Article that Explains our Debt Trap

[JerichoHill]

I have a "crazy' theory. So you'll want other people's stories as well.

The story I see looks something like this.

Housing bubble and runup in housing construction from 2000-2006. Housing price bubble pops in 2007. From mid-2007 to mid-2008 we have a garden-variety recession.

From June to August 2008, a series of shocks hit the American economy.
(1) Continued fallout from the housing bubble which ripples through the financial sector. Nobody has any clear plan of what to do with very large problem banks. Consider this a "demand" shock to money velocity.
(2) The oil price spike in June 2008 was "exogenous" to the American economy and represented a mild supply shock.
(3) Contemporaneously, "confidence" falters as private expectations of future income fall dramatically. (source: U Michigan Survey of Consumers). A 'demand shock" to consumption.
(4) real interest rates soar upward (source: look at the yield on inflation-indexed bonds as a proxy for real interest rates). A "demand shock" to investment.

As a result of these shocks the demand for money (or, equivalently, safe assets like Treasury bills) increased.

However the Fed and Treasury did not act to meet that increased demand. Monetary policy loosened in absolute terms but not relative to where they needed to be.

The "crash" in October-November 2008 was precipitated by a contraction in aggregate demand caused by tight money, falling expectations of future income and soaring real interest rates.

Monetary policy continues to be tight relative to where it needs to be, even today. That's why unemployment is so high and output so low. We can also see this in tepid realized inflation, low inflation expectations and continued low asset prices.

In short: mild "real" recession from mid-2007 to mid-2008. Tight monetary policy (relative to where it needed to be) drove the economy off a cliff in June-August 2008. Large recession followed.

But again, this is a story that I piece together using evidence from the Great Depression and the 1987 stock market crash. The basic causality is "tight money -> financial crash -> recession." It's not the financial crash that caused the recession, it's tight money.

What I need to do now is piece together a causal story that is plausible to people other than monetary economists.

Essentially, I feel that is correct on the macro level but missing some minor micro details. We essentially agree. Be sure to tack on an inappropriate policy response (due to political constraints) following the large recession shock in late 2008.

//Dammit Integral. You've caused me to add another blog to my readings...

 

[Integral]

I agree that I have a lot to learn from you and Whomp in getting good microfoundations for my macro story.

(Whomp and I discussed this over drinks once, and the main sticking point was that I couldn't give a convincing micro-explanation to fit my macro-tale. I'm working on it!)

And I'll admit, I got a lot of this wrong in real-time. I was convinced that monetary policy was appropriately loose in mid- to late-2008. Just re-read the monthly Recession Watch threads. I wasn't on top of the game.

@JH: you absolutely must read two money/macro blogs:
1. The Money Illusion, by Scott Sumner
2. Worthwhile Canadian Initiative, by Nick Rowe and a few others

Both are pitched at the "intermediate-advanced" level, particularly Rowe. They have absurdly good comment sections. Really worth reading.

Oh, Jim Hamilton (the Jim Hamilton, the time-series economist at UCSD) blogs macro as well. Self-recommending.

 

[Core Imposter]

Economics has in it no aspect of math, economics is wholly human psychology expressed in mathmatical terms just as the psychology of dogs is expressed in barks, growls and whines.

Math does not do infinity well but human beings think and behave in infinite, not finite terms. Thus mathematics may very well be used to portray all conceivable visions of economic reality but one, which is that one actual reality. The debt is too damn high not when shown to be by mathematical analysis but when thought to be too damn high, at which point behavior changes. And that horse is long out of the barn.

The Rentenmark stood no mathmatical rigor, it found acceptance by some infinite mixture of sensory presence and desperation. So also the replacement currencies of the years to come will pass muster without any of the fine logical and rational explanations presented.

 

[choxorn]

Nonsense. Over half of our budget is spent on entitlements, and entitlements are the Democrats' sacred cows. The Republicans' sacred cow is the military, which only accounts for less than 20% of the budget.

Last time I checked, large parts of both parties refused to cut either entitlements or the military.

 

[Zardnaar]

Apart from Clintons surplus (which IIRC is debateable) the USA has been in deficit since 1969 AKA the Vietnam war.

Clinton produced a surplus, that leaves 4 years of Carter and 3 years of Obama in 40 years.

42 years total- 27 years of Republican policies producing deficits compared to the Democrats 7. I didnt include the Clinton years as I'm not sure how many of them were deficit/surplus years. Basically the Republicans have dominated US politics since the 68 election and deficits started the following year. 42 years maybe 2 of them?? with a surplus and that leaves a 27-13 scorecard against the Republicans IMHO.

I'm not American though.

 

[Leoreth]

Math does not do infinity well but human beings think and behave in infinite, not finite terms.

You don't seem to know much about math?

 

[JerichoHill]

Economics has in it no aspect of math, economics is wholly human psychology expressed in mathmatical terms just as the psychology of dogs is expressed in barks, growls and whines.

Math does not do infinity well but human beings think and behave in infinite, not finite terms. Thus mathematics may very well be used to portray all conceivable visions of economic reality but one, which is that one actual reality. The debt is too damn high not when shown to be by mathematical analysis but when thought to be too damn high, at which point behavior changes. And that horse is long out of the barn.

The Rentenmark stood no mathmatical rigor, it found acceptance by some infinite mixture of sensory presence and desperation. So also the replacement currencies of the years to come will pass muster without any of the fine logical and rational explanations presented.

All 3 paragraphs are factually inaccurate.