Suppose our leading physicists told us that fire will either lead to high temperatures that will cause burns or very low temperatures that would lead to hypothermia and frostbite, they couldn’t be sure. This would be pretty much the state of macroeconomic debate in the United States and the world.
For decades we have heard endless accounts of how the retirement of the baby boomers was going to devastate the economy. The story was that the cost of their Medicare and Social Security would be an enormous drain of resources from the rest of the economy. We would have to raise taxes and/or run large budget deficits. We would have to pull away resources from infrastructure, educating our children and other vital needs. This is a story of too much demand.
Now we have a story of secular stagnation that is also suppose to stem from retiring baby boomers. This is a story whereby the slower growth in the labor force leads to less need for investment. With less investment there is less demand in the economy, leaving the economy well below its full employment level of output. This is a story of too little demand.
The incredible part of this story for folks standing by as observers should be that they are being told directly opposing stories by people who have great standing in the economics profession. The amazing part of the story is that almost no one seems to recognize this simple fact.
(My answer is that both sides are largely wrong. We will have plenty of resources to cover the costs of the baby boomers retirement. The impact of the growth in the ratio of retirees to workers is swamped by the impact of productivity growth. On the demand side, the impact of the trade deficit swamps the impact of any demographic related investment slowdown.)
Suppose our leading physicists told us that fire will either lead to high temperatures that will cause burns or very low temperatures that would lead to hypothermia and frostbite, they couldn’t be sure. This would be pretty much the state of macroeconomic debate in the United States and the world.
For decades we have heard endless accounts of how the retirement of the baby boomers was going to devastate the economy. The story was that the cost of their Medicare and Social Security would be an enormous drain of resources from the rest of the economy. We would have to raise taxes and/or run large budget deficits. We would have to pull away resources from infrastructure, educating our children and other vital needs. This is a story of too much demand.
Now we have a story of secular stagnation that is also suppose to stem from retiring baby boomers. This is a story whereby the slower growth in the labor force leads to less need for investment. With less investment there is less demand in the economy, leaving the economy well below its full employment level of output. This is a story of too little demand.
The incredible part of this story for folks standing by as observers should be that they are being told directly opposing stories by people who have great standing in the economics profession. The amazing part of the story is that almost no one seems to recognize this simple fact.
(My answer is that both sides are largely wrong. We will have plenty of resources to cover the costs of the baby boomers retirement. The impact of the growth in the ratio of retirees to workers is swamped by the impact of productivity growth. On the demand side, the impact of the trade deficit swamps the impact of any demographic related investment slowdown.)
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It’s always a great day when I have the opportunity to have a substantive exchange with the incredibly erudite Brad DeLong, especially when I am quite sure that I am right. Brad is convinced that the fiinancial crisis is the evil doer responsible for our prolonged downturn instead of the good old-fashioned housing bubble often featured in these pages. He points to the surge in non-residential investment coming in 2007 and 2008. He argues that this surge, along with a rise in exports, would have offset the fall in residential construction and consumption, had it not been for the financial crisis.
I see a somewhat different picture.
Source: Bureau of Economic Analysis.
The difference between my graph and Brad’s is that I have pulled out construction from non-residential investment and shown net exports, rather than just exports. This is helpful because it shows that the surge in non-residential investment was entirely a surge in non-residential construction. This component rose from 2.6 percent of GDP at the start of 2005 to 3.8 percent of GDP in the fourth quarter of 2008. The rest of the non-residential investment component hovered near 9.6 percent over this period. In other words, it was going nowhere.
So what explains this enormous surge (almost a 50 percent increase in own terms) in non-residential construction? It’s called a bubble. It would take me a moment to grab the data, but there was a surge in the price of non-residential properties just as the price of housing was going into reverse. Does this sound too dumb for words? Of course it is, but no one ever said that the folks in the banking system had a clue. We saw massive overbuilding in most areas of non-residential construction in this period. Even seven years later you can walk around the downtown of a relatively prosperous city like Washington and still see vacant retail and office space everywhere. This bubble was destined to burst, with or without a financial crisis.
What about net exports? I actually had some hope for net exports filling the gap, with the assumption that the dollar would drop, increasing the relative competitiveness of U.S. goods and services. There is some story here. The dollar had actually been falling since the beginning of the decade. (The over-valued dollar was an evil legacy of the Clinton years.) But the problem was that there were bubbles elsewhere in the world, most notably Europe. This meant a major export market was not going to be there for us. I don’t see how we can blame the financial crisis for Europe’s housing bubble.
Just to repeat my basic line, if we look at the economy after the financial markets had stabilized (2011 or 2012, pick your year) and ask what component of GDP would be higher if we did not have the financial crisis, it’s hard to see a candidate. Brad’s pick of non-residential investment doesn’t hold water. Perhaps we can claim a bit better picture on net exports if people had not turned to the dollar as a safe haven, but this involved many factors other than the financial crisis. Also, the conscious decision of foreign central banks to prop up the dollar to sustain their export markets has to swamp this effect.
I stand by my housing bubble assessment.
Addendum:
Here’s that commercial real estate price index I was looking for. Looks like it might be a good time to start worrying, especially if you’re in the U.K.
Second Addendum:
I would also question the extent to which the further decline in house prices and construction was due to the financial crisis, as claimed by Brad in his post. It is not surprising that coming out of a bubble markets overshoot on the downside. It happened following the stock crash in 2000-2002. There was no financial crisis then. And the further decline in construction is easily explained by the overbuilding of the bubble years and the record vacancy rates. No need to talk about a financial crisis here either.
Note: typo corrected, thanks Marko.
It’s always a great day when I have the opportunity to have a substantive exchange with the incredibly erudite Brad DeLong, especially when I am quite sure that I am right. Brad is convinced that the fiinancial crisis is the evil doer responsible for our prolonged downturn instead of the good old-fashioned housing bubble often featured in these pages. He points to the surge in non-residential investment coming in 2007 and 2008. He argues that this surge, along with a rise in exports, would have offset the fall in residential construction and consumption, had it not been for the financial crisis.
I see a somewhat different picture.
Source: Bureau of Economic Analysis.
The difference between my graph and Brad’s is that I have pulled out construction from non-residential investment and shown net exports, rather than just exports. This is helpful because it shows that the surge in non-residential investment was entirely a surge in non-residential construction. This component rose from 2.6 percent of GDP at the start of 2005 to 3.8 percent of GDP in the fourth quarter of 2008. The rest of the non-residential investment component hovered near 9.6 percent over this period. In other words, it was going nowhere.
So what explains this enormous surge (almost a 50 percent increase in own terms) in non-residential construction? It’s called a bubble. It would take me a moment to grab the data, but there was a surge in the price of non-residential properties just as the price of housing was going into reverse. Does this sound too dumb for words? Of course it is, but no one ever said that the folks in the banking system had a clue. We saw massive overbuilding in most areas of non-residential construction in this period. Even seven years later you can walk around the downtown of a relatively prosperous city like Washington and still see vacant retail and office space everywhere. This bubble was destined to burst, with or without a financial crisis.
What about net exports? I actually had some hope for net exports filling the gap, with the assumption that the dollar would drop, increasing the relative competitiveness of U.S. goods and services. There is some story here. The dollar had actually been falling since the beginning of the decade. (The over-valued dollar was an evil legacy of the Clinton years.) But the problem was that there were bubbles elsewhere in the world, most notably Europe. This meant a major export market was not going to be there for us. I don’t see how we can blame the financial crisis for Europe’s housing bubble.
Just to repeat my basic line, if we look at the economy after the financial markets had stabilized (2011 or 2012, pick your year) and ask what component of GDP would be higher if we did not have the financial crisis, it’s hard to see a candidate. Brad’s pick of non-residential investment doesn’t hold water. Perhaps we can claim a bit better picture on net exports if people had not turned to the dollar as a safe haven, but this involved many factors other than the financial crisis. Also, the conscious decision of foreign central banks to prop up the dollar to sustain their export markets has to swamp this effect.
I stand by my housing bubble assessment.
Addendum:
Here’s that commercial real estate price index I was looking for. Looks like it might be a good time to start worrying, especially if you’re in the U.K.
Second Addendum:
I would also question the extent to which the further decline in house prices and construction was due to the financial crisis, as claimed by Brad in his post. It is not surprising that coming out of a bubble markets overshoot on the downside. It happened following the stock crash in 2000-2002. There was no financial crisis then. And the further decline in construction is easily explained by the overbuilding of the bubble years and the record vacancy rates. No need to talk about a financial crisis here either.
Note: typo corrected, thanks Marko.
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I see that Paul Krugman and Larry Summers are debating Ben Bernanke on the relative importance of weak domestic demand and our trade deficit in explaining shortfalls in demand. I have a busy morning, but let me throw in a quick tidbit and pronounce our former Fed chair the winner.
Suppose that our trade deficit was 1.0 percent of GDP (@$180 billion) instead of 3.0 percent of GDP (@$540 billion). Does anyone doubt that this difference of two percentage points of GDP would make a massive difference in employment and output in the United States? Where I come from it would have the same impact as a $360 billion (@ $4 trillion over a decade) government infrastructure program. That would go far towards getting us to full employment.
I see that Paul Krugman and Larry Summers are debating Ben Bernanke on the relative importance of weak domestic demand and our trade deficit in explaining shortfalls in demand. I have a busy morning, but let me throw in a quick tidbit and pronounce our former Fed chair the winner.
Suppose that our trade deficit was 1.0 percent of GDP (@$180 billion) instead of 3.0 percent of GDP (@$540 billion). Does anyone doubt that this difference of two percentage points of GDP would make a massive difference in employment and output in the United States? Where I come from it would have the same impact as a $360 billion (@ $4 trillion over a decade) government infrastructure program. That would go far towards getting us to full employment.
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A generous donor has agreed to give BTP big bucks for every case of a silly article complaining about deflation caused by a drop in energy prices. (I wish.) Anyhow, the NYT gave us another one today, thankfully with at least some qualifying language.
As I’ve pointed out many times before (most recently here), it doesn’t matter if prices are falling if the decline is primarily due to an imported product like oil. The reasons that low inflation or deflation are troubling do not apply. Let’s see how long the NYT takes to get it straight and maybe the rest of the media will follow.
A generous donor has agreed to give BTP big bucks for every case of a silly article complaining about deflation caused by a drop in energy prices. (I wish.) Anyhow, the NYT gave us another one today, thankfully with at least some qualifying language.
As I’ve pointed out many times before (most recently here), it doesn’t matter if prices are falling if the decline is primarily due to an imported product like oil. The reasons that low inflation or deflation are troubling do not apply. Let’s see how long the NYT takes to get it straight and maybe the rest of the media will follow.
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The media regularly report the mixed signals from Japan on the state of its recovery (here, for example), but for some reason, they never seem to mention the state of the labor market. The news here is actually quite impressive. Since Shinzo Abe took over as prime minister in 2012 the employment to population ratio (EPOP) for adults under 65 rose by 2.4 percentage points. By comparison, the rise in the EPOP in United States over the same period, which has frequently been celebrated as a boom, was just 1.6 percentage points. Japan’s EPOP is now 2.1 percentage points above its pre-recession level. By contrast, the EPOP in the United States is 3.2 percentage points lower for this group of workers.
In Washington policy debates, 90 percent of the story is what adjective gets applied to a particular set of facts (as in the “crushing” burden of the baby boomers’ retirement). I know that I am not important enough to determine which adjective gets used, but I can take advantage of the adjectives used by others. If the United States has experienced an employment boom in the last two years, then Japan has experienced something better than a boom. It is remarkable that no news outlet has chosen to mention it.
The media regularly report the mixed signals from Japan on the state of its recovery (here, for example), but for some reason, they never seem to mention the state of the labor market. The news here is actually quite impressive. Since Shinzo Abe took over as prime minister in 2012 the employment to population ratio (EPOP) for adults under 65 rose by 2.4 percentage points. By comparison, the rise in the EPOP in United States over the same period, which has frequently been celebrated as a boom, was just 1.6 percentage points. Japan’s EPOP is now 2.1 percentage points above its pre-recession level. By contrast, the EPOP in the United States is 3.2 percentage points lower for this group of workers.
In Washington policy debates, 90 percent of the story is what adjective gets applied to a particular set of facts (as in the “crushing” burden of the baby boomers’ retirement). I know that I am not important enough to determine which adjective gets used, but I can take advantage of the adjectives used by others. If the United States has experienced an employment boom in the last two years, then Japan has experienced something better than a boom. It is remarkable that no news outlet has chosen to mention it.
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Good piece on a study by AARP. (I was a discussant on a panel yesterday.) It will be interesting to see how Obamacare affects this story.
Since older workers can now get insurance through the exchanges, employers will be less concerned about picking up an older worker’s health care costs. It will be interesting to see if this has a positive effect on their reemployment prospects.
Good piece on a study by AARP. (I was a discussant on a panel yesterday.) It will be interesting to see how Obamacare affects this story.
Since older workers can now get insurance through the exchanges, employers will be less concerned about picking up an older worker’s health care costs. It will be interesting to see if this has a positive effect on their reemployment prospects.
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It would have been worth mentioning this fact in a Washington Post article on the cost of providing Medicare and Medicaid patients with Sovaldi. Gilead Sciences, the manufacturer of Sovaldi, can get away with charging $84,000 for a treatment because the government will arrest anyone who tries to produce the drug without its permission.
Of course there is nothing to prevent people from going to India to get treatment there. It would be possible to pay $20,000 for the treatment and travel of a patient and family member, give them $10,000 for their troubles, and still come out $54,000 ahead. This would be a great win-win situation but apparently the Washington Post doesn’t want anyone to consider ways to save the government money at the expense of drug companies.
And yes, we do have to finance the research, but patent monopolies are a horribly inefficient mechanism for this purpose.
It would have been worth mentioning this fact in a Washington Post article on the cost of providing Medicare and Medicaid patients with Sovaldi. Gilead Sciences, the manufacturer of Sovaldi, can get away with charging $84,000 for a treatment because the government will arrest anyone who tries to produce the drug without its permission.
Of course there is nothing to prevent people from going to India to get treatment there. It would be possible to pay $20,000 for the treatment and travel of a patient and family member, give them $10,000 for their troubles, and still come out $54,000 ahead. This would be a great win-win situation but apparently the Washington Post doesn’t want anyone to consider ways to save the government money at the expense of drug companies.
And yes, we do have to finance the research, but patent monopolies are a horribly inefficient mechanism for this purpose.
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