Something must have caused it

Yesterday's post was too brief to be so thumbs-downish. I didn't feel good about that, and I want to take a longer look at Marcus Nunes's post today.

Marcus opens with an excerpt from Mian and Sufi that lays out their picture of "why the housing bubble tanked the economy and the tech bubble didn’t":

The sharp decline in home prices starting in 2007 concentrated losses on people with the least capacity to bear them, disproportionately affecting poor homeowners who then stopped spending. What about the tech crash? In 2001, stocks were held almost exclusively by the rich. The tech crash concentrated losses on the rich, but the rich had almost no debt and didn’t need to cut back their spending.

An interesting picture, from my perspective.

Marcus then quotes David Beckworth, who disputes Mian and Sufi's view. Beckworth admits "it is true there was far more U.S. household debt leading up to the Great Recession" than the 2001 recession. But he considers debt a symptom, not a cause. "In my view," Beckworth says,

the underlying cause was interest-rate targeting central banks running up against the ZLB... The failure by central banks to get around the ZLB caused most of the household deleveraging, not the other way around. Monetary policy, in other words, was too tight during the crisis.

Monetary policy was too tight, Beckworth says.

Relative to what?

I don't read much Beckworth so I don't know, but I imagine he'd say money was too tight relative to the needs of the economy.

To this straw Beckworth I must reply: That's not specific enough.

If money is tight, then obviously it is tight relative to the needs of the economy. But interest rates are at the zero bound. That's as loose as money can get. So the problem cannot be that interest rates are too high.

In the same David Beckworth post that Marcus Nunes quoted, Beckworth says

the real problem is the ZLB. Debt, itself, is not the problem. This is because for every debtor there is a creditor who could provide offsetting spending if the interest rates adjusted down to their natural rate level. This adjustment process is impeded when the natural interest rate is negative since nominal interest rates cannot go below zero percent.

Now, Steve Roth responds to the "for every debtor there is creditor" part of that. I think it's the best banks are not intermediaries argument I've ever seen. But I'm going to skip right over it, because I have a different concern.

Beckworth says debt only became a problem because "the natural interest rate is negative". Okay, but why is the natural rate of interest negative? Sunspots?

C'mon, David. Something must have caused it.

Interest rates are as low as they can go. We can't fix the problem by lowering rates more. So it's obvious to me that the problem is NOT that interest rates are too high. The problem is NOT that money is too tight. There must be some other problem, that is related to money and interest rates.

That problem is debt: excessive private sector debt.

Look: Lowering interest rates did fix the problem, before we got to the ZLB. It worked by making credit less expensive. Other people may offer complicated explanations, but if you lower interest rates you make credit less expensive.

But now we've reached the lower limit and credit is still too expensive. That's Beckworth's argument I think. So, suppose it's true. How can we make credit less expensive when interest rates are low as they can go?

Let me ask the question another way: How can we make total debt less expensive, without lowering interest rates? Only one way: Reduce the size of total debt.

The trouble is, we need some interesting new economic policy to make it happen. Because as things stand now, the only way available to us to reduce the size of total debt is to pay debt down. And paying debt down takes money out of circulation. And then you get the situation where interest rates are at the zero bound and money still seems too tight.

17 May 2014 EDIT: Changed "Other people may have complicated explanations" to "Other people may offer complicated explanations"