Tyler Cowen has an excellent column suggesting that while the past thirty years has indeed been tough for the American middle class, it has also realized astonishing improvements in the living standards of the global poor. Primarily China, and to a lesser extent its neighbor India, have together brought hundreds of millions out of poverty and malnourishment. Surely this is more important than the stagnation of (an already extraordinarily high) income in the western world.

In any way you slice it, the world is becoming a more egalitarian place. Indeed, it is probably the single-fastest restructuring of international economic hierarchy in the modern era. China’s urban upper-middle class is effectively as well-off as America’s lower-middle class. There used to be a time, not so long ago, that the United States could boast it would be better to be born dirt poor here than with a silver spoon anywhere else.

Tyler posits the story as the tension amid between and within country inequality. And he at least implies the enlightened western mind should focus on the success of the former as at least an order of magnitude more important than the failure of the latter. I am not inclined to disagree.


The real story here is really not about inequality. It’s about living standards, and that tells us something about the futile conversation America has had on inequality within its own borders. For example, the research behind Tyler’s column, suggests that global Gini inequality did indeed fall: from 72.2 to 70.5.

Sure that’s something – especially given that North-South inequality had been increasing for the years before – but it’s certainly nothing incredible. Because two big things happened over that time: the international poor crawled into the middle class, and the global one percent pulled further away.

The former still dominates the latter, but the net effect is a lot less impressive. That can mean one of two things. Either the last thirty years have not been as amazing as everyone thinks, or a change in inequality is not the correct lens through which to view the transformation.

I don’t think anyone would go with the former. But this can be extended to the United States as well. I don’t pretend that inequality doesn’t matter, but the real question America has to deal with is an erosion of living standards at the fringes.

And many times these have nothing to do with economic inequality. For example, consider the incredible disutility caused by America’s racist, aggressive, expensive, and futile criminal justice system. Indeed, incarcerating millions of black people every year for smoking crack and pot, and forcing them into penal labor, isn’t pretty far from modern-day slavery.

Or what about the post-industrial ghost towns scattered across Appalachia where unemployed families bond over crystal meth? This contributes to inequality, but only analogously to the poor Indian farmer of 1980. That is to say, the more the only even remotely-sensible political platform in town (the Democratic Party – whether you want to accept it or not) keeps screaming about increasing taxes on the one percent by one percent, as a solution to everything from runaway deficits to inequality, those who are truly suffering miss out on any and all political representation.

America’s criminal justice system has been a heinous crime – and that is blatantly obvious to anyone with a heart – for over a decade. But it takes a libertarian and a man who lived in the Newark slums to do something about it. Democrats, the supposed party of opportunity and progress, have had basically nothing to say about the clearest cause of systematic suffering in the country.

And immigration reform is a close second, yet the party’s effective nominee has clearly hawkish views about sending kids who came into this country back to gang-ridden Central America.

They still have the audacity to claim they champion the poor man’s cause.

To the extent the narrow definition of inequality is the primary avenue to achieve this end, maybe they do. After all, Democrats have had basically nothing new to say about the subject than increasing the capital gains tax, and adding a new top rate at 40%. Or was it 50%?

It’s time that we started talking about living standards. And this may alleviate inequality in the long-run, but just like the reduction of the global Gini by 2 points, that won’t be the main story. Instead, over the next thirty years we’ll see an increasingly large share of the income go towards those the top quartile. And before we talk about taxing them more, let’s talk about how we want to spend that revenue most effectively in improving the broad welfare of the country.

Call be a tax-and-spend liberal, but let’s at least start talking about the “spend”.

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In Battle for Bretton Woods, Benn Steil is a storyteller first, economist second. But that doesn’t mean this intriguing account of the two men who made the international monetary world sacrifices on the tricky, technical implications thereof.

Following the tradition of Liaquat Ahmed’s wildly-successful Lords of Finance, Steil writes the financial history following the life of an economic great, John Maynard Keynes, and his rogue rival, Harry Dexter White.

For a book discussing the most important economic event of the century, Steil is working in a surprisingly uncompetitive market. There seem to be no other books aimed at a popular audience describing the brilliant exploits of this Soviet spy. It turns out that White – the American economist who taught not at Harvard or MIT but Appleton, Wisconsin – was Red. As Steil noted from his essays,

“Russia is the first instance of a socialist economy in action,” the bureaucrat wrote in an unpublished essay that Mr. Steil discovered in White’s papers. “And it works!”

But perhaps what sets White apart from his undercover counterparts is, we learn, his zeal to secure unquestionable American dominance in the new world order. By any measure, the debate between the two men was hardly ideological. Indeed the ultimate result largely matched the expectations of both parties – discouragement of competitive devaluations, stability in exchange rates, control of cross-border capital flows nestled in the spirit of never-before-seen international cooperation in economic affairs.

Rather, the differences derived entirely from the relative position of an emerging behemoth to a fading empire decades past its prime. Where Britishers wanted to think, until the last minute, that Bretton Woods was a landmark conference between two great equals, the Americans saw it as a way to end British dominance forever.

Maybe the most fascinating part of the book, especially for someone of Indian-descent, is the extent to which the socialists in FDR’s administration advanced the anti-colonialist cause, dismantling imperial preference and hence empire itself.

Steil recounts this drama as the magical coincidence of far left and far right. On the one hand, the State department was filled with hardcore free marketers that wanted a world without any tariffs or subsidies, something at odds with imperial preference (which in effect provided Britain’s otherwise uncompetitive exporters captive demand). On the other hand, the socialists advising FDR (not the least White himself) saw the British empire as a grotesque invasion of national sovereignty and axiomatically hated imperialism.

I was always taught that the Americans, despite their lip service towards democracy, always did too little, too late when it came to expediting the end of European Colonialism. While White’s role does not definitively challenge this, it does provide evidence that the Americans went well out of their way by ending a system that would cripple Britain and only benefit American exporters modestly at best.

The central debate between White and Keynes concerned the relationship between creditor and debtor nations, and the role of the American dollar. While Keynes wanted a system that placed the burden of responsibility on creditors to sap their trade surplus, White insisted on a less forgiving system that wouldn’t require very accommodative monetary policy. This is where the latter question comes in: Keynes advocated for the creation of an international reserve currency that would help deficit countries to settle their balances, the bancor, with an elastic supply from a fund towards which all countries would contribute, splitting the austerity between creditor and debtor nations. White, instead, wanted a system where all countries were pegged to the dollar at a fair rate and only the dollar would be convertible to gold, in which debtor countries may only obtain a limited loan from an international fund (the IMF), and where debtor countries may devalue their currencies only 10% (and another 10% if needed). White won the day.

Thus was born the gold-exchange standard where foreign currencies were pegged to the dollar which in turn was convertible to gold to qualified parters (as opposed to the classical standard where all currencies were convertible at any time, by anyone).

As promised, the economics is less interesting than the intrigue thereof, and Steil does a wonderful job telling the tale of deceit and drama that wrought Bretton Woods. We learn of the carefully orchestrated conference agenda in which Keynes was relegated to the debate of a relatively irrelevant institution (the World Bank) while White carefully controlled the creation of the Fund.

The timing of this book couldn’t be better. We are today living through the logical conclusion of a system that was bound to break. As the sole producer of an international reserve currency, it became necessary for the United States to run persistent trade deficits to ensure adequate supply of liquidity abroad. However, the fixed exchange rate system exported American monetary policy, and hence inflation, abroad. The mad irony then is that America is today the world’s largest debtor, a paradox otherwise known as the Triffin dilemma.

Published earlier this year is Eswar Prasad’s The Dollar Trap which discusses the impossibility of a dollar standard in a world with free capital flows, but the lack of any viable alternative. The irony comes from the fact that both official and unofficial American attitudes towards the situation echo Keynes, not White (again reflecting its relative position in the world).

More than anything else, Steil paints the picture of a rich intellectual, nationalistic, and ideological drama between a technocrat and an economist that set the tides for economic policy in the twentieth century. It was economists more than army generals or foreign diplomats that defined geopolitics. This is a trend that continues to this day. Indeed, whereas American-led peace talks secured by the Security Council may seem like a century-old anachronism, the international affairs office of the Treasury department continues to be an exceedingly important component of our foreign policy.

And, people don’t even know about it. When Ben Bernanke opened American credit lines of over half a trillion dollars to a select-few countries and rebuked the requests of others, he arguably made more important geopolitical decisions than Hillary Clinton ever did as Secretary of State. Indeed, the Indonesian Prime Minister once even personally requested Clinton to open a swap line between its reserve bank and the Fed. Unfortunately, that’s not a question over which she much control.

As we move towards a G-Zero world, as international relations superstar Ian Bremmer likes to call it, the United States dollar still represents an overwhelming majority of foreign exchange transactions and is the primary reserve currency. To this end, American monetary policy is exported worldwide and will continue to create dramatic tensions with other countries.

Battle for Bretton Woods is first an epic story (even for those with little interest in economics). But it’s also a reminder how economic policy dominates geopolitics.

I don’t think Paul Krugman is very convincing in his argument that repeated calls for higher interest rates derive from class interest:

You’re living in a fantasy world if you don’t think this has something to do with the diatribes against currency debasement and all that.

Krugman’s argument is simple, and fair at first approximation: the rich earn a disproportionate share of their income from interest-bearing assets and have the most to loose from “artificially low” interest rates.

Similarly, to the extent low interest rates create inflationary pressures, the rich have more to loose given a net surplus position in nominal assets. However, as I remember the story, the economists making this argument made a fundamental error in assuming simple asset swaps (i.e. QE) could somehow cause hyperinflation. Arguing against hyperinflation may be a straw man, but it’s still a fair worry (for rich and poor alike). I don’t think you had many rich people militate in favor of deflation.

But that’s not the most puzzling part of this argument. A side-effect of the Fed’s stimulus have been elevated asset prices. There’s no voodoo behind this: the price of an asset is the discounted value of its future cash flows, and this necessarily increases as the interest rate falls. Since the rich own a disproportionate share of real assets across the country – primarily real estate and equities – they stand to benefit from this program. Indeed the stock market has been setting record highs for the past few years.

Krugman’s tandem argument that high interest rates/low inflation portend a redistribution from the young to the old is also tenuous. (Sure, if there was a long-term increase in expectations this would act like a one-off capital levy. But that hasn’t been the case.) Note that wealth is just a claim on future income, and since Fed policy has increased asset prices and therefore P/E ratios, capital gains will fall in the future, ceteris paribus. To think about it another way, the Fed has moved future returns into the present to stimulate consumption. Or, equivalently, low interest rates increase asset prices redistributing consumption from the future to the present. (Or young to the old, contra Krugman).

Magnitudes matter. Nothing Krugman is saying is inherently false, but seems to be guided more by intuition than data. I’m just pointing out a number of other effects. His primary source indicates that the ratio of interest-bearing income to debt increases as we move up the income distribution. But even at the latter end, debt is twice as important. Krugman is probably right that were the last group to be spliced further, those at the tippy-top may have more even portfolios.

But at the tippy-top you also have a diverse group of people without homogenous incentives. For example, the private equity industry has made a killing financing large, leveraged buyouts at throwaway prices. This similarly stimulates demand for mergers and acquisitions which is one of the few profit centers left for investment banks. These people surely fall among the rich.

On this note, observe that to the extent the data Krugman presents holds to any significant magnitude, we’re talking about 0.01% of the population. Sure, class interests matter for this group, but more effective avenues (even if low interest rates were a huge problem for them) would include lobbying for specific subsidies and tax breaks, which actually works, rather than have discredited economists spill ink in the Wall Street Journal.

Another overlooked consideration is that the United States is somewhat unique. Despite a large current account deficit and soaring obligations, we earn more in foreign income than foreigners earn here. And in fact, the ratio of GNP/GDP has only been increasing. This derives from a large long position by (rich) American investors in emerging markets. To the extent the the dollar is debased (something Krugman suggests the rich are very worried about), the US claim on the rest of the world’s future income increases. (And, conversely, foreign reserves across the world would plummet).

None of this is to say that any of the noisemakers clamoring about money printing and debasement are right. I’m just suggesting that class interest may not be nearly as relevant as Krugman suggests. Occam’s Razor would demand a simpler explanation: these people are simply ignorant or want to sound serious.

But hey, which one percenter among us hasn’t dumped our net worth into the money market.

David Leonhardt at the Upshot suggests (in other words) the only hope Republicans have is that kids today will be too young to remember George Bush. While it is definitely true that 2008 was an anomalously liberal moment – the unlikely marriage of epic crisis with election – there isn’t much reason to believe today’s youth will forget the failure of movement conservatism as they age and that, indeed, the uneasy of the Obama era will weigh heavier than the tragedy of the Bush era.

Consider a primary argument about the time in which kids come of age:

To Americans in their 20s and early 30s — the so-called millennials — many of these problems have their roots in George W. Bush’s presidency. But think about people who were born in 1998, the youngest eligible voters in the next presidential election. They are too young to remember much about the Bush years or the excitement surrounding the first Obama presidential campaign. They instead are coming of age with a Democratic president who often seems unable to fix the world’s problems.

Which purportedly mirrors the eighties:

But the temporary nature of the 1960s should serve as a reminder that politics change. What seems permanent can become fleeting. And the Democratic Party, for all its strengths among Americans under 40, has some serious vulnerabilities, too.

There’s a big difference between the 1960s and 2010s that is obscured when we think about politics independent from policy. In 60s and 70s problems that loomed large included indomitable inflation, rapidly increasing crime across many major cities, a decisive failure of economic micromanagement, an international oil crisis, fall of the Bretton Woods monetary system, and with it persistent trade and budget deficits.

And while liberals would eventually be able to combat many of these issues, they were wholly unprepared at the time. Indeed, the dominating economist-cum-public intellectual of the day was Milton Friedman. Of course, the snake oil supply-side salesman couldn’t deliver an inch of what they promised, and even though the conservative solution failed, it is fair to say that it was the problem for conservatives.

Today’s most prominent problems include thirty years of stagnant income for those at the bottom and with it soaring inequality, incredibly daunting questions of environmental and ecological sustainability, persistently high unemployment, a shortage of skills due to an ailing education system, declining mobility (economically and physically), a low savings rate for a sound retirement, and declining benefits across the board. And in the background lies a supply-side endowment keeping energy affordable, decades of deregulation, an improving trade balance, historically low crime (and mass incarceration), and very low inflation. The supply-siders got what they came for. And, to top it all, today’s most prominent economist-cum-public intellectual is Paul Krugman.

There is certainly debate between liberals and conservatives about ways to deal with today’s issue and the point of this post isn’t to convince you that we (liberals) have the answer to the looming questions of the day. But without question the Obama presidency wasn’t a blip when the problems of the day, as even conservatives would cede, are liberal in nature.

That is to say that while fundamentally conservative principles like smaller government and cultural-familial values might be the answer, they are not the apparent answer. Instead, the biggest threats of the day at first site require a formidable degree of collective action, indeed probably to the level the world has never seen before. Here are some things we have to deal with, in no particular order of severity:

  • A monetary system that doesn’t lead to the necessary imbalances of today’s dollar standard.
  • Education of a student body that is behind the world on many measures.
  • Solvency of entitlement-institutions that both parties agree are here to stay but only one has an a way to actually pay for it.
  • Mass incarceration.
  • Unstable financial institutions that can quickly move capital across borders.
  • Nuclear weapons.
  • Rising inequality (which, game theoretically, will at least require some form of bilateral side payment to ensure revolution is not the dominant strategy for the poor).
  • Last, and about the opposite of least, climate change that threatens every aspect of the way we live requiring not just national, but international, coordination of the finest sort.

This is a liberal problem.

And to say that young Americans will forget the lies and human tragedy of the Bush administration, filled with scoundrels of the first order, is hopefully a joke. Because Americans just a few years older remember the 90s with a sort of nostalgia that Bill Clinton probably does not deserve, but receives anyway. Cultural memory is a fickle thing, but with neocons dying all over (and this will be literal soon enough) it doesn’t look like America has forgiven George Bush.

There are ways the Republican party can fix itself. But let Rand Paul win the primary before the party talks about appealing to anyone not asking their doctor about Botox.


The National Association for Business Economics recently published Larry Summers’ remarks on secular stagnation earlier this year. The conversation picked up after his speech at the IMF conference last year, though has been floating around for some time. Excluding gloomy prognostications from Alvin Hanson in the 1930s, I can trace back the idea that the US has fallen into a secular trap back to Paul Krugman at the Munk Debates in 2011.

Though Summers is seen today as the ringleader of the stagnationistas, Krugman’s formidable opponent was none other than Larry Summers. Summers has since undergone, as I’ve documented before, a remarkable intellectual evolution making very similar claims to Krugman in 2011. While even the chance of a somewhat permanent slump is sobering, there are reasons to doubt both the theory and evidence behind this claim.

Let’s start with the labor force. Summers is understandably unhappy about the recent decline in participation rate. He controls for demographic factors by looking only at working age (25-54 yo.) men which should account for an older population and students staying in school longer:

But that is not the largest part of the story. Even if one looks at 25-to-54 year-old men, a group where  there is perhaps the least ambiguity because there is the greatest societal expectation of work, Figure 3 shows that the employment/population ratio declined sharply during the downturn, and only a small portion of that decrease has been recovered since that time. The recovery has not represented a return to potential; and, according to the best estimates we have, the downturn has cast a substantial shadow on the economy’s future potential.

With the graph:



While there is certainly a sense in which this has not recovered to trend level, there is also an argument that the crash just accelerated an already fermenting labor force. While Summers argues this is due to features of the recovery, and not structural or technological issues, the data may suggest otherwise:


For example, the graph above demonstrates that the rough participation rate of those with a college degree or higher fluctuates within a very narrow band and has, if anything, continued on an increasing trend. This militates in favor of a skills-biased technological change hypothesis which is inconsistent with secular stagnation (of output at least).

The evidence is stronger still. Take these two charts from JP Morgan:

lfpr lfpr2

Discouraged workers are peripheral to the question of labor force participation. Nor is “working age men” the representative statistic it once was, as Summers analysis makes it out to be. If anything, females are obtaining college degrees at higher rates and are employable in a wide array of increasingly-important occupations, prominently healthcare and education. Traditionally male fields, on the other hand, are in largely tradable sectors and probably not coming back. This has worrisome implications for the distribution of income and the underlying social structure itself. And we should do something about that. But robots and cheap, Chinese goods are anything but “secular stagnation”.

This brings us to our next point:

Third, changes in the distribution of income, both between labor income and capital income and between those with more wealth and those with less, have operated to raise the propensity to save, as have increases in corporate-retained earnings. These phe- nomena are shown in Figures 9 and 10. An increase in inequality and the capital income share operate to increase the level of savings. Reduced investment demand and increased propensity to save operate in the direction of a lower equilibrium real interest rate.

This sounds good in theory, but in reality the very period over which income inequality has increased the most, total savings rates have fallen precipitously:


Gross private saving is the broadest measure of saving and accounts for increased savings in the form of corporate profits. Government saving, to nobody’s surprise, has also fallen over this period. While richer people most certainly do have a lower propensity to consume, the magnitude of this effect is clearly dwarfed by forces like the Asian saving glut and potentially overvalued dollar. Luxury markets are booming: and it may not be to a good liberal’s taste, but demand for chauffeurs and butlers creates employment just like that for apparel and electronics. Indeed, to the extent richer people consume at the margin on non-tradable services, the leakage is also lower.

But Summers’ grander point here remains: real interest rates have been on a secular decline. This strikes at what may be the heart of the problem: low investment demand. While low equilibrium interest rates have other problems, like increasing the risk of a liquidity trap, the structural impact isn’t necessarily felt in investment. The interest-rate elasticity of investment has always been tough to measure and Treasury yields may not be the best gauge: lets look at the corporate bond market once yields start to diverge. This isn’t too important (yet).

Rather, advanced economies currently function on what Paul Krugman has called a “bicycle model”. Firms invest on the expectation of higher returns in the future due to economic growth. The accelerator model of output, therefore, frames investment demand as a function of long-run potential growth. When this expectation falls, so does investment. In other words growth is necessary for growth. If long-run growth expectations fall substantially the US is by the principle of recursion screwed. But the bicycle doesn’t have to fall if we transition to a steadier, consumption driven model. And that’s just what we’ve been doing:


So long as we’re able to keep consumption growth to meet a lower steady-state investment rate, the economy won’t self-implode (though, definition, will grow slower). Given that the largest projected increases in future private and public spending come from education, healthcare, and a geriatric economy this transition will be rather easy for the United States to make. (Not to mention the ample space for public investment, something I know Summers is on total board with).

However, we should still be uncertain about the extent to which potential growth has fallen. As Summers notes:

Ponder that the leading technological companies of this age—I think, for example, of Apple and Google— find themselves swimming in cash and facing the challenge of what to do with a very large cash hoard. Ponder the fact that WhatsApp has a greater market value than Sony, with next to no capital investment required to achieve it. Ponder the fact that it used to require tens of millions of dollars to start a significant new venture, and significant new ventures today are seeded with hundreds of thousands of dollars. All of this means reduced demand for investment, with con- sequences for equilibrium levels of interest rates.

It is valuable here to think in terms of inputs and outputs. We need less “debt” to achieve a similar valuation that once required tons of borrowing. What Summers is describing is technological, if not economic, progress. Indeed the interest-rate elasticity of demand has probably fallen, but only in a small segment of the economy. I’ve written about this in some detail before:


While he’s right that there are secular trends toward cheaper capital, I’m not sure we can attribute much of that to the information technology era. Even granting that the magnitude of technology is substantial, something I’ll get back to in a minute, it’s important to explore the consequences. I would argue that the information era doesn’t reduce the demand for investment, as Summers proposes, as much as the interest rate elasticity of demand – that is to say firms are less sensitive to changes in the cost of capital. The reason isn’t obvious. Interest rates matter a lot for long-term, capacity building investments—like opening a huge new factory. But software is usually rented on a monthly basis from the firm’s own cash—so interest rates matter a lot less. (Reduced demand and reduced need mean the same thing in English, but not economese).

But that’s coming from the same cash pile Summers is talking about—and it’s still investment. In general it’s not that there’s a lot less investment as much as the factors that affect its demand are changing. This is where we get back to magnitudes. Take a look at software’s share of total private investment:


There are two stories here. One, in sheer magnitude, software (the blue line) is still only 15 percent of private investment and not significantly higher than points in the past two decades when interest rates were a lot higher. On the other hand, residential investment as a share of private investment, hasn’t changed much in structure since the mid-’60s and is still very sensitive to changes in the interest rate.

The point here is that while WhatsApp didn’t need any real investment, a lot of the economy does, and as sexy as Silicon Valley is, main street America is not irrelevant. There’s another point here, and I’d file it under, as Scott Sumner might say, “never reason from a price change.” The Silicon Valley story tells us that the returns on very small investments can be huge and, under competitive markets, this would imply that the marginal return on capital is falling rapidly after a certain level. However, that isn’t consistent with the broad increase in capital’s share of income we’ve noticed over the past decade or so. In a simple (but empirically powerful) Cobb-Douglas production function, the exponent on capital is its share of total income, and the higher the exponent, the larger the marginal product at any given point (other things equal).

Of course, other things are never equal, and that’s Sumner’s point.

Summers is right, that to the extent software is significant, there are important implications for the equilibrium interest rate. As the elasticity falls (that is, as the demand curve becomes more vertical) changes in the supply of loanable funds will be felt entirely through interest rate adjustment. So an increase in supply has a lot more potential to keep the economy under a low interest rate environment than before.

Ultimately, this is all pretty speculative. Calculating the importance of interest rates, as an empirical phenomenon, is notoriously difficult (studies disagree, for example, on whether higher interest rates even increase savings)—and observing shifts in the shape of the determining curves is harder still. While interest rates are low for a number of reasons, technology per se may not be one.

The practical point here is that since long-term interest rates are what drive the kind of investment Summers says is dwindling, it’s ever more incumbent that the Fed doesn’t let the term premium on long bonds rise too much. That is, keep quantitative easing hard.


Lower interest rates and interest-rate elasticity of demand pose a real threat to the current model of monetary policymaking. These are good arguments for a slightly higher inflation target.

But maybe the most important problem with secular stagnation is the cyclical recovery, which to some extent are mutually exclusive. While the economy is still really tough for those at the bottom, there are signs of life with increasing quits, inflation, and pressure in the market in general. There’s a lot more we can and should be doing, but these should perhaps be considered for redistributive and supply-side – rather than purely demand-side – reasons.

Of course, until we do get consistently sufficient inflation, demand is still lacking. The question is whether that seems impossible, and I think it would be difficult to answer in the affirmative. Unfortunately, my post has none of the optimism with which Larry Summers and Ian Bremmer challenged Paul Krugman in the Munk Debate. The Depression was the last time we were in such a bad position. As horrific as that was, it was no secular stagnation.

It may not be an overstatement to call Atif Mian and Amir Sufi’s new book the most important economic read this side of the year. Unlike the other two famous and/or acclaimed economics books recently released, The House of Debt is concise and incisively to the point (unlike, I realize, the phrase I just used). Mian and Sufi’s principal charge is that while fiscal, monetary, and financial drama – the stimulus, quantitative easing, and bank bailouts respectively – may have played an important role, they are each subordinate to what has really held recovery back: household debt.

Using granular microeconomic data, Mian and Sufi show that the economy was sputtering well-before financial Armageddon in fall 2007, conclusively invalidating the nonsense view that had we saved Lehman, all would be right with the world. In addition to pages of empirical data proving this claim, the book provides two things:

  1. A levered-loss framework (if not full theory) of business cycles. Since debtors are generally poorer – and almost always liquidity-constrained – falling wealth results in a much more concentrated fall in spending than in a less leveraged economy.
  2. The sketch for a better housing policy through what they call “shared responsibility mortgages” (SRMs for short) which provide downside protection to homeowners, resembling an equity-like claim on the house.

There are several problems with this argument. The book has (rightfully) received critical-acclaim in the liberal blogosphere, and I would like to raise a few questions the book avoided: from least severe to most.

They fall in the same trap I think a number of other critics of bank bailouts fall. Mian and Sufi concede that large-scaled intervention was necessary, but nothing beyond what might be justified by the “Bagehot principle”, in other words that the Fed as lender-of-las-resort should “lend freely at a penalty rate on collateral that would be acceptable in good times”. In its plainest form, this would imply that the Fed should open its discount window and lend to any solvent bank. The problem rests in the last two words.

When a bank is forced to sell its long-term debt immediately to finance its short-term commitments, thereby depressing the value of said assets, the distinction between liquidity and solvency becomes ambiguous. Moreover, the focus of government bailouts were not traditional banks, but other financial institutions that facilitated money market financing of capital market borrowing (i.e. funds that issued bank-like promises backed by commercial paper).

These certainly do not provide the same “main street” value as a traditional bank, but as financial disintermediation increased they played two roles that you may use to define a bank itself: maturity transformation and real lending. In the heart of financial crisis, it makes more sense to provide the liquidity as necessary and regulate these institutions as banks later (in fact, the first money market fund, the Reserve Primary Fund, was formed specifically to evade government-caps on interest rates paid by depository institutions).

More importantly, it is not clear that the extent to which the government provided anything more than liquidity. The most clearly insolvent institution – Lehman – was let go, and the government earned ultimately earned a profit. Marking to market on an institution that transforms maturity during a time of low liquidity is unnecessary.

The next quibble is philosophical. A number of times Mian and Sufi are disdainful of the bailouts because they benefitted those who fell squarely on the right-tail. This is a utilitarian problem, for clear reasons, but also an economic one: in the levered-loss framework increasing the income of bankers is not very helpful. But this is predicated on the assumption that bank bailouts came at the opportunity cost of homeowner relief. Except the government was not capital or liquidity constrained (if anything investors were begging the government to hold their money) – rather, the trouble was political. While high spending on one relief program certainly reduces public appetite for another, the relationship is nowhere near one-to-one. As Mian and Sufi note, bankers had a much stronger lobby than homeowners – so one did not prevent the other.

To the extent there were any distributional concerns, it is the tax system – and only the tax system – that should be responsible. In the same vein as many economists oppose minimum wage as a method of redistribution, neglecting banks of necessary liquidity during the crisis for concerns of equity is short-sighted. Rich people, a group within which bankers certainly rule, may have an unfair share of national income: and to that end they ought to be taxed at a higher rate.

Similarly, the argument for debt relief is strong, but in the House of Debt, it rests too strongly on distributional concerns. Since there is, as the authors themselves note, a very strong correlation between those with high debt and those with low income, targeted stimulus would benefit from a levered-loss multiplier as well. Sure, they don’t insist that recipients pay their debt back down, but the immediate stimulus would have been similar.

I also wish the book considered the very role of debt in recent economic growth a little more. While there is certainly a compelling case that debt fueled an unnecessarily sharp boom-bust cycle, recent concerns – voiced most prominently by Larry Summers and Paul Krugman – surrounding the necessity of debt for any growth at all are important. Note that despite large borrowing collateralized on home equity, the post-Clinton middle-class grew at an anemic pace. Without leverage, living standards would have stagnated and falling investment and growth potential, the accelerator effect would have resulted in slower growth still.

This is all to say that variance of income, while non-desirable, is of secondary importance to the mean itself: and explaining why debt caused the crash without acknowledging explicitly it also financed the boom is unsatisfying. (This is no fault of Mian or Sufi – just an question for commentators in general). Of course, the crisis as an event redistributed wealth decisively away from the poor, and that is certainly a detrimental effect. But the world without debt in the last ten years would also have been one without growth and inflation, at least some smart people argue, and that cannot be ignored. (Just think about the employment created by construction and consumption of durables, many from non-tradable sectors).

My final concern is with the viability and unique necessity of a rather complex policy solution, the SRM which would force creditors to take a haircut in the case of falling prices in return for part of realized capital gains. Real estate is a far less lucrative investment than the stock and bond markets, and the poor already hold an inefficiently large portion of their wealth in this form. The SRM would only exacerbate this problem, further reducing the long-run returns for this group. More importantly, the SRM faces problems of adverse selection. Those who know they can pay back their debt, and careful enough not to leverage themselves too much versus future income (in other words, the affluent) would have no reason to take an SRM: they would much rather finance their house via debt (largely risk-free for them) and put everything else in the stock market. This would leave riskier borrowers in the pool for an SRM, naturally increasing the risk premium. The argument holds in much more force for the other suggestion of student loans that require a percent of future income as payment. Of course, debt-financed home ownership is a huge burden on economic growth. And the answer isn’t equity-financed home ownership. It’s less home ownership.

The brings great empirical evidence in favor of a compelling argument to the layman. The theory is far from settled, and has been debated for at least half a century, when James Tobin took a stab at the Pigou Effect – which argued recessions are self-correcting as deflation increases the real value of debt – noting that “debtors are debtors because they have high propensities to spend”.

I decided to take the easy route and read Stress Test before Piketty. The story of this book is particularly important to me. I came of age in the throes of financial crisis. I was just starting high school the fall that Lehman Brothers fell. I was somewhat (though not very) precocious and could feel the current of the time around me, but had neither the motivation nor sophistication to really understand everything that was taking place. In fact, I would remain an economic muggle through much of the European crisis, and maybe it was the summer of “whatever it takes” when I finally started reading more carefully.

This is all to say that while of course I knew many theories of all that went wrong by reading reflections in retrospect, I was largely starved of any overarching narrative of the crisis itself. And yet it was largely what thrust me towards economics to begin with and, at least in that sense, Geithner paints a great picture of the war against financial panic.

It was a book that was a little too long. The theme of the book pits Geithner and other weary veterans of previous emerging market crises in a war against the “moral hazard fundamentalists”. The bailouts were of course a public relations debacle, though Geithner makes as compelling a case as is possible in their favor.

Geithner had the misfortune of releasing his book simultaneously with Amir Sufi and Atif Mian’s masterpiece on household debt which fairly thoroughly debunks Geithner’s claim that household relief wouldn’t have made a big difference. (He considered liquidity, not solvency, to be the central issue).

However, many of the critical reviews of Stress Test have unfairly pointed to House of Debt as some sort of counterpoint. While it certainly is, the strength of Geithner’s argument lies in the counterfactual – what would have happened if we let the financial system burn down – that no one seems to address.

Geithner certainly has history on his side when noting that far more benign banking crises have caused far more pain when confidence is missing. And, indeed, expectations are everything – putting cash in the window makes depositors less worried about taking it out now.

The really damning part of Stress Test is its total disregard for monetary policy. In the sprawling seven hundred pages, there wasn’t even one fully devoted to understanding the importance of the Fed in stabilizing not just the financial system but stimulating the economy. Geithner admits that Obama almost always heeded his advice, which makes Geithner’s own apathy towards the economics, not just finance, of the Fed that much more astonishing.

The long unfilled vacancies and a bias towards bubble-bursters rather than economy-growers really redoubles the view that the Obama administration neither knew nor cared about monetary policy beyond as an immediate bandaid for Wall Street. I’m not sure what the lesson here is, but I think it militates in favor of more academic expertise within high politics. While finance is certainly well-represented, the Federal Reserve’s goal goes beyond financial stability, and no one in the administration seemed to realize this.

Ultimately, unlike Sufi and Mian, Geithner is unable to provide a theoretical justification behind his policy action as so much of it is predicated on huge counterfactuals. The many reviewers out there criticizing Geithner for not writing-off underwater mortgages better ask themselves whether that would be enough to undo an unraveling of the world’s largest financial center.


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