A few comments on the INET panel, Getting Back on Track: Macroeconomic Management After A Financial Crisis.
Here’s Richard Koo’s presentation about the need for fiscal stimulus during a balance-sheet recession, or the bursting of a nationwide-asset price bubble financed with debt:
I got a message from someone in attendance saying “I’m hearing Carmen Reinhart saying “I really buy Duncan Foley’s argument..’, and share Richard Koo’s belief in the balance sheet recession approach..Cognitive dissonance for me.” Heh.
Richard [Koo] argued that–just as in Japan in the 1990s–the collapse of asset values had created a world desperately short of financial assets, in this particular case savings vehicles of moderate and long duration. The impairment of balance sheets thus left households and businesses anxious to cut back on their spending in order to rebuild their balance sheets. Since the interest rate could not fall any further to clear the market for savings vehicles, recession followed. The recession would, he said, last until and unless the supply of financial assets to serve as savings vehicles rose to levels consistent with financial-market demand. And government could materially accelerate this process if it stood up while the private sector was standing down: if it spent, invested, and borrowed in order to boost the market supply of savings vehicles.
Carmen by contrast argued that the world was desperately short not of savings vehicles but rather, due to overleverage, of safe financial assets. We had an excess supply of risky and leveraged financial assets and an excess demand for safe financial assets. Hence households and businesses cut back on their spending to try, in vain, to build up their holdings of safe financial assets that just were not there. Hence recession.
What did Carmen say could be done? Nothing. The privates cannot accelerate the deleveraging process because nothing they do can transform risky into safe assets right now. And if the government tries to do so it will crack its status as a safe debtor and we will have a bigger sovereign debt crisis on our hands which will make the recession worse, Basically, we are all Austria and it is 1931.
Of course, financial markets do not think we are all Austria and it is 1931. They think that Iceland, Ireland, Greece, Portugal, and Spain are Austria in 1931–and they are right.
My view is that Richard Koo is right, and economic core governments should be frantically engaging in expansionary fiscal policy right now until the wake-up call from financial markets comes, and then they should stop.
The main takeaway point, however, is that this is all the macroeconomics of 1873.
Readers of this blog know that I am on Team Koo, but I want to add a quick point on Carmen’s point on nothing can transfer risky assets into safe assets. Yes, it would require a magical piece of technology to turn risky, uncertain assets into safe assets – this machine would need to take into account the interests of borrowers and lenders, it would need to readjust the debt, forcing borrowers to take first losses, and giving lenders a piece of the upside after-the-fact. It would have to readjust the terms of the debt and risk to incorporate new information while handling the collective and evenhanded treatment of creditors. Why not ask for a jetpack too!
Oh but wait, we do have such a technology – it’s called the bankruptcy code. Too bad it needs a quick fix in order to start churning collapsed housing assets, and bundles of housing assets, into something that better reflects the new reality of the housing collapse, a safer assets for investors.
Last point, I wonder how the Great Stagnation crew would think about this Duncan Foley paper, “The Political Economy of U.S. Output and Employment 2001–2010”:
Service industries such as Finance, Insurance, and Real Estate, Education and Health Services, and Professional and Business Services, for which value added is imputed from incomes, are included in Gross Domestic Product, distorting measures of recession and recovery. An alternative index, Narrow Measured Value Added, which excludes all services, has similar historic correlations with employment to GDP, and tracks employment in recent business cycles better. The U.S. economy as measured by NMVA has a lower long-term real rate of growth. Long-term macroeconomic policy requires attention to some version of the productive-unproductive labor distinction of the classical political economists.
My ﬁrst paranoid suspicion was that the “recovery” was concentrated in the ﬁnancial industry. The ﬁnancial industry (Finance, Insurance, and Real Estate–FIRE) shares a peculiar feature with theGovernment (GOV), Education and Health Services (EHS), and Professional and Business Services (PBS) industries in the national income accounts. While in other industries such as Manufacturing(MFG) there are independent measures of the value added by the industry and the incomes generated by it (value added being measurable as the diﬀerence between sales revenue and costs of purchasedinputs excluding new investment and labor), there is no independent measure of value added in the FIRE and similar industries mentionedabove. The national accounts “impute” value added in these industries to make it equal to the incomes (wages and proﬁts) generated.Thus when Apple Computer or General Electric pay a bonus to their executives, GDP does not change (since value added does not change–the bonus increases compensation of employees and decreases retained earnings), but when Goldman-Sachs pays a bonus to its executives, GDP increases by the same amount. I was also aware of the fact that the national income accounts impute as value added to FIREthe diﬀerence between interest received and interest paid, which, asa result of the aggressive post-crisis easing of monetary policy, wasbound to increase signiﬁcantly. One consequence of the imputation ofvalue added in these industries is that the relation between employment and value added in them is weaker and more volatile than inindustries where value added can be measured directly from markettransactions. Since there is no direct relation of imputed value addedto sales, the connection of aggregate demand to measured output in the industries subject to imputation is likely to be much less close aswell.
The proﬁts of ﬁnancial capital from this classical political economypoint of view are a share of the surplus value that takes the form ofinterest paid on borrowed capital. From this perspective it is doublecounting to “impute” an imaginary produced “ﬁnancial service” as thecounterpart of interest payments. Interest payments are a transferof a part of the surplus value appropriated in production, not thepurchase of a good or service. From the beginning, the problem of the treatment of ﬁnancial interest posed problems for the creators of the system of accounts, and discussion of the appropriate method for themeasurement of the value and volume of “ﬁnancial services” continueto provoke vigorous debate (Diewert, 2007, see, for example). Partsof other service categories, such as health care and professional andbusiness services might also reasonably be regarded as costs of thereproduction of society rather than as contributions to its net output.
I’m starting to research “financialization” as a topic, and this problem – how do you measure the output of the financial sector so you can compare and contrast it along the same quantitative measure as manufacturing and other real economy industries – is a really fascinating one.