, then I think we'll have a hard time sustaining demand.
Adam Smith looked around him and saw the owners of land, the commoners, and a rising third group, and considered the income associated with each of these groups as a cost. For most of my life, I look around and see another group developing: Finance.
Finance comes at a cost that competes for income with wages and profits and old-style rent. The growth of finance means, therefore, that wages and profits and rent,together must make up a declining share of total income. In a world where the economics cares only about wages and profits -- jobs and growth -- the rise of finance is a problematic cost.
Steve, you point out that lower-income households might increase borrowing while total borrowing declines. I like to point out that even in a world of perfect equality, if finance grows sufficiently the income to finance will compete with the income to labor and productive capital.
We have what you call our "ordinary lives", and we have our saving. If economic troubles lead to an increase in saving, things are so much the worse in our ordinary lives... our provision for future consumption fares much better than our current consumption. The growth of finance by itself is enough to create the troubles we've had since the 1960s. Add income inequality on top of that, and it only makes things that much worse.
Finance is the middle man, the guy that connects the buyer and seller, and hes taking a larger and larger piece of the deal in addition to creating ways, via control of govt policy, that make it necessary that you use him. You cant go direct, you have to go through him.
Health care is the perfect example, with the large insurers. The CEOs and stock holders are taking a larger share of our premium money which is supposed to pay for health care not yachts.
It really shouldnt be an arguable position that what we have seen the last 5-6 years is simply a result of people running out of the ability to pay for past consumption (debt) and continue present consumption. When something has to give, many choose to stop paying past consumption (default) others choose to curtail present consumption (low sales volumes) Neither is good in keeping our current system running.
Arts right, finance has gotten too big, and its because of policy.
You won't get an argument from me re the debilitating role of expanding finance. But I think that's complimentary to, rather than an alternative to, the inequality and demand story. Because you have to explain, so, suppose thieves in bankers' suits suddenly steal 5% of the money. That's going to be bad for the economy somehow, but how? You could argue a supply-side explanation: productive people are demoralized, the fruits of their labor are worth less, so they choose to produce less. But then you wouldn't expect to see disinflation and involuntary unemployment. After all, the money the bankers steal isn't burned, but it should be burning a hole in their pockets, they should be converting it into real goods and services and bidding up the prices of things, if people aren't producing as much. That's not what we see -- we see involuntary unemployment and sluggish prices. Somehow all of this thieving has not (just) interfered with supply, but it has diminished demand! But why should bankers not buy as much as whoever else might have had that money? They've no need to hide the loot in mattresses; their theft was perfectly legal. The cops guard their moneybags.
My explanation is that it's because the bankers are rich already. They don't use their marginal dollar to buy goods and services, they hold the income for the status and safety they experience by being rich. The channel by which finance diminishes rather than merely redistributing demand is, I claim, inequality. Income to the already rich is a drag on demand.
Suppose instead of finance, a reinvigorated union movement were to effectively organize, or from an economist's perspective cartelize, labor, such that ordinary workers all received raises and labor's take was an extra 5% of GDP. Would that "cost" translate to a collapse of demand the way that finance's vig has? Obviously not, I say, but what say you?
You won't get an argument from me re the debilitating role of expanding finance. But I think that's complimentary to, rather than an alternative to, the inequality and demand story.
I can live with that, if I have to :)
We're on the same page, I think.
Because you have to explain, so, suppose thieves in bankers' suits suddenly steal 5% of the money. That's going to be bad for the economy somehow, but how?
Some economists (I can't tell one school from another) say you could double the Q of M, or cut it in half, and there would be no difference other than that prices would be twice as high, or half. That could be true, in the long run. But it is the period of transition where the interesting things happen. Maynard pointed that out, as I recall, or pointed out that Hume pointed it out.
During the transition, you see the troubles that arise for an economy with an insufficient money supply.
I can't answer how stealing 5% is bad, because... Not sure. Can't answer, because the context is missing, or because certain assumptions are unstated, something like that.
You could argue a supply-side explanation: productive people are demoralized, the fruits of their labor are worth less, so they choose to produce less. But then you wouldn't expect to see disinflation and involuntary unemployment.
I'll pass on that one.
After all, the money the bankers steal isn't burned, but it should be burning a hole in their pockets, they should be converting it into real goods and services and bidding up the prices of things, if people aren't producing as much. That's not what we see -- we see involuntary unemployment and sluggish prices. Somehow all of this thieving has not (just) interfered with supply, but it has diminished demand! But why should bankers not buy as much as whoever else might have had that money? They've no need to hide the loot in mattresses; their theft was perfectly legal. The cops guard their moneybags.
Oh! You know what I see? I see you equating "finance" with "bankers" much the way Thomas Philippon does.
Yes, I think I know where you are going (I already read your next sentence) and I agree. But I have this other thing going on, that I don't see anybody else talking about. I wrote of it before:
The cost Philippon considers is the cost of wages and profits associated with finance and insurance...
From my perspective -- and Adam Smith's, I daresay -- the wages and profits of finance belong in the same categories as the wages and profits of the Nonfinancial sector, for they are payments to labor and to capital...
Interest is not the same as wages. Nor is it the same as profit, as Smith points out. And it is not the same as rent as Smith used the term. So I am changing his definition, and counting "the interest of money" as a fourth original source of revenue.
The problem is not that bankers get paid. The problem is that too much income, interest income, accrues to the non-productive factor of production, which I call finance.
No doubt, the two are related, bankers' wages and cumulative interest cost.
My explanation is that it's because the bankers are rich already. They don't use their marginal dollar to buy goods and services, they hold the income for the status and safety they experience by being rich. The channel by which finance diminishes rather than merely redistributing demand is, I claim, inequality. Income to the already rich is a drag on demand.
I like that: "The channel by which finance diminishes rather than merely redistributing demand".
Irony within irony like Russian dolls. The accumulation and/or concentration of financial wealth creates economic problems. People who can afford it respond to the economic problems by saving more, which aggravates the economic problems, which increases the pressure to save. This cycle may have been largely contained within the 1%, which would support your view Steve, until the crisis of 2008.
Suppose instead of finance, a reinvigorated union movement were to effectively organize, or from an economist's perspective cartelize, labor, such that ordinary workers all received raises and labor's take was an extra 5% of GDP. Would that "cost" translate to a collapse of demand the way that finance's vig has? Obviously not, I say, but what say you?
Sounds like what happened in the 1960s and '70s. (Growth was very good then, except during bouts of inflation-fighting.) Or, sounds like what people think happened, who say the inflation was wage-push. It's a popular story. See the graph here to see why my story is different.
I say it is not so much the inequality that creates the problem, as it is the excessive saving (aka inadequate demand). Yes, inequality makes it easier to get excessive saving... this is the "channel" that you described.
But I can imagine a society of perfect equality in which people decide that the solution to every economic problem is to increase their saving. The result will be excessive finance regardless despite the perfect equality.
I know that's unrealistic. I agree it is much easier to create "excessive finance" if you have the channel of inequality.
It's late. I can't proofread any more. It turns to jibberish.
Oh, and I should add that the income to finance tends to stay with finance. Interest tends to stay in savings. (I have no evidence of this other than the growth of savings, and what I would do as a saver, but this is nonetheless my view.)
Thus the behavior of finance differs from labor.
"Oh, and I should add that the income to finance tends to stay with finance. Interest tends to stay in savings. (I have no evidence of this other than the growth of savings, and what I would do as a saver, but this is nonetheless my view.)"
I agree very much with this.
One thing that occurs to me is that we have to be careful about looking at banking and finance and evaluating them like any other private company. SInce banks simply create money they dont really spend their income. Other companies are limited to spending what they collect in sales revenues, they must meet all their payment obligations out of sales revenues. Banks have no such limit because they simply create money for others to spend and take a piece of the action. They can always expand their balance sheet provided they have people seeking loans from them.
So what do I think this means? This means for banks, running a surplus so to speak, is a negative, just like a govt running a surplus is a negative. Banks dont save, people save. Banks pay out salaries to people who might save some of it but on a macro level I cant see how banks save. They might have equity level changes due to market price changes and they can have expanding or contracting balance sheets but they cant save, at least not in the sense that macroeconomists talk about saving....... as a way to conserve some future purchasing power by purchasing less today
So I dont think banks can save too much and cause a paradox of thrift but they can (and do) influence policy which makes govts save too much and support monetary policies like QE which are not stimulatory of the real economy and often worsen the inequality in incomes.
"...they can (and do) influence policy..."
Between his election and inauguration, President Clinton held a big meeting with big business leaders to get their advice on improving the economy. Such behavior suggests that Clinton did not know what was wrong with the economy.
People sometimes speak of "leadership" as if there is no question of what needs to be done. I think it's the things that have been done that are the problem.
Things that have been done by Congress, tilting the playing field so money tends to roll to a particular corner. And then they expect the Federal Reserve to be able to compensate for everything they've done and still keep everything "good".
Post a Comment