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October 18, 2013
Why Was the Housing-Price Collapse So Painful? (And Why Is It Still?)
Foresight about the disaster to come was not the primary reason this year’s Nobel Prize in economics went to Robert Shiller (jointly with Eugene Fama and Lars Hansen). But Professor Shiller’s early claim that a housing-price bubble was full on, and his prediction that trouble was a-comin’, is arguably the primary source of his claim to fame in the public sphere.
Several years down the road, the causes and effects of the housing-price run-up, collapse, and ensuing financial crisis are still under the microscope. Consider, for example, this opinion by Dean Baker, co-director of the Center for Economic and Policy Research:
...the downturn is not primarily a “financial crisis.” The story of the downturn is a simple story of a collapsed housing bubble. The $8 trillion housing bubble was driving demand in the U.S. economy in the last decade until it collapsed in 2007. When the bubble burst we lost more than 4 percentage points of GDP worth of demand due to a plunge in residential construction. We lost roughly the same amount of demand due to a falloff in consumption associated with the disappearance of $8 trillion in housing wealth.
The collapse of the bubble created a hole in annual demand equal to 8 percent of GDP, which would be $1.3 trillion in today’s economy. The central problem facing the U.S., the euro zone, and the U.K. was finding ways to fill this hole.
In part, Baker’s post relates to an ongoing pundit catfight, which Baker himself concedes is fairly uninteresting. As he says, “What matters is the underlying issues of economic policy.” Agreed, and in that light I am skeptical about dismissing the centrality of the financial crisis to the story of the downturn and, perhaps more important, to the tepid recovery that has followed.
Interpreting what Baker has in mind is important, so let me start there. I have not scoured Baker’s writings for pithy hyperlinks, but I assume that his statement cited above does not deny that the immediate post-Lehman period is best characterized as a period of panic leading to severe stress in financial markets. What I read is his assertion that the basic problem—perhaps outside the crisis period in late 2008—is a rather plain-vanilla drop in wealth that has dramatically suppressed consumer demand, and with it economic growth. An assertion that the decline in wealth is what led us into the recession, is what accounts for the depth and duration of the recession, and is what’s responsible for the shallow recovery since.
With respect to the pace of recovery, evidence supports the proposition that financial crises without housing busts are not so unique—or if they are, the data tend to associate financial-related downturns with stronger-than-average recoveries. Mike Bordo and Joe Haubrich, respectively from Rutgers University and the Federal Reserve Bank of Cleveland, argue that the historical record of U.S. recessions leads us to view housing and the pace of residential investment as the key to whether tepid recoveries will follow sharp recessions:
Our analysis of the data shows that steep expansions tend to follow deep contractions, though this depends heavily on when the recovery is measured. In contrast to much conventional wisdom, the stylized fact that deep contractions breed strong recoveries is particularly true when there is a financial crisis. In fact, on average, it is cycles without a financial crisis that show the weakest relation between contraction depth and recovery strength. For many configurations, the evidence for a robust bounce-back is stronger for cycles with financial crises than those without...
Our results also suggest that a sizeable fraction of the shortfall of the present recovery from the average experience of recoveries after deep recessions is due to the collapse of residential investment.
From here, however, it gets trickier to reach conclusions about why changes in housing values are so important.
Simply put, why should there be a “wealth effect” at all? If the price of my house falls and I suffer a capital loss, I do in fact feel less wealthy. But all potential buyers of my house just gained the opportunity to obtain my house at a lower price. For them, the implied wealth gain is the same as my loss. If buyers and sellers essentially behave the same way, why should there be a large impact on consumption? *
I think this notion quickly leads you to the thought there is something fundamentally special about housing assets and that this special role relates to credit markets and finance. This angle is clearly articulated in these passages from a Bloomberg piece earlier in the year, one of a spate of articles in the spring about why rapidly recovering house prices were apparently not driving the recovery into a higher gear:
The wealth effect from rising house prices may not be as effective as it once was in spurring the U.S. economy...
The wealth effect “is much smaller,” said Amir Sufi, professor of finance at the University of Chicago Booth School of Business. Sufi, who participated in last year’s central-bank conference at Jackson Hole, Wyoming, reckons that each dollar increase in housing wealth may yield as little as an extra cent in spending. That compares with a 3-to-5-cent estimate by economists prior to the recession.
Many homeowners are finding they can’t refinance their mortgages because banks have tightened credit conditions so much they’re not eligible for new loans. Most who can refinance are opting not to withdraw equity after the first nationwide decline in house prices since the Great Depression reminded them home values can fall as well as rise...
Others are finding it difficult to refinance because credit has become a lot harder to come by. And that situation could worsen as banks respond to stepped-up government oversight.
“Credit is going to get tighter before it gets easier,” said David Stevens, president and chief executive officer of the Washington-based Mortgage Bankers Association...
“Households that have been through foreclosure or have underwater mortgages or are otherwise credit-constrained are less able than other households to take advantage” of low interest rates, Fed Governor Sarah Bloom Raskin said in an April 18 speech in New York.
(I should note that Sufi et al. previously delved into the relationship between household balance sheets and the economic downturn here.)
A more systematic take comes from the Federal Reserve Board’s Matteo Iacoviello:
Empirically, housing wealth and consumption tend to move together: this could happen because some third factor moves both variables, or because there is a more direct effect going from one variable to the other. Studies based on time-series data, on panel data and on more detailed, recent micro data point suggest that a considerable portion of the effect of housing wealth on consumption reflects the influence of changes in housing wealth on borrowing against such wealth.
That sounds like a financial problem to me and, in the spirit of Baker’s plea that it is the policy that matters, this distinction is more than semantic. The policy implications of an economic shock that alters the capacity to engage in borrowing and lending are not necessarily the same as those that result from a straightforward decline in wealth.
Having said that, it is not so clear how the policy implications are different. One possibility is that diminished access to credit markets also weakens policy-transmission mechanisms, calling for even more aggressive demand-oriented “pump-priming” policies of the sort Dean Baker advocates. But it is also possible that we have entered a period of deep structural repair that only time (and not merely government stimulus) can (or should) engineer: deleveraging and balance sheet repair, sectoral resource reallocation, new consumption habits, new business models driven by both market and regulatory imperatives, you name it.
In my view, it’s not yet clear which policy approach is closest to optimal. But I am fairly well convinced that good judgment will require us to think of the past decade as the financial event it was, and in many ways still is.
*Update: A colleague pointed out that my example describing housing price changes and wealth effects may be simplified to the point of being misleading. Implicitly, I am in fact assuming that the flow of housing services derived from housing assets is fixed, a condition that obviously would not hold in general. See section 3 of the Iacoviello paper cited above for a theoretical description of why, to a first approximation, we would not expect there to be a large consumption effect from changes in housing values.
By Dave Altig, executive vice president and research director at the Atlanta Fed
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October 09, 2013
Delving into Labor Markets
Though never far from the headlines, the Federal Reserve's dual mandate comes front and center again with the announcement today of President Obama's nomination of Fed Vice Chair Janet Yellen as the next chair of the Board of Governors. Inevitably, analysis will turn to discussions of who is a hawk and who is a dove, who cares relatively more about inflation, and who cares relatively more about growth and employment.
That's unfortunate, because such characterizations really do miss the point. The debate among different policymakers is not about whether person A is more concerned about jobs and unemployment than person B, but about legitimate and longstanding conversations about what accounts for the performance of labor markets and what role monetary policy might have in the event that performance is judged to be subpar.
As it happens, the Atlanta Fed's most recent contribution to this discussion came last week in the form of the annual employment conference sponsored by the Bank's Center for Human Capital Studies. Organized, as in past years, by Richard Rogerson (Princeton University), Robert Shimer (University of Chicago), and Melinda Pitts (Federal Reserve Bank of Atlanta), the conference explored the causes of the continued weak labor market recovery in the United States. The existing literature has suggested a number of possibilities: wage rigidities, mismatch between workers' skills and the skills required by new jobs, extended unemployment insurance benefits and other government policy changes, and firms' reorganizing and asking workers to do more. The papers sought to analyze and document the importance of these factors for the slow recovery.
One notable policy change in the recent recession was the unprecedented expansion of unemployment insurance (UI) benefits to as long as 99 weeks for a very large fraction of UI-eligible workers. Did this increase play an important role in high levels of unemployment? Two papers from the conference addressed this question from different perspectives. "Do Extended Unemployment Benefits Lengthen Unemployment Spells? Evidence from Recent Cycles in the U.S. Labor Market," by Henry S. Farber and Robert G. Valetta, assessed the extent to which extended UI benefits result in higher unemployment because workers choose to remain unemployed longer. They find a statistically significant effect of longer UI durations on the duration of unemployment spells, but they conclude that the overall contribution to the unemployment rate was less than half a percentage point. Because the aggregate unemployment rate rose by more than 5 percent, this effect accounts for less than 10 percent of the overall increase.
"Unemployment Benefits and Unemployment in the Great Recession: The Role of Macro Effects," by Marcus Hagedorn, Fatih Karahan, Iourii Manovskii, and Kurt Mitman, offered a different perspective. The authors look at the evolution of unemployment rates in counties that are adjacent but lie in different states. They use the fact that the timing of extended benefits occurs at different times across states to identify the effect of extended UI durations on country-level unemployment. They find that the effects are sufficiently large that the increase in UI duration can account for virtually all of the increase in unemployment.
While seemingly at odds, the results of these two studies are consistent. The first paper shows that the decrease in the job-finding rate for workers with relatively longer benefits did not increase that much compared with the rate for workers with shorter-duration benefits, holding the overall unemployment rate constant. The second paper argues that the job-finding rate decreases for everyone when benefits are extended. The authors find that when some workers have access to longer-duration UI benefits, being unemployed is not as painful for them, which puts upward pressure on wages. To the extent that firms cannot target their job openings toward workers without access to UI, firms may be less likely to create jobs, making it harder for all workers to get job offers. The impact on uninsured workers may be as large as the impact on insured workers, and so the microeconomic estimates in Farber and Valetta will not necessarily uncover UI's total impact on the unemployment rate.
The possible role of wage rigidities has figured prominently in many accounts of the large increase in unemployment during the recent recession. Two papers considered the importance of this explanation. "Wage Adjustment in the Great Recession," by Michael Elsby, Donggyun Shin and Gary Solon, used microdata from the U.S. Census Bureau's Current Population Survey to examine the extent to which wages are sticky. The paper finds that there has been less response in average real wages during the recent recession than in previous recessions, perhaps suggesting that real wage rigidity contributed to the large increase in unemployment. However, they also show that wages at the individual level are really quite flexible. Specifically, relatively few individuals have zero nominal wage growth from one year to the next, and many people experience decreases in nominal wage rates.
A key issue in the theoretical literature is the extent to which wage stickiness affects new hires versus existing workers. In "How Sticky Wages in Existing Jobs Can Affect Hiring," authors Mark Bils, Yongsung Chang and Sun-Bin Kim show that even if wages for new hires are completely flexible, they may nonetheless have large effects on unemployment fluctuations when one allows for an "effort decision" for existing workers. This decision means that in response to negative shocks, firms require existing workers to expend more effort given that their wage is fixed, decreasing the need to hire new workers. The authors show that this effect is quantitatively significant and can come close to resolving the unemployment volatility puzzle, which relates to the large fluctuations in unemployment relative to productivity.
An empirical regularity that has appeared in the last few years is an outward shift in the Beveridge curve, which relates the unemployment rate to the level of vacancies. One interpretation of this upward shift is that the matching of unemployed workers and vacancies has worsened. Yet there is a lot of variety in the job-search effort by workers with different characteristics, such as the length of unemployment, whether they are on temporary layoff, and so on. In "Measuring Matching Efficiency with Heterogeneous Jobseekers," Robert Hall and Sam Schulhofer-Wohl devise a method for incorporating this heterogeneity into the analysis and show that there has indeed been a decrease in the matching rate for workers during the last few years. It will be important for future research to determine how much this decrease reflects a decline in search intensity or whether the lower job-finding rates represent a decrease for a given level of search intensity.
Related to the two issues of nominal rigidities and mismatch, in the paper "Labor Mobility within Currency Unions," Emmanuel Farhi and Ivan Werning study the role of labor mobility in diminishing the effects associated with nominal rigidities. For example, some researchers have suggested that a key difference between the apparent success of the United States relative to the euro zone is U.S. labor is more mobile. Farhi and Werning argue that one should not assume the mobility necessarily reduces the effects of nominal rigidities. In particular, they conclude that mobility eases the effects of nominal rigidities only if goods markets are well integrated.
Two papers focused on the nature of worker mobility across firms in the recent recession. In "Worker Flows over the Business Cycle: The Role of Firm Quality," Lisa Kahn and Erika McEntarfer examine recent changes in flows of workers between firms that offer jobs of differing quality. They find that that lower-quality firms decreased both hiring and separations by large and equal amounts, whereas high-quality firms have much smaller declines in both hiring and separations. The net result is that the fraction of workers in lower-quality jobs tends to increase during recessions.
In closely related work, "Did the Job Ladder Fail after the Great Recession?" by Giuseppi Moscarini and Fabien Postel-Vinay, uses data from the U.S. Bureau of Labor Statistics' Job Openings and Labor Turnover Survey (JOLTS) to study the hiring and separation patterns across firms of different sizes. They determine that the pattern of firm growth across size classes was different during this recession than in previous recessions. In particular, they find that following the Lehman Brothers collapse, smaller firms actually fared worse than larger firms, perhaps because financing constraints had more severe consequences for smaller firms.
As the provisions in the Affordable Care Act (ACA) take effect in the coming months, there may be large effects not only on the market for health care but also on the labor market. In particular, the ACA will implicitly introduce taxes and subsidies that will differ across firms and workers of different types. In "Effects of the Affordable Care Act on the Amount and Composition of Labor Market Activity," Trevor Gallen and Casey Mulligan develop a framework to think about how these provisions will influence labor market outcomes across different sectors and worker types, and they use a calibrated version of the model to quantify the effects. The authors predict that the ACA will substantially reduce the return to market work for low-skilled individuals and that a large number of individuals who currently receive health insurance through their employers will end up purchasing insurance through the exchanges established as part of the ACA.
The conference also featured a presentation by Ed Lazear, "The New Normal? Productivity and Employment during the Recession and Recovery." The talk highlighted three themes from Lazear's recent research. First, productivity did not decline in the recent recession—as it typically had done in previous recessions—perhaps reflecting that workers expend more effort during periods of high unemployment since they fear unemployment more in a weak labor market. Second, the unemployment rate is a less useful indicator of the overall state of the labor market during the current recovery (in recent years the decline in the unemployment rate has not been accompanied by an increase in the employment-to-population ratio, since labor force participation has declined). The third theme is that the deterioration in labor market outcomes during the recent recession should be interpreted as cyclical rather than structural and, hence, a labor market recovery is likely once GDP growth is stronger.
We certainly wouldn't claim that the conference put to rest any of the relevant questions that will confront the Federal Open Market Committee and its new chair going forward. But we do believe that continuing to support the dissemination of the type of research presented at this conference gives us a fighting chance.
By Richard Rogerson of Princeton University and Robert Shimer of the University of Chicago, both advisers to the Atlanta Fed's Center for Human Capital Studies, and Melinda Pitts, director of the Atlanta Fed's Center for Human Capital Studies
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October 04, 2013
Certain about Uncertainty
The Bloom-Davis index of Economic Policy Uncertainty hit 162 in September, up from 102 in August and the highest level seen since December 2012. With all this uncertainty, we can be certain that the events surrounding the government shutdown are having an impact.
This notion of increased uncertainty is captured nicely in our most recent poll of small businesses in the Southeast (past results available here), which went live on September 30, the day before the government shutdown. Although the survey is still out in the field, some early results show:
- Most firms are expressing more uncertainty (see the chart),
- For a significant portion of firms, uncertainty today is having a greater impact than six months ago, and
- The government is heavily featured as a source of the uncertainty.
Of course, what we really care about is whether higher uncertainty is affecting economic activity. When asked, 45 percent of our respondents indicate that uncertainty is in fact having a greater impact on their business than six months ago, up from 37 percent in the first-quarter 2013 survey (relative to fall 2012). Further, fewer firms so far have indicated that uncertainty is having less of an impact. In the current survey, 9 percent of firms have reported less of an effect, compared with 16 percent at the close of last April's survey.
And what are the sources of uncertainty, as seen by our panel of businesses? Eighty-percent of participants have responded to our open-ended question about the primary source(s) of uncertainty. The following "word cloud" summarizes their views:
We will get more responses to the survey over the next week or so, and these may show a different picture. But we're pretty certain of one thing—the duration of the current fiscal impasse in Washington will make a difference.
By John Robertson, vice president and senior economist, and
Ellyn Terry, economic policy analysis specialist, both in the research department of the Atlanta Fed
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October 03, 2013
Why No Taper? One Man's View
One possibility is that Bernanke and the other FOMC leaders… never intended to start tapering…
A second possible explanation is that Bernanke and other Fed leaders were indeed anticipating that they would begin tapering QE in September but were startled at how rapidly long-term rates had risen in response to their earlier statements…
The third scenario is that economic activity was clearly slowing, with the future pace of activity therefore vulnerable to even higher interest rates.
Speaking only for myself, I choose Feldstein's third option. He goes a good way to making the case himself:
The annualized GDP growth rate in the first half of 2013 was just 1.8%, and final sales were up by only 1.2%. Although there are no official GDP estimates for the third quarter, private-sector assessments anticipate no acceleration in growth, putting the economy on a path that will keep this year's output gain at well under 2%.
That unfortunate story was pretty clear on the eve of the FOMC meeting—in particular, the lack of evidence that growth in the second half of the year would be an improvement on the already disappointing pace of the first half. Our own internal "nowcast" tracking model was suggesting third-quarter GDP growth in the neighborhood of the sub-2 percent growth that Feldstein cites. And as this table shows, things have not improved since:
These facts, of course, were reflected in the downgrade of the 2013 growth forecasts published in FOMC participants' Summary of Economic Projections. But that is not all, as Professor Feldstein reports:
In addition, the Fed's preferred measure of inflation was much lower than its 2% target. The annual price index for personal consumer expenditure, excluding food and energy, has been rising for several months at a rate of just 1.2%, increasing the possibility of a slide into deflation.
And even if you don't go in for inflation measures that exclude food and energy, it doesn't much matter, because all-in inflation was, and still is, also running well below that 2 percent target:
Though the August personal consumption expenditures price report finally provided a slight uptick in year-over-year core inflation, there was not even that scant hint of a return to the 2 percent inflation target by FOMC meeting time.
And that was looking a lot like strike number two to me. As Fed Chairman Ben Bernanke explained at the post-meeting press conference, repeating the criteria for adjustments to the FOMC asset purchase program that he laid out in June:
We have a three-part baseline projection which involves increasing growth…, continuing gains in the labor market, and inflation moving back towards objective… we'll be looking to see if the data confirm that basic outlook.
Of the remaining element of the three-part baseline, it is true that 12-month average monthly job gains looked pretty much like they did in June, when the talk of taper got serious:
But the momentum—which I measure here as the ratio of three-month average monthly job gains to the 12-month average—was clearly in the downward direction:
What's more, the revisions in prior months' employment statistics were running in the wrong direction:
As a rule, forecasters don't sweat being wrong. That comes with the territory. But when you are persistently wrong in the same direction, it is time to worry at least a bit.
So, what do we have, then?
- Inflation is low relative to the FOMC's objective—and has not moved in the direction of that objective with any conviction.
- GDP growth has disappointed, with the anticipated pickup in second-half growth nowhere in sight.
- "Continuing gains in the labor market" at the pace seen earlier in the year are looking a little shaky.
I find it pretty easy to see how this fails to add up to satisfaction of the three-part economic conditionality laid out in June by the Chairman (on behalf of the FOMC).
One could argue, I suppose, that the FOMC's explicit tying of asset purchases to improvement in the labor market makes it first among equals in the three-part test (as long as inflation is relatively stable), that similar downward momentum on the job front arose and disappeared in the summer of 2012, and that with a little patience things will appear on track.
Maybe. But I would point out that the reversal of negative momentum in the labor market the summer before was accompanied by the initiation of "QE3" (or at least the MBS part of QE3). You can draw your own conclusions about causality, but there is a fairly convincing case to be made for the proposition that, with the data in hand at the time, a wait-and-see decision was what patience dictated.
That, of course, begs the main question posed in Feldstein's article: When will it be time to taper? On that, and in the spirit of baseball playoff season, get your scorecard here.
By Dave Altig, executive vice president and research director at the Atlanta Fed
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