Tuesday, August 27, 2019

Coming to terms with discretion

The development of such a strong canon regarding what caused the housing bubble and what we should expect the economy to do during the recession has led to a subtle issue regarding causes and consequences.

The strength of the canon - that excessive lending and speculating had to be beaten down - and the passion for approaching it, meant that the entire episode has an air of inevitability, even where it was completely discretionary.

I mean, really, take any version of what happened in 2008.  It will have the pretense of inevitability.  Ask, "What caused the financial crisis?" and the answer will contain an implicit transitory property so that the answer will actually be the answer to "What caused the housing bubble?"  The FCIC report is basically entirely built on this premise.

Basically, a=c (things that might have caused a housing bubble = a crisis happened) was so universally accepted, that nobody has paid much attention to the second part of a=b and b=c (things that might have caused a bubble = did cause a bubble) and (the development of a bubble = a crisis).  Of course, much of my work debunks a=b.  This naturally means b=c is essentially a meaningless relationship.  A bubble that never really was could hardly be said to have caused anything.

Now, as far as a=b goes, there are library shelves full of claims about that connection.  Even though one might disagree with them, at least they exist.  But b=c was essentially presumed.  Yet, it wasn't inevitable at all.  In fact, once one is led to doubt whether a=b, one realizes that regardless of whether credit, speculation, etc. caused a bubble, the question of whether a collapse is inevitable isn't settled at all.  The collapse was completely under our discretion, and it was simply the universal agreement about that discretion that made it seem inevitable.  Like an abusive parent hitting a child and exclaiming, "Well, he broke the rules.  What would you have me do?"  The answer to that question was obviously to accept the abuse 100 or 200 years ago, simply because its acceptance was canonized.  It isn't acceptable today.

Simply questioning the premise reveals the dissonance.  The reason the crisis happened wasn't because there was nothing we could do about it.  The reason it happened was that, going as far back as 2006, or arguably even earlier, turning points just kept piling up where policymakers chose contraction, panic, decline, and collapse because to do otherwise would be coddling risk takers, bailing out wrong-doers, letting those who did this to us off the hook.  I don't even think I need to establish the point.  The public record is so saturated with that idea that it is undeniable.  It covers practically every page of every review of the period, every criticism of the Fed and the Treasury.  It's the story we have told ourselves about what happened.

Anyway, I am treading again over this territory, because I came across this graph today (here).

And, it really drives home the damage that those discretionary decisions did.  The places that are hurt much, much worse by cyclical dislocations are the places that are struggling already.  Successful places bounce back.  If not for the recession, "distressed Americana" in this graph would at least still be treading water.  Instead, there is a gash in its flesh in 2009 that isn't going to heal.  And, rest assured, the parts of the country that suffered that gash were not in the throes of a speculative frenzy.  They certainly didn't need to be taken down a notch so that those reckless people that did this to us had to be punished.

If you are concerned about the bifurcation of economic growth in this country, then there is a big giant elephant in the room regarding that issue.  We walked that elephant into the room, and it took a big, elephant-sized crap on the places that really needed stability.

Even if you think there was an unsustainable bubble and excesses had to be painfully purged from the system, consequences be damned:  THIS is the consequence.  Oh, by the way, it didn't need to be done.  a<>b .  But, even if we save that debate for another day, the imposed "discipline" that so universally was hoisted on the economy to knock it down to size had downsides that should be faced honestly.  a<>b, but even if a=b, there are a lot of questions we should have asked about, really, how committed we should have been to b=c.


  1. There are revered totems in macroeconomics, and one must speak in hushed tones.

    You speak of elephants. And defecation.

    How about this one? We have globalised capital markets. Mark Carney, Bank of England Governor, just spoke at Jackson Hole and more or less said interest rates are set globally. This means one of the favorite tools of the Federal Reserve, the setting of interest rates, really doesn't apply anymore. Oh sure, they can set interest rates on excess reserves but medium and long-term rates will do what they do. What the Fed can accomplish is an inverted yield curve. And there is a global capital cut.

    And if there is a global capital cut, and about $350 trillion of Assets in global capital markets, then what is the effect of a quantitative easing program? So the Fed pumps a couple trillion dollars into Global Capital markets? Global capital markets are already flooded with cash.

    So we have this picture of the US central bank trying to stimulate the domestic economy of the United States by lowering interest rates globally and by pumping cash into global capital markets.

    This is the pachyderm in the room in monetary policy circles. But the macroeconomics profession remains entrenched on old battlefields under antique escutcheons, fighting wars that no longer matter Keynesian versus monetarists (although given this new Global Order, maybe the Keynesian sir more right).

    1. I'm not sure setting interest rates ever applied.

  2. Yes, you are right, look at NGDP growth. Mark Carney's point is that the next recession the Fed won't be able to do much, right or wrong, to affect NGDP growth. So let us say NGDP growth starts to tank. Obviously the Fed should act, but...

    1. The Fed lowers interest rates. But long-term rates stay where they are (may already be negative). The Fed is a bystander.

    2. Okay, so the Fed goes to QE. So what? Global capital markets are awash in cash anyway. Flooded. The Fed puts a water hose into the flood.

    I will exaggerate to make a point: Trying to boost the US economy through Fed actions--and thus through globalized capital markets---is like trying to inflate a ballon by lowering global atmospheric pressure (instead of inflating the ballon directly).

    I see why the BlackRocks, the Pimcos, the Ray Dalios are calling for helicopter drops. The macroeconomics profession is, well, stuck in their ways.

    I am not making fun of death. But Martin Feldstein predicted higher interest rates and inflation were pending, for decades. He literally died before seeing his predictions come to fruition. The same thing may happen to Jim Grant, Interest Rate Observer. These guys do not change.

    1. I mean, there is something to what you say, but if QE is toothless, why did they have to keep ending them? If they hadn't ended QE1, the target rate would have been moving above the zero bound by 2010 or 2011.

      They did terminate the QEs, so maybe the fed as is cant inflate, but I dont see evidence that they lack the tools. As always, thinking of interest rates as the policy tool is the main problem.

    2. You write that “the next recession the Fed won't be able to do much, right or wrong, to affect NGDP growth.” But the Fed can debase the currency—the U.S. dollar (that’s very easy to do)—which will raise NGDP (after all, ‘N’ stands for nominal).