There we go again: Poor man´s debt did it!

Sufi and Mian continue to develop their argument in: Why the Housing Bubble Tanked the Economy And the Tech Bubble Didn’t:

Despite seeing similar nominal dollar losses, the housing crash led to the Great Recession, while the dot-com crash led to a mild recession. Part of this difference can be seen in consumer spending. The housing crash killed retail spending, which collapsed 8 percent from 2007 to 2009, one of the largest two-year drops in recorded American history.2 The bursting of the tech bubble, on the other hand, had almost no effect at all; retail spending from 2000 to 2002 actually increased by 5 percent. What explains these different outcomes? In our forthcoming book, “House of Debt,” we argue that it was the distribution of losses that made the housing crash so much more severe than the dot-com crash. 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.

David Beckworth counter argues in: “What Caused the Great Recession: Household Deleveraging or the Zero Lower Bound?”:

While it is true there was far more U.S. household debt leading up to the Great Recession and that cross country evidence shows that countries with more debt were generally hit harder during the crisis, I think they are confusing a symptom with the cause. In my view, the underlying cause was interest-rate targeting central banks running up against the ZLB. (Yes, there are ways around it for a determined central bank but most did not fully explore these options.) 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.

The fact is that in after 2007 the poor man was doubly penalized. On the one hand his nominal income took a plunge and insult was added to injury when his job was taken away! The chart compares nominal income growth (NGDP) during the two cycles. Is it hard to see why consumer spending (and all the other components of GDP) and employment crashed? poor man debt   PS. Don´t miss Mark Sadowski´s comments below. At the very end he writes, quoting I. Fisher:

On the other hand, if the foregoing analysis is correct, it is always economically possible to stop or prevent such a depression simply by reflating the price level up to the average level at which outstanding debts were contracted by existing debtors and assumed by existing creditors, and then maintaining that level unchanged.

That the price level is controllable is not only claimed by monetary theorists but has recently been evidenced by two great events: (1) Sweden has now for nearly two years maintained a stable price level, practically always within 2 per cent of the chosen par and usually within 1 per cent. Note Chart IV. (2) The fact that immediate reversal of deflation is easily achieved by the use, or even the prospect of use, of appropriate instrumentalities has just been demonstrated by President Roosevelt. Note Charts VII and VIII.”

It’s a tragic shame that we’re still debating Irving Fisher’s original point 81 years later.

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6 thoughts on “There we go again: Poor man´s debt did it!

  1. David Beckworth:
    “While it is true there was far more U.S. household debt leading up to the Great Recession and that cross country evidence shows that countries with more debt were generally hit harder during the crisis, I think they are confusing a symptom with the cause.”

    Actually the premise of this statement isn’t even true.

    I got into a conversation with Sufi and Mian at their recent post on the correlation between the increase in Chicago mortgage debt by zipcode between 2002 to 2006 and the decline in auto purchases between 2006 and 2009:

    http://houseofdebt.org/2014/05/08/chicago-and-the-causes-of-the-great-recession.html

    And that premise was in fact the nub of our argument. What follows are the comments I presented.

    What if we repeated the [Chicago] exercise by looking at international data involving countries with different monetary policies? Would household sector leverage growth in 2002-2006 be correlated with a decline in real household sector consumption expenditures in 2006-2009?

    The best source for such data is the OECD. Household sector leverage can be calculated as the ratio of household sector loan liabilities to household sector Gross Adjusted Disposable Income (GADI) which is equivalent to BEA Disposable Personal Income (DPI). Household Sector Final Consumption Expenditures (FCE) is equivalent to BEA Personal Consumption Expenditures (PCE). To convert it to real consumption it can be adjusted by the Household Sector FCE Deflator.

    Unfortunately this data is only available for ten OECD members with independent monetary policies. The OECD also has this data for 12 out of the 18 Euro Area members (all but Cyprus, Estonia, Latvia, Luxembourg, Malta and Slovenia), so I calculated a weighted averaged for those 12 countries for the Euro Area average.

    Here is the household sector leverage data in percent.

    Country—–2002-2006-Change
    1.Czech Rep-15.8–30.7–14.9
    2.Euro Area-66.1–77.9–11.8
    3.Hungary—15.7–36.5–20.7
    4.Japan—–90.8–88.1-(-2.7)
    5.Korea—-106.0-111.2—5.1
    6.Norway—-97.1-129.0–31.9
    7.Poland—-15.3–23.7—8.4
    8.Sweden—-77.4–99.9–22.4
    9.Switz.—156.2-167.4–11.2
    10.U.K.—–99.8-123.1–23.4
    11.U.S.—–94.3-116.9–22.6

    Here is the change in leverage with the change in real Household FCE from 2006-2009.

    Country–Leverage–RFCE
    1.Czech Rep-14.9—7.4
    2.Euro Area-11.8—0.9
    3.Hungary—20.7-(-6.3)
    4.Japan—(-2.7)-(-0.7)
    5.Korea——5.1—6.4
    6.Norway—-31.9—7.4
    7.Poland—–8.4–13.2
    8.Sweden—-22.4—3.4
    9.Switz.—-11.2—5.3
    10.U.K.—–23.4-(-1.9)
    11.U.S.—–22.6—0.3
    Average—–15.4—3.2

    When one regresses the change in real Household FCE on the change in leverage ratio the R-squared value is 0.0211 meaning that only 2.1% of the variation Household real FCE change can be explained by the change in the leverage ratio. In other words there is almost zero correlation when one considers geographic regions which have differing monetary policies.

    The only countries which had above average leverage growth in 2002-2006 combined with slower than average real consumption growth in 2006-2009 are in fact the US, the UK and Hungary. Norway and Sweden had above average leverage growth growth in 2002-2006 and above average real consumption growth in 2006-2009, and the Euro Area and Japan had below average leverage growth in 2002-2006 and below average real consumption growth in 2006-2009.

  2. Sufi and Mian responded by citing four studies to support their claims. Perhaps what they didn’t realize was that two of those studies had inspired my above comment. Here is what I said in response.

    Levels of private debt can explain the geographical distribution of the effects of debt-deflation recessions if one controls for monetary policy. But Irving Fisher, the author of the debt-deflation theory of depressions, assigned a pivotal role to monetary policy in causing such recessions and in ameliorating, or preventing them.

    First let’s take a look at some of the supposed empirical evidence presented against this claim.

    1) Jorda, Schularick and Taylor (2012)
    JST examine 67 cases of systemic financial recessions. Of these, 50 occurred under a gold standard regime. Ten occurred in the most recent recession with six of the countries affected either members of the Euro Area or pegged to the euro (Denmark). (The only exceptions are Sweden, Switzerland, the UK, the US.) Of the remaining seven systemic financial recessions, all but Australia (1989) and Japan (1997) involved a fixed exchange rate regime (and it’s also now known that Australia’s recession was largely allowed to occur, in order to achieve significant disinflation). Thus only six out of the 67 systemic financial recessions JST look at involved flexible exchange rate regimes, and consequently occurred under circumstances in which monetary policy was totally free to prevent or respond to the recession.

    2) IMF: “Dealing With Household Debt” (2012)
    Figure 3.2 was one of the two things that inspired my first comment. (The other was Figure 4 from Glick and Lansing.) There are 36 countries in the regression and the time period almost perfectly matches what I did above, except that the IMF look at the change in real consumption through 2010. But 14 of these countries were in the Euro Area, and 4 more were pegged to the euro. Thus 18, or half of the observations, involved countries that had the exact same monetary policy.

    One of the whole points of my exercise was to see if the correlation still existed if you replaced the euro members with a single observation. It clearly does not.

    3) Glick and Lansing (2010)
    Figure 4 was the other thing that inspired my exercise. There are 16 countries of which 9 are Euro Area members and one (Denmark) is pegged to the Euro.

    The story is of course the same. Remove the countries in the Euro Area, or pegged to the euro, and replace them with a single Euro Area observation, and the correlation totally vanishes.

    4) Mervyn King (1994)
    Figure 7 has ten countries of which six, or over half, were part of the European Exchange Rate Mechanism (ERM). Remove those countries and the correlation totally vanishes (and the number of observations becomes ridiculously small).

    An interesting thing about this particular example is that the decline in consumption is calculated through 1992, which happens to be the very year that three of the countries (Norway, Sweden and the UK) abandoned the ERM and significantly devalued their currencies. This was in fact what turned those economies around.

    In Figure 8 on the following page King repeats the exercise with regional UK data, in a fashion very similar to the Chicago diagram. Pointedly, King states that the reason why he used data from the same country was because it “helps to control for differences in national fiscal and monetary policy shocks.”

    In the conclusion, while paying Irving Fisher homage as the author of the debt-deflation theory of depressions, King notes:

    “I have argued that debt-deflation should be seen as a real business cycle [RBC] rather than a monetary phenomenon.”

    This is certainly not what Irving Fisher himself thought, who states on page 346 of “The Debt-Deflation Theory of Great Depressions”:

    http://fraser.stlouisfed.org/docs/meltzer/fisdeb33.pdf

    “On the other hand, if the foregoing analysis is correct, it is always economically possible to stop or prevent such a depression simply by reflating the price level up to the average level at which outstanding debts were contracted by existing debtors and assumed by existing creditors, and then maintaining that level unchanged.

    That the price level is controllable is not only claimed by monetary theorists but has recently been evidenced by two great events: (1) Sweden has now for nearly two years maintained a stable price level, practically always within 2 per cent of the chosen par and usually within 1 per cent. Note Chart IV. (2) The fact that immediate reversal of deflation is easily achieved by the use, or even the prospect of use, of appropriate instrumentalities has just been demonstrated by President Roosevelt. Note Charts VII and VIII.”

    It’s a tragic shame that we’re still debating Irving Fisher’s original point 81 years later.

  3. “The only countries which had above average leverage growth in 2002-2006 combined with slower than average real consumption growth in 2006-2009 are in fact the US, the UK and Hungary. ”

    Mark, would you happen to have the growth in consumption for the same time period as the leverage growth for these countries? I would be interested to see what it looks like.

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