At Economist's View, Stiglitz: Towards a General Theory of Deep Downturns. Excerpts from a recent paper.
Here, excerpts from the excerpts:
This paper, an extension of the Presidential Address to the International Economic Association, evaluates alternative strands of macro-economics in terms of the three basic questions posed by deep downturns: What is the source of large perturbations? How can we explain the magnitude of volatility? How do we explain persistence?
Why so deep? Why so long? And, where do they come from?
The paper argues that while real business cycles and New Keynesian theories with nominal rigidities may help explain certain historical episodes, alternative strands of New Keynesian economics focusing on financial market imperfections, credit, and real rigidities provides a more convincing interpretation of deep downturns, such as the Great Depression and the Great Recession, giving a more plausible explanation of the origins of downturns, their depth and duration.
Finance, credit, and real rigidities. In that order.
Or, not quite in that order I guess:
Since excessive credit expansions have preceded many deep downturns, particularly important is an understanding of finance, the credit creation process and banking, which in a modern economy are markedly different from the way envisioned in more traditional models.
A lot of people will like that one: Since credit expansion is a problem, it is important to understand the credit creation process and banking.
Why?
Is excessive credit use a problem, or is it not? Simple question.
The blatantly obvious problem with excessive credit use is the cost of it. Or it should be blatantly obvious, but every time I say "the cost of it" people think I mean the rate of interest. Duh. How about the interest rate times the number of dollars of debt outstanding, to get a total cost of all the credit that is presently in use. How about that?
7 comments:
Is excessive credit use a problem, or is it not? Simple question.
Lots of complexities lurk in simple questions.
First, what does "excessive" mean. Could be lots of things, and I'll posit there is no consensus.
Second, does this credit represent public or private debt. I believe that makes a huge difference, and I think you probably do too.
Third, I firmly believe what the credit is used for makes a huge difference. if it's for public works projects or other kinds of meaningful investment, then there is a payback that [at least potentially] makes the debt worth while. If it is used for stock buy-backs, or to pay dividends to shareholders - and these things have happened - then it does not contribute to economic expansion, and might actually be contractionary. If it's used for financial tail chasing, then it just leads to destructive bubbles. If it's used to finance war, it's money down the damned drain.
Since credit expansion is a problem, it is important to understand the credit creation process and banking. Why?
I think there is a real lack here. With Neoclassical, Keynesian, NeoKeynsian, Austrian and various heterodox views of the economy, and MMT vs market monetarism views of money, it's clear that there is no clear or common understanding of the most fundamental items in the economy - money and banking. With all these views, they can't all be right - but they can all be wrong.
If these things are misunderstood, then nobody can comprehend inflation, booms, busts, steady growth, or the movement of interest rates. I believe that is the case.
And I believe this answers your why question.
Cheers!
JzB
This graph suggests the cost of debt is not a problem much less THE only problem. The burden of debt on households is currently the lowest it has been in 40 years (or more).
https://research.stlouisfed.org/fred2/graph/?g=1hXk
Also pointing fingers at debt owed to banks seems a bit misplaced since the percentage of debt owed to banks compared to all debt has been declining for decades before the 2008 meltdown.
https://research.stlouisfed.org/fred2/graph/?g=1Oty
Art
I agree with Jazz on this and I think this is similar to the discussion on inflation.
We don't understand or agree on the causes of excessive debt, we don't agree what we mean by excessive debt (public or private) and we have no universally accepted means of measuring it for historical context.
Yet we are absolutely terrified of it, which IMO is a perfectly normal emotional reaction, but may be much to do about nothing.
Jim, the other day you said:
"What I see in graph #6 is that whenever the ratio of private debt to all debt is going up it corresponds to a period of what is generally regarded as good economic times. And when the ratio is going down those are periods generally regarded as bad economic times."
I bring this up because I think one can see the same correspondences in your 1hXk graph: increase (and good times) in the mid-1980s and in the mid-1990s; decline (and bad times) in the early 1990s and since the crisis.
Note that the decline since the crisis is about twice as deep as the early 1990s decline, and lasts about twice as long. Also, we appear to be at the same point on the curve now as in late 1993 -- almost ready to have an uptrend and good economic times for a while.
Your observation that "The burden of debt on households is currently the lowest it has been in 40 years (or more)" seems to be a reference in particular to the sharp decline during the past 8 years, the decline that followed from the crisis. That decline corresponds to bad economic times, as you so correctly point out.
And now that the decline seems to be bottoming out, I am willing to say we might be ready to begin a period of good times of approximately the same duration as the decline. But you seem to say that if I was right about the cost of debt being a factor related to economic performance, then the economy would be in the midst of good times right now because the cost of debt is already low.
Not at all. For the cost of debt has only just become low. So now, conditions will be able to improve.
The increase in debt (or, really, the use of credit (which is recorded as an increase in debt)) adds to good economic times. But existing debt is a cost that subtracts from good economic times. When existing debt is low it does little to hurt the good economy, and when existing debt is high it does much to hurt the good economy.
Therefore, an uptrend in credit use that begins when existing debt is at a low level is likely to be vigorous, and may continue (though with decreasing vigor as the level of debt rises) until the damage done by existing debt equals or exceeds the benefit derived from new credit use.
Jazz, if you want to put specific numbers on my theory, knock yourself out.
OT: "We don't understand or agree on the causes of excessive debt, we don't agree what we mean by excessive debt (public or private) and we have no universally accepted means of measuring it for historical context."
Isn't denial wonderful?
The causes of excessive debt are the economic policies that encourage the use of credit and the economic policies that discourage repayment of debt.
Debt becomes excessive when it starts to do more harm than good for the economy as a whole.
Universal acceptance? Waiting for universal acceptance impedes universal acceptance. It is better to evaluate things on their own merits and in your own experience.
Yes the shape of the 2 graphs are very similar to each other from 1990 onward. And somewhat similar before. The both appear to be pro-cyclical
It would be interesting to know what debt service graph looked like before 1980.
https://research.stlouisfed.org/fred2/graph/?g=1OSs
But the graph is not a graph of the amount of debt. It is the ratio of private debt to all debt. The amount of debt for households hasn't changed much in the last 8 years.
Jim: "It would be interesting to know what debt service graph looked like before 1980."
It sure would. I Googled debt service payment data and found a 12-page PDF from 1986: Estimating Household Debt Service Payments.
http://www.newyorkfed.org/research/quarterly_review/1986v11/v11n2article2.pdf
It provides estimates back to 1975, describes the calculation in some detail, and identifies the data used. I looked it over till it made my head spin. Now I'll pass it on to you.
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