Getting and Spending, We Lay Waste Our Powers
Okay, so, recall that our framework is that at times there may be insufficient spending to create full employment of an economy's resources. The two main policy tools to prevent this are low interest rates and increased government spending. And although, as we have seen, those policies are capable of generating spending (rather than just drawing it into the present from the future), we would still hope to be able to time-shift spending as part of a stimulus program.
But so now imagine that unemployment is elevated and inflation is muted. The central bank keeps interest rates low and the government runs a deficit. People begin borrowing heavily to finance current spending, and in particular they buy a lot of durable goods like houses. They are time-shifting their spending, buying things now while knowing that they will have to pay for them later. (Ignore for a moment whether people might be overconfident about the future value of the houses they are buying/building.) So you end up with a bunch of highly-indebted individuals who will definitely not be spending a lot of money on housing in the future - they have drawn all of that spending back to the present. (Even if they wanted to spend in the future, they wouldn't be able to - they are using up their borrowing capacity, and not only will they be unable to borrow more in the future, they won't even be able to spend everything they earn - a lot of their future income is earmarked for paying down debt.) From a macroeconomic perspective, the economy's future spending capacity is being deployed now rather than later.
By the way, the same thing happens when businesses accumulate inventory. If a business is going to sell 500 units during T1 and 500 units during T2, it can manufacture all 1,000 units in T1 and hold 500 of them in inventory. That might be a sensible thing to do if interest rates are low. It effectively shifts spending from T2 to T1, which is good for full employment at T1 but ensures that the spending on that particular item will be lower in T2 than it otherwise would have been.
And so certain kinds of spending can effectively strip future spending out of the economy. Now I want to emphasize, this is not necessarily a bad thing. It leaves more resources available at time T2 for spending on other things, while keeping people employed at time T1. But it raises the possibility that there will be a spending shortfall in T2.
And of course that's roughly what happened to the U.S. in the period from 2003 (or so) through today. A tremendous amount of economic activity in 2003-2007 consisted of the accumulation of housing and other durable goods, and so it was incredibly difficult to generate sufficient spending in 2008-present. Now I want to emphasize, I think the recession could have been handled far better, with far less unemployment and misery. To repeat my earlier point: in theory all of that time-shifting freed up future resources for other productive use. If our fiscal stimulus had been 2-3 times larger, maybe we would have enjoyed a several-year period in which we could enjoy high levels of government spending at low cost, without nearly so much unemployment. It was a wasted opportunity in a lot of ways. But for a variety of reasons that didn't happen, and so we came to regret all of that time-shifted activity in the 2003-2007 period.
But the central bank doesn't choose how people use low interest rates, and the government doesn't have all that much control over how the private sector spends its money. So I don't mean to suggest, as some people have, that interest rates were "too low" during the 2003-2007 period. I'm just observing that you can get into some pretty serious trouble if people time-shift their spending in certain ways.
But so now imagine that unemployment is elevated and inflation is muted. The central bank keeps interest rates low and the government runs a deficit. People begin borrowing heavily to finance current spending, and in particular they buy a lot of durable goods like houses. They are time-shifting their spending, buying things now while knowing that they will have to pay for them later. (Ignore for a moment whether people might be overconfident about the future value of the houses they are buying/building.) So you end up with a bunch of highly-indebted individuals who will definitely not be spending a lot of money on housing in the future - they have drawn all of that spending back to the present. (Even if they wanted to spend in the future, they wouldn't be able to - they are using up their borrowing capacity, and not only will they be unable to borrow more in the future, they won't even be able to spend everything they earn - a lot of their future income is earmarked for paying down debt.) From a macroeconomic perspective, the economy's future spending capacity is being deployed now rather than later.
By the way, the same thing happens when businesses accumulate inventory. If a business is going to sell 500 units during T1 and 500 units during T2, it can manufacture all 1,000 units in T1 and hold 500 of them in inventory. That might be a sensible thing to do if interest rates are low. It effectively shifts spending from T2 to T1, which is good for full employment at T1 but ensures that the spending on that particular item will be lower in T2 than it otherwise would have been.
And so certain kinds of spending can effectively strip future spending out of the economy. Now I want to emphasize, this is not necessarily a bad thing. It leaves more resources available at time T2 for spending on other things, while keeping people employed at time T1. But it raises the possibility that there will be a spending shortfall in T2.
And of course that's roughly what happened to the U.S. in the period from 2003 (or so) through today. A tremendous amount of economic activity in 2003-2007 consisted of the accumulation of housing and other durable goods, and so it was incredibly difficult to generate sufficient spending in 2008-present. Now I want to emphasize, I think the recession could have been handled far better, with far less unemployment and misery. To repeat my earlier point: in theory all of that time-shifting freed up future resources for other productive use. If our fiscal stimulus had been 2-3 times larger, maybe we would have enjoyed a several-year period in which we could enjoy high levels of government spending at low cost, without nearly so much unemployment. It was a wasted opportunity in a lot of ways. But for a variety of reasons that didn't happen, and so we came to regret all of that time-shifted activity in the 2003-2007 period.
But the central bank doesn't choose how people use low interest rates, and the government doesn't have all that much control over how the private sector spends its money. So I don't mean to suggest, as some people have, that interest rates were "too low" during the 2003-2007 period. I'm just observing that you can get into some pretty serious trouble if people time-shift their spending in certain ways.
posted by James | 8:35 AM
2 Comments:
I feel like this is kind of going down a blame the victim path. Time shifting has been problematic mostly because the gov isn't doing it's job. If the gov had taken advantage to negative real rate the us could have had a total infrastructure overhaul at an extreamly low cost and reaped the prosperity benefit in year to come.
Yeah, I don't mean to blame the victim. That's why I wrote the second-to-last paragraph the way I did. My point is just that you can get into a situation in which spending has to come from somewhere, and if the private sector doesn't supply it for whatever reason, and the public sector doesn't provide it for political reasons, then you are in trouble. But I'm in complete agreement that in fact the public sector should have stepped up.
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