Matt Nolan

Borrowing, expectations, and potential output

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Over at EconoSpeak they have attacked Kevin Hassett on his call that the US government should run a balanced budget (ht Economist’s View).

Now, although I don’t necessarily agree with Kevin Hassett’s prescriptions, I can understand his feeling that the “paradox of thrift” argument for more government spending seems a bit strange in the case where public and private debt are elevated.

Fundamentally, I believe that all the debate stems from different peoples view of “the natural rate of output”.

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Matt Nolan

Is this all a rational reaction to falling household wealth

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House prices in New Zealand have fallen 6.8% on a year earlier according toe QVNZ (for November). Given that inflation was running at somewhere around 4% during this time this implies that the real value of houses has fallen by around 11%.

Now, prior to the recent crisis, households based decisions on the (wrong) assumption that house prices would continue to appreciate. As a result, relative to what has happened, household have “over-borrowed”. The sharp pullback in consumption is their rational response to the sharp decline in households expected lifetime wealth.

This is consistent with David Rosenberg’s view of what is happening in the US economy. (here is a version of the report)

If this is the primary factor behind the sharp drop in economic activity then this implies two things:

  1. We can expect further drops in consumption as house prices moderate over 2009,
  2. This household rebalancing process has to occur (unless we expect expectations of household wealth to overshoot on the downside) and so there is nothing that the government can do to help us.

Thoughts?

Matt Nolan

Branding too big to fail: TBTF

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Too big to fail has to be one of the “catch phrases” of 2008.  Catch phrases often deserve some fan art – however, over 2008 I didn’t see any.

The Minneapolis Fed obviously felt that fan art was necessary – which lead to this banner (ht CPW):

Excellent.  The related post is here.  In it, they discuss how to identify and quantify the issue in the future – so Fed action does not appear so “ad hoc”.

Matt Nolan

Is the US overestimating its “potential”?

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Over in the good old US the Congressional Budget Office has released their forecasts (ht Paul Krugman). It is an ugly sight, as would be expected, with growth falling miles below its “potential” level and a large negative output gap opening up.

As Paul Krugman points out, this type of large output gap would provide massive deflationary pressure – he suggests that we could have a deflation rate of between 3-5%!

Now, I’m sure his logic is spot on given this estimate of potential output – however this raises a question for me, has potential been forecast correctly? Generally, growth in potential output is forecast to be relatively stable – and trends along with historic growth. But this doesn’t feel quite right. There are two reasons why this may fail:

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Matt Nolan

Cars and inventories

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Chrysler has shut down production for a month, while Ford and GM have cut back substantially.  Some people feel that this is a disaster – and that it indicates we need government intervention, and fast!

But I’m confused.  Car inventories are at record high levels, and demand for cars is very poor – as a result, doesn’t it make sense to reduce the number of cars we produce?  Why should the government intervene to get industry to keep producing something people don’t want – I am very confused about this.

If anything, the decision to cut back production tells me that these firms are reacting sensibly to a drop in demand – why would we want to spoil their reaction to market signals?

Matt Nolan

A question: Why are low rates having a bigger impact on the housing market here than in the US?

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Today when I was peeking across a number of economics blogs, I noticed a post from the Rates Blog on the NZ housing market, and a post on the Big Picture on the US housing market.

They both had graphs for housing loan approvals:

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