[ad_1]
This article originally appeared on the Brookings Institution website on September 21, 2018. To read the original version of this article, including the graphs, click right here.
Why was the Great Recession so profound? Admittedly, the collapse of the real estate bubble was the most important trigger event; Falling real estate prices depressed wealth and consumer spending while driving strong cuts in residential construction. However, as I say in a new newspaper and newspaper article, the most damaging aspect of the unblocking bubble has been a widespread financial panic, including wholesale funding and uncontrolled sales of even non-mortgage credits. Panic in turn has stifled the supply of credit, pushing the economy into a much more severe decline than otherwise. I am convinced that the panic indicators, including the sharp increase in funding costs for financial institutions and the high returns of securitized non-mortgage assets, are significantly better indicators of the timing and depth of the recession than the variables related to housing. such as house prices, market prices for subprime mortgages or default rates for mortgages.
In a recent article, Paul Krugman looked at the causes of the Great Recession. Contrary to my findings, he tends to focus on the effects of the housing crisis on aggregate demand rather than the financial panic that led to the recession. In a follow-up response to my article, Krugman asks for evidence on the transmission mechanism. Specifically, if financial turmoil was the main cause of the recession, how were its effects reflected in the major components of GDP, such as consumption and investment? In this post, I will offer some thoughts on Paul's questions.
I will begin with some observations on the transmission mechanism. Admittedly, a reduction in the supply of credit will normally affect the components of credit-sensitive spending, such as capital investment, as Krugman notes. But a widespread and violent financial panic, like the one that hit the country ten years ago, will also affect the behavior of businesses and households that are not currently looking for new loans. For example, in a panic, any business that relies on credit to finance its ongoing activities (such as large companies that use commercial paper) or that may need credit in the future will have a strong incentive to save money. money and save with caution. For many companies, the fastest way to reduce costs is to lay off workers rather than build up labor and stockpile in the event of slowing demand, as they would normally do. That seems to be what happened: job losses, which averaged 120,000 per month between the beginning of the recession in December 2007 and August 2008, reached 670,000 per month between September 2008 and March 2009, the most intense period of panic. The unemployment rate, which, despite falling housing prices for more than two years, was still around 6% in September 2008, jumped almost 4 percentage points the following year. These are not small effects. Workers, in turn, having been made redundant or knowing that they might be, and expecting a lack of access to credit, would also have been encouraged to cut back on their spending and try to build cash reserves. Indeed, research has shown a significant increase in precautionary savings during the financial crisis for households and businesses. In Krugman's preferred IS-LM terminology, panic induced a large downward shift of the IS curve.
While it is difficult to isolate the effects of the credit shock on the components of individual spending, it is nevertheless interesting to follow Krugman and examine how the main components of GDP behaved during the period. recession. The chart below shows real residential investment and real GDP (all data below are quarterly, at annualized growth rates) for the period 2006-2009. As Krugman points out, residential investment fell sharply in 2006-2007, before major disruptions in the financial markets. This is consistent with the recession theory of the housing crisis. However, note two points. First, despite the decline in residential investment in 2006-07, real GDP growth remained positive until the first quarter of 2008 and declined only slightly in the first three quarters of this year, which does not predict what would happen. However, after the intensification of the crisis in August / September 2008, GDP fell at annual rates of 8.4% in the fourth quarter of 2008 and 4.4% in the first quarter of 2009. This precipitous decline has taken late and did not reverse in the spring of 2009.
Secondly, panic clearly affected the structure of residential investment, which accelerated its rate of decline to reach a remarkable rate of -34% in the fourth quarter of 2008 and -33% in the first quarter of 2009, before stabilizing at the second half of 2009 as panic decreased. The fact that panic would affect the pace of home building is intuitive, given the reliance on credit by construction companies and homebuyers. Indeed, my research shows that housing-related indicators, such as housing prices and sub-prime mortgage valuations, predict housing starts well enough in 2007, but that after that, financial panic including returns on non-mortgage credit, are actually better predictors of housing activity. In short, in the absence of panic, the pace and magnitude of the decline in the housing sector may not have been as severe.
The following chart shows the growth of non-residential investment in companies, which Krugman also cites as housing behavior. But again, timing is essential to interpretation. Unlike residential investment, which began to contract in early 2006, business investment began to decline only well after the bursting of the housing bubble. Between the beginning of 2006 and the third quarter of 2007, when house prices had fallen, non-residential fixed investment growth averaged nearly 8%, in line with pre-crisis standards, or even above. From the beginning of the recession in the fourth quarter of 2007 to the third quarter of 2008, average investment growth has been slow but positive. However, from the fourth quarter of 2008, when panic intensified, until the end of the recession in mid-2009, the growth rate of business investment dropped to an average annualized rate of -20%. Virtually all of the decline in business investment occurred during the most intense period of panic.
The next two graphs show the growth of (1) actual personal consumption expenditures for durable goods and (2) components of the US trade balance. As with business investment, the worst declines in these series occurred during the period of extreme panic. In particular, spending on consumer durables remained healthy throughout 2006 and 2007, despite lower house prices and home construction. However, in the fourth quarter of 2008, spending on durable goods declined at an annual rate of 26%, recovering in early 2009 at the end of the panic. Similarly, during the fourth quarter of 2008 and the first quarter of 2009, real exports and real imports fell at an average annualized rate of almost 24%, with global trade falling sharply.
As exports and imports fell, the net contribution of trade to aggregate demand in the United States was modest. The behavior of the trade components shown in the figure is nevertheless interesting for this discussion. Trade is particularly sensitive to credit because importers and exporters rely on trade finance and because a significant portion of trade is in durable goods, a credit sensitive category. The collapse of trade in late 2008 and early 2009 is therefore a good signal of disruptions in the supply of credit. Similarly, the trade improvements in 2009 probably reflected the policies that ended the panic. Acting on the international theme, also note that the global financial crisis may explain, in a way that the US housing bubble is not able, the depth and timing of the global recession of 2008-2009. (See for example, recent analysis of the Bank of England.)
To be clear, none of this denies that the housing bubble and its outcome were a major cause of the recession. In addition to their direct effects on demand, problems in the housing and mortgage markets triggered panic. and the slow recovery after the initial slowdown was probably due in part to the deleveraging of households and businesses exposed to the housing sector.[1] Indeed, my own past research has argued that the factors related to balance sheet deleveraging and the financial accelerator can have a significant impact on the pace of economic growth. I argue, however, that had the financial system been strong enough to absorb the collapse of the real estate bubble without sinking into panic, the Great Recession would have been much smaller. Similarly, if panic had not been brought under control by an aggressive response from the government, the economic costs would have been much greater.
Another piece of evidence on this point comes from contemporary macroeconomic forecasts. Forecasts made in 2008 by both government agencies and private forecasters generally included sharp declines in housing and construction prices among their assumptions, but still did not anticipate the severity of the recession. For example, as discussed in a recent article by Don Kohn and Brian Sack, the Greenbook report released in August 2008 by Fed staff included economic forecasts in a "severe financial stress scenario." Among the assumptions of this conditional forecast, house prices would decrease Additional 10% compared to baseline forecasts (which already included significant declines). As a result, the alleged declines in real estate prices in this projection were close to those that would actually occur. However, even with these assumptions, Fed economists predicted that the unemployment rate would peak at just 6.7 percent, up from an actual peak of about 10 percent in the fall of 2009. This conditional expectation would have taken full hold housing construction and the wealth effects of lower house prices. The fact that forecasts have still grossly underestimated the increase in unemployment and the extent of the slowdown suggests that some other factors – financial panic, in my opinion – would play an important role in the contraction.
The failure of conventional economic models to predict the effects of financial panic is related to another point raised by Krugman in a more recent article, in which he claims that the experience of the crisis and the Great Recession validates traditional macroeconomics. In many ways – like the prediction that the Fed's monetary policies would not be inflationary – I have been and I still agree with him. However, as I explain in my paper, current macroeconomic models still do not sufficiently take into account the effects of credit market conditions or financial instability on real activity. This is an area where a lot of work is needed.
* Sage Belz and Michael Ng contributed to this article.
[1] Other factors have probably contributed to the sluggishness of the recovery, including the weakened fiscal response and the constraints on monetary policy by the lower limit of nominal interest rates.
To read the original version of this article, including graphics, click right here.
[ad_2]
Source link
