The Last Economic Recovery Sightings of 2011


At Slate, Matt Yglesias stands against the "conventional wisdom" (i.e., a headline in the fake-earthquake-retweeting New York Times) that the economy's "relatively strong growth in the fourth quarter was a false dawn." Instead, Yglesias, who takes meetings with Secretary of the Treasury Tim Geithner, draws on 19th century economist Knut Wicksell to argue that the economy is already rebounding in this year of the Mayan apocalypse. In a related piece, he says the glutted and deflating real estate market just needs more houses. 

When this house is asking less than a million dollars, policymakers need to do solve the problem.

I'm a fan of Slate's contrarian habit, and I appreciate the chutzpah required to tell a nation of people holding nothing but shards of piggy banks that the recovery is here. 

I'm less sure of the proof, the only hard evidence for which seems to be the rapid fall in official unemployment. That decline does appear to be legitimate in the sense that it is no longer coupled with an increase in marginal attachment to the workforce or a decline in labor force participation (which would indicate jobless claims are declining not because unemployed people have returned to work but because they have used up their benefits and withdrawn from the productive economy entirely). The marginal attachment figure has been declining along with unemployment.  

But there's a reason the Obama Administration and the Federal Reserve have not been bragging about the unemployment decline more aggressively. Most of the one-year decline in unemployment (from 9.8 percent in November 2010 to 8.6 percent in November 2011) took place through March 2011 – since which time unemployment has moved sideways. (I should also put that phrase "rapid fall in official unemployment" into perspective: The job recovery period from the 2007-2009 recession long ago set the postwar record for slowness. Only the aftermath of the 2001 recession comes close.) 

There also seem to be some serious flaws in Slate's reasoning: 

Wicksell argued that there is a "natural rate of interest," at which desired savings is balanced by desired investment and the economy suffers from neither inflation nor massive excess capacity. A recession occurs when the natural rate of interest falls below the actual interest rate. Instead of savings being channeled into investment and driving the economy forward, firms and households start merely hoarding and the economy stalls, leaving workers and equipment idle.

I think Matt is mixing up "investment" with "spending." (Easy enough to do when you live in DC.) Investment is putting capital into an asset or venture in hope of profit – through income, interest or appreciation in value. Yet a few paragraphs later (during one of those this-good-thing-will-happen-and-cause-that-good-thing-to-happen scenarios interventionists like to lay out), we find the following: 

That will make it easier for Americans to buy new cars and reverse the four years of growth in the average age of America's passenger vehicles. Families will also invest in other kinds of durable goods—refrigerators, washing machines, etc.

Now all these purchases may be good for GM and Maytag, but they are not by any definition "investment." This is not just a semantic quibble. The current recession has provided a striking lesson in asset depreciation. Real estate, which for many years was dubiously promoted as a source of future value, now looks less like an investment than like an asset comprising two parts: land, which may or may not appreciate; and building materials, which depreciate immediately. 

Slate's understanding of what would be a market-clearing rate of interest is even more strange: 

Unfortunately, the financial crisis we've been suffering through pushed the natural rate very low—below zero. The Fed can't set the nominal interest below zero, and has steadfastly refused to engage in the variety of "unorthodox" measures that would push real rates lower, thus ensuring a long and painful recovery process.

This is not true. Since 2008 the Fed has been engaged in a novel practice of paying banks interest on reserves (IOR) – both required reserves and reserves in excess of requirements. The scale and nature of the effects of this new authority are subject to intense debate, but IOR is definitely exotic, allowing the Fed to create money while also keeping that money out of circulation. If that's not unorthodox it's only because the orthodoxy has changed. 

Saying the Fed can't set the nominal rate below zero is also misleading. At the beginning of 2009 I persuaded my eldest child to put $100 into a savings account, so that she might learn something about savings. In the three years since, that account has earned exactly ten cents. The lesson – don't save – has certainly taken hold, but that 0.1 percent rate over three years is in fact negative: According to the BLS inflation calculator, she would have had to make $5.45 just to keep pace with inflation. 

Mortgage interest rates are also being suppressed. Right now a 30-year fixed-rate mortgage can be had (presuming you can get anybody to lend to you without outside coercion) for less than 4 percent – well below where the rate was at the height of the boom. This is after a period during which one in every ten mortgage borrowers has defaulted. I'm just a simple caveman, but it seems to me when the risk profile of lenders has increased more rapidly than at any time in postwar history, interest rates should logically go up to reflect that risk. They have instead gone down because the Fed, the Treasury and HUD are all exerting downward pressure on interest rates. 

It's hard to imagine any more compelling pressure from policymakers to get people to spend. And it's worth repeating that these policies have had the intended effect: Consumer spending is well above where it was at the peak. The St. Louis Fed informs us that consumer debt is rising steadily and almost back to its pre-crash high. According to the Bureau of Economic Analysis [pdf], the personal savings rate, which reached almost 6 percent at the beginning of 2011, had collapsed to 3.5 percent by November. And the BLS calculator shows that inflation is in fact occurring. About the only evidence that Americans are using available dollars to repair personal balance sheets (which Yglesias defines as "hoarding") is a negligible increase in the equity portion of real estate. 

The problem is that the American consumer has no blood left to give. Inflationists have failed to cause an economic recovery, but not because they haven't had a chance to put their ideas into practice. The ideas have been put into practice, and they have failed. To claim now that pushing on a string has finally started to pay off, on as little evidence as Slate presents here, goes beyond contrarianism and into Cloud Cuckoo Land – where it's always the right time to buy a house

Speaking of which, Yglesias does have one deflationary proposal. He believes the country needs a policy of starting new housing construction. Despite all the REO For Sale signs still going up in my neighborhood (and probably yours), Yglesias says we're facing a housing shortage

Again, I think we may be seeing some geographical confirmation bias: As we noted recently, the District of Columbia is the only major real estate market that has been appreciating since 2009. I have spent plenty of time explaining why real estate remains overpriced, but unless all the data we've been hearing about non-performing loans, redefaults and the shadow inventory are really off-base, the claim that we're not facing a durable supply glut in the real estate market is just silly. 

At the risk of sounding like the economics professor with the $100 on the ground, sometimes the market really does send accurate signals without the need for costly public policy initiatives. If there is a housing shortage, all those idled contractors, laid-off construction workers and big developers have plenty of incentive to solve the problem. They are not doing so because there is no housing shortage.

Whether there's a more general economic recovery in the offing, well, best wishes for a Happy New Year.