DeLong: Comments at Quigley Housing Finance Symposium
Moderator: Case
Papers: Leamer, Shiller
Discussants: Hall, Wilcox, DeLong
Date: October 31, 2008
Brad DeLong's Comments:
In Ed Leamer's formulation, our eleven recessions since World War II--for Robert Hall and his business-cycle dating colleagues will someday declare that the economy peaked in the fourth quarter of 2007 and has since then been in a recession--consist of one sharp reduction in defense spending, one "comeuppance" after the end of a high-tech bubble, eight housing- and consumer-driven recessions, and today. Ed wants to be a macroeconomic time-series econometrician, and use the patterns of previous housing- and consumer-driven recessions to analyze what is going on.
Now this is a brave, a bold, but I think a foolhardy exercise. Even in normal times, I would not wish the task of a macroeconomic time-series econometrician on a mangy dog. Especially not now. For what is going on now is not only not like the post-Korean War structural adjustment and shift out of defense and into consumption, not only like the post-2000 structural adjustment and shift out of Silicon Valley and into housing, but also not like the previous eight housing- and durable-led recessions we have seen since World War II.
You see, those eight other previous post-WWII housing recessions have their origins in the big conference room of the Eccles Building on the Mall in Washington DC. The impulse is that in each case, at some moment, the 19 voting and non-voting members of the Federal Reserve Open Market Committee said: "Oh, BLANK, inflation is too high. We can't let this go on. We have to..." and then the Keynesian members of the committee say "raise interest rates" and the monetarist members say "stop interfering with the normal market processes that would push interest rates up." Basically, the Federal Reserve fights inflation by attempting to create deficient demand. It creates deficient demand by using high interest rates as a brick with which to hit the housing sector on the head, and also credit-financed consumer durables on the head as well. Demand shrinks, production shrinks, employment shrinks, income shrinks until the people in the Eccles Building say either "we have done enough" or "ooops, we've done more than enough" or "ooops, we just bankrupted Mexico" and lowers interest rates, and housing and credit-financed consumer durables bounce back.
That is not what is happening now. Something different is happening. The Federal Reserve did not hit the housing sector on the head with a high interest-rate brick. Wall Street has done something bad. Do patterns derived from looking back at historical events unlike what is going on now in key features provide a useful guide, or rather in what respects do they provide a useful guide and in what respects are they misleading?
That is a question. I know that Ed Leamer is very smart and very brave to be a macroeconomic time-series econometrician. But it is not clear what macroeconomic time-series econometricians have to offer here. I have no answer.
Robert Shiller wants to step back and talk about long-run considerations for policy. He is one of the leaders in what is now a consensus among economists that we need to reject the theory of economic policy that I call "Greenspanism." Greenspanism is the doctrine that the Federal Reserve must make sure that consumer-price inflation stays low and that expectations of future consumer-price inflation stay low, but that otherwise should let the macroeconomy govern itself and if exuberance leads to an episode in which the economy is saying laissez les bon temps roulez, then laissez les bon temps roulez. If the exuberance turns out to be irrational, and if a big crash does come, and if the risk that crashes is not properly diversified but is instead held unhedged by highly leveraged financial intermediaries, and if they go bankrupt--well, the central bank and the Treasury have the tools to clean up the mess. Better to clean up the mess afterwards than to, anticipatorily, hit the economy on the head with a brick and cause high unemployment and business bankruptcies just because you fear that a boom will turn into an irrational bubble which will generate a crash in which you find that risk was not properly hedged and your big financial institutions go belly-up and then you will have a problem.
Nowadays there are few Greenspanists. Indeed, Alan Greenspan is no longer a Greenspanist. I relied, he said, on the self-interest of financial-sector professionals to keep their organizations properly hedged. And, properly hedged, we shouldn't have a problem. There are now $2T of mortgage security losses. There are $70T of financial assets in the global economy. A 3% decline in aggregate asset values should not be a big problem for the macroeconomy. Yet it is.
So there are no Greenspanists now. To be a Greenspanist you need to believe that (i) market exuberance won't turn irrational or (ii) if it does it will deflate rather than crash or (iii) if it crashes portfolios will be diversified or (iv) if they aren't diversified the financial system will be able to work it out on its own. We don't believe, anymore, that we can trust that even one of these four lines of defense will hold.
So if we are none of us Greenspanists now, what should we do--both in the short term, now, and in the long term, in the way of institution design?
That is, also, a auestion. I have no answer--this is an answer-free discussion. I do know that I do not trust Henry Paulson: his career means that his thinking is too close to that of the investment banking industry and his Republican ideology means that he cannot adopt policies that involve government control without being dragged kicking and screaming. I do trust Ben Bernanke: his academic career seems to have been ideal preparation for dealing with the worst financial crisis since the Great Depression, and his staff is very good and very large.
