Williamson writes
Here’s an idea that struck me in class last Thursday. There are basically two ways to think about financial crises, or the process by which financial factors affect aggregate economic activity. The first is indeterminacy. . .
The second process potentially driving a financial crisis is amplification – the idea that financial factors can amplify a small shock to the economy and make it a big one. . .
What struck me is that my idea of what the real estate bubble was and Jim Bullard’s view are quite different. My view is that the bubble was about amplification. . .
Bullard’s view is essentially indeterminacy. The real estate bubble was a self-fulfilling good equilibrium, and now we’re in a bad one.
The two views get us to the same place. I.e. potential GDP is much smaller than the Old Keynesians are telling us. What you see may be what you get. However, the policy conclusions implied by each view could be quite different.
If I may be so bold, the problem with both these views is that their end point is sharply at odds with reality.
Ignore any theory about the crisis or equilibrium and simply walk step-by-step through the elements of the current economy that is different from the one in 2006.
Is there some element of the economy that you can point to and say – this was supported in 2006, is not supported now and the resources cannot be repurposed.
To my knowledge the only elements are fairly minor
The biggest difference seems to be that it will be hard to support as much owner-occupied housing, which in turn will result in a higher rental stock, which is inefficient to operate with single-family homes.
However, to reorient the total stock towards multi-family is not that difficult. You just build almost no single family and a bunch of multi-family for a few years and the mix will have shifted back.
Now, what you do see is that consumption will be more expensive without the collateral coming from single family homes, because it will be difficult to hold down inflation in emerging markets in general and China in particular.
However, production in the United States doesn’t look to be changed in any way that is significant.
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Sunday ~ February 26th, 2012 at 6:32 am
reason
“I.e. potential GDP is much smaller than the Old Keynesians are telling us. ”
Huh? Where did that come from? He pulled his conclusion from thin air.
Sunday ~ February 26th, 2012 at 9:38 am
Curt Doolittle
Your opinion and Williamson’s are not mutually exclusive. He is simply describing it from the point of view of the actors, and you from the Smithian abstract.
And YES OUR GDP POTENTIAL IS LOWER because we misallocated human capital so severely.
Smithian reasoning as you apply it is productivity-neutral. Austrian reasoning is temporally sensitive and productivity is the goal.
Monday ~ February 27th, 2012 at 5:05 am
reason
“And YES OUR GDP POTENTIAL IS LOWER because we misallocated human capital so severely.”
We did? Where and when precisely?
Monday ~ February 27th, 2012 at 5:13 am
reason
1. Stephen Williamson is not “Austrian”
2. What has Austrian reasoning (completely unconvincing to me – as it lacks empirical support) got to do with it.
Sunday ~ February 26th, 2012 at 11:14 am
Lord
What has changed is that housing is now an expense rather than a income. Yes we can shift from housing to resource production and exports, but we need exchange rates to change and still have to shift. The rest of the economy won’t change much because it is largely about consumption rather than production and consumption doesn’t really change that rapidly. Our gdp may be lower but that does not mean our potential is lower, only that change is necessary, relatively insignificant overall, but still significant for gdp as a whole.
Sunday ~ February 26th, 2012 at 11:35 am
David Pearson
The intensity of financial intermediation is significantly lower. The level of liquidity and maturity transformation is reduced by the loss of a large part of the shadow banking sector. That loss has resulted from the discovery that its underlying analytical foundations — tranching, using VAR analysis to gauge risk, using historical volumes to gauge appropriate days-to-liquidate, etc — were deeply flawed as they ignored the build-up of systemic risk. As a result of that loss of transformation activity, there is a larger mismatch between the needs of savers and those of borrowers. This mismatch reduces potential output.
One example: during the bubble entrepreneurs across the economy were able to tap home equity lines for start up capital. Essentially these HELOC’s were financial intermediation between very long term, risky borrowers (essentially equity) and very short term risk-averse creditors. A “PSST” emerged to match these two groups as never before; that PSST has now disappeared. The effect transcends housing activity: it will be noticed in the amount of employment produced through net new firm creation.
Monday ~ February 27th, 2012 at 5:09 am
reason
“there is a larger mismatch between the needs of savers and those of borrowers. This mismatch reduces potential output.”
?????
Why exactly?
As I see it the problem is that large numbers of consumers have had a massive wealth shock and a trying (all at once to delever). Its not that there are heaps of good borrowers who can’t get credit – good borrowers don’t want creditors. The economy is suffering from a demand shock not a supply shock. This is something that is hidden – it is obvious!
Monday ~ February 27th, 2012 at 5:10 am
reason
Oops
This got published before I edited it.
… want creditors – should be want credit.
This is NOT some that is hidden – it is obvious (or should be). If we gave everybody $50 a month – do you really think GDP would not rise?