There is strong evidence that house prices and consumption are synchronised. There is, however, disagreement over the causes of this link. This study examines if there is a wealth effect of house prices on consumption. Using a household-level panel data set with information about house ownership, income, wealth and demographics for a large sample of the Danish population in the period 1987–96, we model the dependence of the growth rate of total household expenditure with unanticipated innovations to house prices. Controlling for factors related to competing explanations, we find little evidence of a housing wealth effect.
Category Archives: Depression II discussion
The excel error in Rogoff-Reinhart
I see the Rogoff-Reinhart figures regarding the correlation between GDP growth and the size of the debt stock are currently under attack – due largely to an unfortunate excel error discovered reported by Mike Konczal. Here are the list of posts about it at the moment:
- The initial post.
- Tyler Cowen’s thoughts.
- The R-R reply. (Here)
- A post suggesting that it mattered for policy settings.
All very nice. Depending on the message people were trying to sell they either said the result was meaningless, or central, so I don’t think this makes any actual difference. Honestly, without clear causal drivers there just were not good evidence based claims for actual policy adjustments – a lot of people were actually just saying we need to do X based on their preconceptions. And they found this correlation either something that supports that (somehow) or something they need to rule out.
Over the last few years I have seen authors, at different times, use R-R as central to their argument on one thing, and then dismiss it for arguments regarding other issues (I’m not going to name names). For example, you can’t use this result to say we need more savings policy because the stock of debt is to high, then complain that the study is flawed when you want more government borrowing … just focus on the actual core elements of your frikken argument instead!
My problem with the result isn’t the excel errors, or anything R-R appear to have said – it is the way it has been used as an inconsistent marketing tool by people for selling their own unrelated ideological policies. I’m just hoping that this shuts that up.
As a side note, here are my feelings on twitter:
People who think the R&R result caused austerity overestimate the impact evidence has on government policy.
Ex-ante concerns about moral hazard
Fascinating post by Stephen Williams, who is a great monetary economist. In it, he goes through speeches at the Federal Reserve from September 2007 – a few months into the burgeoning credit crisis. In it he shows that there was a debate between the views of “inherent instability” and “induced fragility” for what was going on – this sort of trade-off was captured in the Sargent paper (at least in part) that we’ve mentioned before.
Now when I’ve described the crisis to people I’ve stuck to the inherent instability line, the trilogy of articles (*,*,*) I did on Rates Blog was supposed to give that impression to people – with the third article pointing out that moral hazard exists as a more long-term point. According to this, the Fed and then the ECB didn’t do enough to stop a bank run due to “too much” weight on moral hazard – and this drove a deep crisis.
However, the induced fragility hypothesis is also compelling (note they could both have happened – but where you put the weight determines what policy lessons you learn). According to this, it wasn’t until the policy actions of late 2007 and then the bail out of Bear Sterns then the moral hazard became compelling. However, once financial institutions saw they would be bailed out, they immediately took on lots of risk – making the system a lot more fragile when the Fed finally decided not to bail out Lehman Brothers.
There is evidence for this, Lehman Brothers took on a lot of debt – highly risky debt – following the collapse of Bear Sterns. I remember reading the paper that had this, a paper that actually said it was the bailout of Bear Sterns that made the crisis worse, but I have forgotten where it is … I’ll link when I find it.
If the spectre of moral hazard fed into the fragility of the finanical system that quickly, the justification for bailouts becomes a lot weaker – if we accept significant inherent instability in the financial sector, then regulation with a lender of last resort becomes more acceptable. Evidence helping to determine what weights to put on these explanations will be very useful for designing regulation (or the lack of) in the post-GFC world.
Induced fragility as a medium term concept is a central part of how most economists see this crisis. However, it is an open question about whether the bailout of Bear Sterns (and the earlier TAF) created “induced fragility” that made the collapse much worse. More research on this issue will be pretty interesting, and will help to inform what sort of trade-off we are facing with policy.
Financial regulation: Efficiency vs stability trade-off
Over at Rates Blog the trilogy of articles I’ve put up about the GFC has been completed with this one. The first two artices are here and here, and the blog post I did on them are here and here. Infometrics will be popping up some more articles on Tuesday’s, but they won’t be on the GFC anymore 
So in the first two I mentioned uncertainty about the lender of last resort function as a catalyst for the crisis, and a reason why it persisted. However, this isn’t a costless function – it is true that introducing financial regulation to induce “stability” will impact on the efficiency of the financial markets.
We like to pretend this is not the case. We like to pretend that the government has the knowledge and ability to figure out what the “externality” is and what “credit ratios” are appropriate – and so faced with a crisis we tend to focus solely on stability.
However, this is not the case. In fact, the crisis occurred in part due to our determination to make the banking sector around the world more competitive – leading to the development of the shadow banking sector to avoid regulation. In such a case, we can only get “appropriate” regulation when we in turn accept lower competitiveness in the banking sector. And given the “supernormal profits” banks get in this case, they are ripe for second best style regulation through the central bank.
In truth, we either throw out the central bank and have competition over the medium of account through banks directly (allowing them to work together in the face of bank runs), or we have a central bank who directly regulates the whole businesses – it was our attempt to get the best of both worlds that helped us wander into the situation we found ourselves in.
Now none of this is news for central banks – they have been trying to length maturities for bank liabilities and clarify and improve regulation in the banking sector for some time. The crisis was a reminder of the unintended consequences of regulation – firms (in this case banks) can innovate to avoid regulation as well, and that can be costly. This must be taken into account, and the full cost involved should be accepted, when it comes to setting up policy – rather than throwing around piecemeal rushed ideas and concepts.
More on describing the crisis
Rates blog posted another article by me, this time talking about why the GFC persisted. So in the first one I laid down Fed actions as the catalyst, and in the second one I’ve primarily laid the blame on institutional confusion in Europe. I’m not sure anyone will find this article, by itself, particularly enlightening. These first two are both simply descriptive (although with a background structure guiding what I talk about), and their only purpose is to illustrate that the “crisis” itself was kicked off by a sudden change in the expected actions of policy makers, and uncertainty about that action. This isn’t to say that even with perfect policy we wouldn’t have had a recession – but it is to say that the depth and length of the slowdown that has occurred is related to such policy inconsistency.
So if we live in a world where we have decided that a lender of last resort is required in the case of such a crisis, what does that mean for the rest of the time. After all such a commitment leads to moral hazard. I’ll be covering that next week in the conclusion article.
The reason I’ve tied these three articles together as I have is because I wanted to create a clear narrative, and then work out what that suggests from policy – that requires answering a bunch of stylised facts (the timing in the crisis, the length of the crisis) with a central story. The world is not that simple, and so every movement and every “bad thing” that occurred cannot be explained by such a clear narrative. But it does allow us to help identify an issue and then understand what this means.
It’s about the “right” counterfactual
In a recent post, Mark Calabria from the Cato Institute took aim at the idea that the Lehman Brothers crisis was the “trigger” for a big crisis.
Now I do not disagree that there was, and would have been, a recession without Lehman Brothers – and even without the uncertainty caused by the lack of clarity around insurance of the shadow banking system which grew post August 2007. However, these issues, and in turn the failure of Lehman Brothers did make the crisis significantly more severe than it would have been.
He appears to say that the failure of Lehman Brothers was a good thing (Note: There is nothing wrong with wiping out the company – but the way it was handled, was a big driver of the global slowdown that was to come), and that the US was on the road to recovery post this. So here we are focusing just on the US, not the contagion to other countries. His evidence is the following graph:
Employment and consumption stopped declining not long after Lehman Brothers failed, and although the largest declines occurred WHEN Lehman Brothers failed this doesn’t mean the failure caused them – in fact, employment tends to lag the cycle and the drop may well have been the result of prior economic weakness … and the amazingly high fuel prices through the first half of 2008.
Now I agree that there were factors driving a recession prior to the failure of Lehman Brothers – but the impact of Lehman Brothers as an event is captured by asking what would have happened in the absence of the Global Financial Crisis that stemmed from it, and the full blown “bank run” on wholesale financial markets that had been building pressure from the start of 2008. Going to FRED, grabbing consumption and population, and running a basic time regression in excel no less (so it’s easy to copy) we can get an idea of what the “trend” rate of consumption per capita was during the 1952-2012 period. Armed with that, we can ask what the percentage difference is between this trend and actual consumption per capita outcomes. This is:
Something is broken here – I will try to fix that up tonight. The strange thing is that I can see the graph when editing the post … but it then wont let me do anything with it
Now we can start arguing that consumption per person was too high and a whole bunch of other things if we want to here. However, this basic analysis clearly shows that the gap between trend consumption and actual consumption, something that should have a tendancy to head back to zero after a recession, actually deterioarted further … and has continued to deteroriate. We look at business cycles “around trends” not “around levels” given that our counterfactual involves growth – and this makes this post by the Cato institute a bit misleading.
Saying that the downturn, or even the crisis, started with Lehman Brothers is wrong, I agree with the author here – however Lehman Brothers failure started a new dangerous stage of the crisis which, when combined with the persistent institutional failure in Europe, has made sure that the US economy has remained below potential. A market monetarist would say that the Fed is truly responsible for this in terms of policy action, but even if we were to accept this it is undeniable that it is the “shocks” that have occurred in financial markets are the very things the Fed needs to respond to by “loosening policy”.
It’s failure is indicative of what was underlying the crisis, and the evidence shown in no way suggests that allowing its failure and initially ignoring the quiet, and then full scale, bank runs in wholesale financial markets was good policy.