Yes Janet, by all means “mind the gap”

In “Mind the (spending) gap”. Atif Mian and Amir Sufi of Princeton and Chicago, respectively, are on the right track but go about it the wrong way and so arrive at a wrong conclusion. They wonder:

We all know that households cut back on spending dramatically during the Great Recession. Are they spending now? Has spending caught up to the trend the United States was on before?

The red line in the chart below plots retail spending in real terms in the United States from 1992 to 2013. We want to get a sense of the trend in spending so we plot spending on a logarithmic scale, and we subtract off the 1992 level to start the line at zero. A logarithmic scale is informative because a straight line in the chart would imply that spending was growing at a constant rate in real terms.

Mind Spending Gap_1

Why aren’t we getting back to trend? One answer often given is that the housing boom artificially boosted spending from 2002 to 2006, and so the trend we were on was an unrealistic benchmark that could not be sustained.

But the data contradict that story. There is no evidence that spending was above trend from 2002 to 2006. In the chart above, the red line doesn’t go above the black dots during the housing boom. Further, there is no evidence that the economy was overheating in terms of capacity from 2002 to 2006. House prices were booming, but other measures of inflation were steady.

Instead, the chart above may be evidence corroborating the worrisome “secular stagnation” view. The housing boom fueled household spending, but that spending only kept us on the same path we were on before – and it was done by enticing debtors to borrow and spend out of ephemeral housing wealth. When the housing boom disappeared, the permanent adjustment downward in the chart above suggests that we were already on a secular decline in household spending that the housing boom masked temporarily.

Why focus on one component of spending? Why do it in real (inflation adjusted) terms? What we should be interested in is in the total dollar amount of spending, i.e. NGDP, something closely influenced by the Fed´s monetary policy. As the chart shows, the overall story has the same pattern.

Mind Spending Gap_2

What the chart suggests is not that we were already in a secular decline in aggregate spending (not only household spending), but that the Fed allowed aggregate nominal spending (NGDP or AD) to tank. And aggregate spending has not caught up to trend for the very simple reason that the Fed has not allowed it to grow sufficiently to do so. And why not? Because it is terrified of any rise in inflation that might accompany it, even though inflation is still far below the Fed´s target!

The end result is that we are mired in a depression. That didn´t (and doesn´t) have to be so. And “suggesting” we were already in a secular decline which was “masked” is just “lazy-thinking” on the part of the honorable professors.

8 thoughts on “Yes Janet, by all means “mind the gap”

  1. Again, I just do not get it! First, the slope of the two lines in household spending is the same after 2009. Therefore household spending is growing at the pre-crises trend rate of growth. In other words, the recent gap is constant in percentage terms. I do not think that is so bad. Simply look at the sharp break (reversal) in the graph! Second, I have a hard time with the claim that the Fed is not doing enough. Well. interest rates are at historically low levels, the federal funds rate remains at the zero-lower-bound, the balance sheet of the Fed has increased by 400% and there is a threat of deflation. Have you heard of the liquidity trap? Third, is not the fiscal cliff a drag on growth? What about US total factor productivity? What about the hysteresis effect of the greatest recession since the great depression? What about the fragility of the financial system? What about a depressed demand for loans as a result of incomplete deleveraging? I wonder if the authors would lend me money at todays interest rates to buy a home when I am unemployed and I am still overly indebted?

    As the authors suggest, what the Fed has done so far has proven ineffective! Yes, that is the painful thruth, whether we like it or not. Monetary policy has reached its limit. There is no monetary or fiscal space left. Just imagine the crude counterfactual of the Fed had done nothing or really caring about inflation: positive federal funds rates in real terms, no quantiative easing at all. Imagine this together with a much more pressing fiscal situation and no deleveraging of households had taken place. The “new deal” is not working anymore. Keynesians are dead! The classical and monetary economists too! The only way out of this crisis is not to make things worse. Market forces must be left to do the job (otherwise we will really be all dead in the long-run!). Things must settle down by themselves. More government interventionism would do more harm than good.

    • Mr Velas:

      On the Fed, forgive me for using a poor analogy, but here goes: It is not how much air you pump into the tire; it is whether you have pumped enough.

      Yes, the Fed has a larger balance sheet—but why not much larger? Inflation is below target, and as you hint, we are on the cusp of deflation. If a general loses on the battlefield, but has scant troops, was he a poor general, or just underpowered?

      The Fed has been timid in its use of QE, always dubbing it an “unconventional tool,” and ever telling markets it would retreat from QE at earliest possible moment. Indeed, QE1 and QE2 incorrectly had sizes and dates attached, rather than results—that is, “we will do QE, and ramp up QE, until we get real results.” QE3 was better,and indeed obtained better results, but already the Fed is signaling retreat.

      The market has correctly determined that the Fed lacks resolve or nerve in its quest to avoid deflation and recession.

      I certainly agree that government interventionism in most matters is unsuccessful. I prefer far less government, and balanced federal budgets.

      But the Fed, under QE, is only buying bonds from willing sellers. It is simply printing money and giving cash to bondholders in exchange for their bonds. We anticipate that bond sellers will place their funds onto other assets, such as equities and property, or spend it—all good results. But all market results–the bond sellers will invest and spend their money in market-determined fashions. This is the least intrusive government intervention that I can imagine. No one is coerced into anything, and no taxes are raised or must be raised in the future. Quite the contrary.

      The QE has the side benefit of deleveraging the American taxpayer, and I see nothing wrong with that.

      I hope I can convert you to the Market Monetarist bandwagon. A man of your zeal would be welcome!

  2. The resistance of the Fed or the economics profession to NGDP targeting is mysyifying…is NGDP targeting too obvious? Not artful? Not inflation-phobic?

  3. Pingback: Yes Janet, by all means “mind the gap” | The Corner

  4. Dear Mr. Cole:

    I consider myself an ortodox, market-oriented economist. Almost an Austrian and a Friedmanian. I am a monetarist also, despite Austrian disregard central banking. I have been a central banker for 27 years and a professor of advanced economics courses in monetary economics and macroeconomics. I need no conversion at all.

    Anyway, the bottom line is, as you state, it appears not enough money has been thrown at the economy. If you read my former comment carefully, my argument was precisely that it is not a matter of pouring enough money. I wish things were that simple. The US economy would have rebounded and gathered momentum since 2009-2010. Why would the Fed be against such a thing when pumping more money it is all it is needed? Why would the Fed then start the tapering? Why the Fed diregard the dual mandate of price stability and promoting full-employment? It is never openly acknowledged to be an inflation-targeting nutter. I also insist that we have not seen the counterfactual. We have not seen either the counterfactual of increasing continuously the amount of money in the economy. And I pray to God that we don’t!

    A well positive economics statement in the profession is that “inflation is always and everyhere a monetary phenomenum”. The long-term relationship between money and prices is an undisputable fact. Base money as a fraction of GDP has multiplied by five. This implies an enourmous slowdown in the velocity of circulation of money, something which is usually associated with higher (not incredibly low) interest rates. Andthis is happening at a time when the Fed is also concerned about the lower demand for banknotes as a result of the extensive use of electronic means of payment.

    As many central bankers have stated: “this time is different” because we are “sailing on unchartered waters”.

    Best regards,
    Mr VELA (not Velas)

  5. Mr. Vela:

    First, my sincere apologies for misspelling your name. I am just a little old bald man, sometimes I miss things.

    I am not a scholar, as yourself, just a washed-up financial journalist.So I propose not an intellectual wrestling match, but that we sit down in a cafe, and trade a few stories and jokes, a cup of brew (so something stronger) and I will tell you my observations, feeble though they may be.

    I will implore you to pay no attention to me, but to read the works of Milton Friedman and John Taylor, both of whom advised QE for Japan, and Taylor gushed about the positive results of the BoJ’s QE efforts 2001-2006

    In 1998, Milton Friedman published a seminal work,advocating that the Bank of Japan buy bonds, and keep buying until it got the results it wanted. Here is the link:

    In 2006, John Taylor published “Lessons from the Recovery from the ‘Lost Decade’ in Japan: The Case of the Great Intervention and Money Injection,” Background paper for the International Conference of the Economic and Social Research Institute Cabinet Office, Government of Japan, September 2006 pdf

    The link is but you have to look under “Less Recent Papers,” and then go to 2006 and then find that particular paper.

    Taylor gushes about the success of QE in rescuing Japan from the purgatory of deflation, recession and ZLB.

    So, I think we can say QE, per se, is not in principle a bad idea or is always ineffective, if we believe in the Taylors and Friedmans of the world.

    You may say that QE is a bad idea now in the USA. Maybe that is true. I would respectfully disagree.

    When I look at very low inflation, unused capacity, slumping confidence, and rising defeatism in the USA, I say to our central bank, “pour it on.” I would rather endure a few years of 4-5 percent inflation that the tail-between-the-legs economy we have now. Worse, we are being told this is the “new normal”!

    Now, of course, Market Monetarists do not advocate targeting inflation or have an inflation ceiling. We advocate that a central bank targets NGDP. I find this approach very appealing. I sense targeting would get us out of the near-ZLB gloom we are in now, and would result in less violent gyrations in the future.

    I repeat my invitation to you to join ranks with Market Monetarists, but if not we should share a cup of coffee someday anyway. I live in Thailand now, but if you swing by this way, I will try to meet up with you.

  6. Dear Mr Cole:

    Your are a smart guy. I have much respect for sensible journalists.

    The Historians have just released today another piece of evidence that I think is very enlightenning regarding our discussion: The Jobless recovery. Simply put, one of my mentors, Ed Leamer of UCLA, published a paper showing that NGDP and TGDP have rebound but jobs have not. This is really puzzling, but it is not news. Indeed, the Fed has recurrently stressed this feature of the crisis aftermath and has explained the reasons in terms of the labor participation rate.

    I think the piece brings our ides closer. Anyway, I enjoyed the piece, and I hope you will too.
    All the Best,

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