Last week I promised a discussion of my new paper with Arjun Jayadev on "Fisher dynamics" and the evolution of household debt. That discussion is now here, not here, but at Rortybomb, where Mike Konczal has graciously invited me to post a summary of the paper.
The summary of the summary is that the increase in household debt-to-income ratios over the past 30 years can be fully explained, in an accounting sense, y changes in growth, inflation, and interest rate. Except during the housing bubble period of 2000-2006, household spending relative to income has actually been lower in the post 1980 period than in preceding decades. If interest rates, inflation and growth had remained at their 1950-1980 average level, then the exact same household decisions about spending out of income would have left them with lower debt in 2010 than in 1980. And just as it wasn't more borrowing that got us higher debt, less borrowing almost certainly won't get us to lower debt. If household leverage is a problem, then the solution will have to be some mix of large-scale writedowns, higher inflation, and lower interest rates via financial repression.
But I encourage you to read the whole summary over at Rortybomb or, if you're really interested, the paper itself. Comments very welcome, there or here.
UPDATE: Now also at New Deal 2.0.
UPDATE 2: Responses by Kevin Drum, Karl Smith, Merijn Knibbe, Reihan Salam, and The New Arthurian. There's some good discussion in comments at Mark Thoma's place. And a very interesting long comment by Steve Randy Waldman in comments right here.
Showing posts with label work in progress. Show all posts
Showing posts with label work in progress. Show all posts
Thursday, February 23, 2012
Friday, February 10, 2012
The Dynamics of Household Debt
Regular readers of this blog will remember some interesting discussions here a few months ago of the dynamics of public debt. The point -- which is taught in any graduate macro course, but seldom emphasized in public debates -- is that the change in debt-GDP ratios over time depends not just on government deficits or surpluses, but also on growth, inflation and interest rates. In particular, for the US, the UK and many other countries [1], the decline in debt/GDP in the postwar decades is entirely due to growth rates in excess of interest rates, with primary surpluses contributing nothing or less than nothing.
An obvious extension of that discussion is the question, What about private debt? After all, the rise in private leverage over the past few decades is even more dramatic than the rise in public leverage:
 |
| Sectoral Debt as Share of GDP, 1929-2010. Click to embiggen. |
So what if you apply the same kind of decomposition to private debt that is done for public debt, and ask how much of the change in sector's debt in a given period is due to changes in borrowing behavior, and how much is due to changes in interest rates, growth rates, and or inflation? Surprisingly, no one seems to have done this. So Arjun Jayadev and I decided to try it, for household debt specifically, with (IMO) some very interesting results. A preliminary draft of our paper is here.
I'll have more on the content shortly, but if you're interested please take a look at the paper. We're in the process of revising it now, and any comments/questions/thoughts on making it better would be most welcome.
Thursday, September 30, 2010
How Much Would a Lower Dollar Boost Demand?
Lots of economists of the liberal Keynesian persuasion (Paul Krugman, Dean Baker, Robert Blecker [1] -- very smart guys all) think dollar devaluation is an important step in getting back toward full employment in the US. But have any of them backed this up with a quantitative analysis of how much a lower dollar would raise demand for American goods?
It's not an easy question, of course, but a first cut is not that complicated. There are four variables, two each for imports and exports: How much a given change in the dollar moves prices in the destination country (the passthrough rate), and how much demand for traded goods responds to a change in price (the price elasticity.) [2] We can't observe these relationships directly, of course, so we have to estimate them based on historical data on trade flows and exchange rates. Once we choose values of them, it's straightforward to calculate the effect of a given exchange rate change. And the short answer to this post's title is, Not much.
For passthrough, estimates are quite consistent that dollar changes are passed through more or less one for one to US export prices, but considerably less to US import prices. (In other words, US exporters set prices based solely on domestic costs, but exporters to the US "price to market".) The OECD macro model uses a value of 0.33 for import passthrough at a two-year horizon; a simple OLS regression of changes in import prices on the trade-weighted exchange rate yields basically the same value. Estimates of import price elasticity are almost always less than unity. Here are a few: Kwack et al., 0.93; Crane, Crowley and Quayyum, 0.47 to 0.63; Mann and Plück, 0.28; Marquez, 0.63 to 0.92. [3] (Studies that use the real exchange rate rather than import prices almost all find import elasticities smaller than 0.25, which also supports a passthrough rate of about one-third.) So a reasonable assumption for import price elasticity would be about 0.75; there is no support for a larger value than 1.0. Estimated export elasticities vary more widely, but most fall between 0.5 and 1.0.
So let's use values near the midpoint of the published estimates. Let's say import passthrough of 0.33, import price elasticity of 0.75, and export passthrough and price elasticity both of 1.0. And let's assume initial trade flows at their average levels of the 2000s -- imports of 15 percent of GDP and exports at 10.5 percent of GDP. Given those assumptions, what happens if the dollar falls by 20 percent? The answer is, US net exports increase by 1.9 percent of GDP.
1.9 percent of GDP might sound like a lot (it's about $300 billion). But keep in mind, these are long-run elasticities -- in general, it takes as much as two years for price movements to have their full effect on trade. And the fall in the dollar also can't happen overnight, at least not without severe disruptions to financial markets. So we are talking about an annual boost to demand of somewhere between 0.5 and 1.0 percent of GDP, for two to three years. And then, of course, the stimulus ends, unless the depreciation continues indefinitely. This is less than half the size of the stimulus passed last January (altho to be fair, increased demand for tradables will certainly have a higher multiplier than the tax cuts that made up a large share of the Obama stimulus.) The employment effect woul probably be of the same magnitude -- a reduction of the unemployment rate by between 0.5 and 1.0 points.
I would argue this is still an overestimate, since it ignores income effects, which are much stronger determinants of trade than exchange rates are -- to the extent the US grows faster and its trading partners grow more slowly as a stronger US current account, that will tend to cancel out the initial improvement. I would also argue that the gain to US employment from this sort of rebalancing would be more than offset by the loss to our trade partners, who are much more likely to face balance of payments constraints on domestic demand.
But those are second-order issues. The real question is, why aren't the economist calling for a lower dollar providing quantitative estimates of its effects, and explicitly stating their assumptions? Because on its face, the data suggests that an overvalued dollar plays only a modest role in US unemployment.
[1] I was going to include Peter Dorman on this list but I see that while he shares the IMO misplaced concern with global imbalances, he says, "Will a coordinated dollar devaluation do the trick? Maybe, if you can get coordination (no easy feat), but it is also possible that US capacity in tradables has deteriorated too far for price adjustment alone to succeed." Which is a more realistic view of the matter than the one Krugman seems to hold. On the other hand, Dorman was also writing just a couple years ago about The Coming Dollar Crash. That dog that didn't bark is something I'll hopefully be writing about in a future post.
[2] Many studies collapse passthrough and price elasticity into a single measure of real exchange rate elasticity. While this is a standard approach -- about half the published papers take it -- I would argue it's not the right one for either analytic or policy purposes. Analytically, the real exchange rate elasticity doesn't distinguish between the behavior of buyers and sellers: A low value could mean either that consumers are not responsive to price, or that sellers are holding price stable in the face of exchange rate changes. And on the other side, it's the nominal, not real, exchange rate that's accessible to policy. Policy-induced movements in the nominal exchange rate only translate into movements in the real rate if we assume that price levels (and real wages, if we're deflating by labor costs) don't respond to movements in the exchange rate, which is not generally a safe assumption.
[3] Price elasticities are all negative of course. I'm omitting the negative sign for simplicity.
It's not an easy question, of course, but a first cut is not that complicated. There are four variables, two each for imports and exports: How much a given change in the dollar moves prices in the destination country (the passthrough rate), and how much demand for traded goods responds to a change in price (the price elasticity.) [2] We can't observe these relationships directly, of course, so we have to estimate them based on historical data on trade flows and exchange rates. Once we choose values of them, it's straightforward to calculate the effect of a given exchange rate change. And the short answer to this post's title is, Not much.
For passthrough, estimates are quite consistent that dollar changes are passed through more or less one for one to US export prices, but considerably less to US import prices. (In other words, US exporters set prices based solely on domestic costs, but exporters to the US "price to market".) The OECD macro model uses a value of 0.33 for import passthrough at a two-year horizon; a simple OLS regression of changes in import prices on the trade-weighted exchange rate yields basically the same value. Estimates of import price elasticity are almost always less than unity. Here are a few: Kwack et al., 0.93; Crane, Crowley and Quayyum, 0.47 to 0.63; Mann and Plück, 0.28; Marquez, 0.63 to 0.92. [3] (Studies that use the real exchange rate rather than import prices almost all find import elasticities smaller than 0.25, which also supports a passthrough rate of about one-third.) So a reasonable assumption for import price elasticity would be about 0.75; there is no support for a larger value than 1.0. Estimated export elasticities vary more widely, but most fall between 0.5 and 1.0.
So let's use values near the midpoint of the published estimates. Let's say import passthrough of 0.33, import price elasticity of 0.75, and export passthrough and price elasticity both of 1.0. And let's assume initial trade flows at their average levels of the 2000s -- imports of 15 percent of GDP and exports at 10.5 percent of GDP. Given those assumptions, what happens if the dollar falls by 20 percent? The answer is, US net exports increase by 1.9 percent of GDP.
1.9 percent of GDP might sound like a lot (it's about $300 billion). But keep in mind, these are long-run elasticities -- in general, it takes as much as two years for price movements to have their full effect on trade. And the fall in the dollar also can't happen overnight, at least not without severe disruptions to financial markets. So we are talking about an annual boost to demand of somewhere between 0.5 and 1.0 percent of GDP, for two to three years. And then, of course, the stimulus ends, unless the depreciation continues indefinitely. This is less than half the size of the stimulus passed last January (altho to be fair, increased demand for tradables will certainly have a higher multiplier than the tax cuts that made up a large share of the Obama stimulus.) The employment effect woul probably be of the same magnitude -- a reduction of the unemployment rate by between 0.5 and 1.0 points.
I would argue this is still an overestimate, since it ignores income effects, which are much stronger determinants of trade than exchange rates are -- to the extent the US grows faster and its trading partners grow more slowly as a stronger US current account, that will tend to cancel out the initial improvement. I would also argue that the gain to US employment from this sort of rebalancing would be more than offset by the loss to our trade partners, who are much more likely to face balance of payments constraints on domestic demand.
But those are second-order issues. The real question is, why aren't the economist calling for a lower dollar providing quantitative estimates of its effects, and explicitly stating their assumptions? Because on its face, the data suggests that an overvalued dollar plays only a modest role in US unemployment.
[1] I was going to include Peter Dorman on this list but I see that while he shares the IMO misplaced concern with global imbalances, he says, "Will a coordinated dollar devaluation do the trick? Maybe, if you can get coordination (no easy feat), but it is also possible that US capacity in tradables has deteriorated too far for price adjustment alone to succeed." Which is a more realistic view of the matter than the one Krugman seems to hold. On the other hand, Dorman was also writing just a couple years ago about The Coming Dollar Crash. That dog that didn't bark is something I'll hopefully be writing about in a future post.
[2] Many studies collapse passthrough and price elasticity into a single measure of real exchange rate elasticity. While this is a standard approach -- about half the published papers take it -- I would argue it's not the right one for either analytic or policy purposes. Analytically, the real exchange rate elasticity doesn't distinguish between the behavior of buyers and sellers: A low value could mean either that consumers are not responsive to price, or that sellers are holding price stable in the face of exchange rate changes. And on the other side, it's the nominal, not real, exchange rate that's accessible to policy. Policy-induced movements in the nominal exchange rate only translate into movements in the real rate if we assume that price levels (and real wages, if we're deflating by labor costs) don't respond to movements in the exchange rate, which is not generally a safe assumption.
[3] Price elasticities are all negative of course. I'm omitting the negative sign for simplicity.
Wednesday, September 15, 2010
Macro Models and the Long Run
I was just looking at this working paper on the OECD's new global macro model. What it is, is a set of equations relating a dozen or so macro aggregates for each major country or region in the OECD, at a quarterly timescale. OK, that sounds stupid and naive to economists, and hopelessly cryptic to everyone else. Let's proceed. Some observations, first on structure, second on content.
The equations comes in two flavors, long-term and short-term. Salient fact about the long-term ones is that most of them are imposed (singly or jointly) rather than estimated. For instance, the elasticities of consumption with respect to income and wealth are constrained to sum to one. The elasticity of employment with respect to real wages is constrained to be negative one. (Oh, that one makes me mad.) The elasticities of exports and imports with respect to their respective market sizes are constrained to be one. And so on. Meanwhile, the short-term (one- and two-year) equations are allowed to be determined by the data.
There's a couple reasons for this, at least one of which is reasonable. The reasonable one is that they want the long-run behavior of the model to converge to an equilibrium. If, let's say, the long-run elasticity of imports with respect to income was anything but 1, the share of imports in consumption would rise without limit over time. I'm not sure how I feel about this. (Bad blogger!) On the one hand, it's obviously true that that imports or consumption relative to GDP, or the wage share, or relative prices among trading patterns, don't diverge to infinity. On the other hand, time doesn't pass to infinity either. The practical relevance of the long-run conditions is only for a period long enough that exogenous fluctuations have canceled out, yet short enough that the parameters of the model remain unchanged. It's not at all clear to me that the set of such periods is not empty. On the other hand, there may be reasons why postulating a long-run equilibrium is useful, even if we recognize that no such equilibrium is ever reached.
The other reason for the long-run restrictions is less defensible -- or, since really who cares about my opinion, let's say it's substantive rather than methodological. The model "combines short-term Keynesian-type dynamics with a consistent neoclassical supply-side in the long run." (Interestingly, mainstream macro has this in common with a major strand of Marxist economics, in contrast with the (post-)Keynesians who allow a role for demand even in the long run.) So some of the long-run restrictions are imposed not simply to get an equilibrium, but to get a particular, tastes-endowments-and-technology equilibrium. There's no reason in principle that practical macroeconomics should exclude the possibility of changes in real wages changing income shares in the long run. That the OECD does, tells you something.
On to the substance:
A couple interesting things here, which unlike the thumbsucking above, one can actually use. These are hardly gospel, of course; but enshrined in the OECD macro model they can be taken as stylized facts, in the sense that in many contexts they don't, qualitatively, have to be explicitly argued for.
1. Wealth effects (on consumption) are largest for the US, smallest for Japan.
2. The effect of import prices on the domestic price level is negligible in the US and Japan, but substantial in Europe.
3. Trade flows are much more responsive to income changes than to relative prices. Estimated export elasticities are two to three times higher for income than for "competitiveness" [3]; estimated import elasticities are two to four times higher.
4. US export prices move with domestic prices essentially one for one; US import prices move with foreign prices only slightly. For most other countries, export pass-through is lower and import pass-through is greater.
The last two are particularly interesting.
Eventually, one would like to think through the conceptual basis, and limits, of these sorts of models. There's that never-realized long-term. Meanwhile here in the short-term, when you're making heterodox arguments it's nice to get empirical backup from some place impeccably orthodox.
On form:
The equations comes in two flavors, long-term and short-term. Salient fact about the long-term ones is that most of them are imposed (singly or jointly) rather than estimated. For instance, the elasticities of consumption with respect to income and wealth are constrained to sum to one. The elasticity of employment with respect to real wages is constrained to be negative one. (Oh, that one makes me mad.) The elasticities of exports and imports with respect to their respective market sizes are constrained to be one. And so on. Meanwhile, the short-term (one- and two-year) equations are allowed to be determined by the data.
There's a couple reasons for this, at least one of which is reasonable. The reasonable one is that they want the long-run behavior of the model to converge to an equilibrium. If, let's say, the long-run elasticity of imports with respect to income was anything but 1, the share of imports in consumption would rise without limit over time. I'm not sure how I feel about this. (Bad blogger!) On the one hand, it's obviously true that that imports or consumption relative to GDP, or the wage share, or relative prices among trading patterns, don't diverge to infinity. On the other hand, time doesn't pass to infinity either. The practical relevance of the long-run conditions is only for a period long enough that exogenous fluctuations have canceled out, yet short enough that the parameters of the model remain unchanged. It's not at all clear to me that the set of such periods is not empty. On the other hand, there may be reasons why postulating a long-run equilibrium is useful, even if we recognize that no such equilibrium is ever reached.
The other reason for the long-run restrictions is less defensible -- or, since really who cares about my opinion, let's say it's substantive rather than methodological. The model "combines short-term Keynesian-type dynamics with a consistent neoclassical supply-side in the long run." (Interestingly, mainstream macro has this in common with a major strand of Marxist economics, in contrast with the (post-)Keynesians who allow a role for demand even in the long run.) So some of the long-run restrictions are imposed not simply to get an equilibrium, but to get a particular, tastes-endowments-and-technology equilibrium. There's no reason in principle that practical macroeconomics should exclude the possibility of changes in real wages changing income shares in the long run. That the OECD does, tells you something.
On to the substance:
A couple interesting things here, which unlike the thumbsucking above, one can actually use. These are hardly gospel, of course; but enshrined in the OECD macro model they can be taken as stylized facts, in the sense that in many contexts they don't, qualitatively, have to be explicitly argued for.
1. Wealth effects (on consumption) are largest for the US, smallest for Japan.
2. The effect of import prices on the domestic price level is negligible in the US and Japan, but substantial in Europe.
3. Trade flows are much more responsive to income changes than to relative prices. Estimated export elasticities are two to three times higher for income than for "competitiveness" [3]; estimated import elasticities are two to four times higher.
4. US export prices move with domestic prices essentially one for one; US import prices move with foreign prices only slightly. For most other countries, export pass-through is lower and import pass-through is greater.
The last two are particularly interesting.
Eventually, one would like to think through the conceptual basis, and limits, of these sorts of models. There's that never-realized long-term. Meanwhile here in the short-term, when you're making heterodox arguments it's nice to get empirical backup from some place impeccably orthodox.
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