This post takes its title from an Economic Newsletter by Kevin J. Lansing of the San Francisco Federal Reserve. The most interesting result is shown in the figure below.
This figure compares trajectories for nominal, real, and real per-person consumption expenditures during the Great Recession. Nominal consumption expenditures continued to trend upwards for eight months after the recession started because spiking fuel prices inflated the nominal value of many transactions. In contrast, real consumption expenditures started trending down immediately, but have since recovered to levels exceeding their pre-recession peak. Real consumption per person has recovered more slowly because the U.S. population has grown just under 1% per year.
Lansing has plotted pre- and post-recession trend lines for real consumption per person.
[This figure plots an exponential growth trend for real consumption per person from January 2000 to December 2007. The trend line is carried forward to produce an alternate trajectory for real consumption per person if the recession had not occurred. The space between the extrapolated trend and the actual trajectory measures foregone consumption per person, yielding a figure of $7,356 per person in 2005 dollars over 42 months. This averages a spending loss of $175 per person per month.
It is that foregone consumption per person ($175/person/month) which in part measures the impact of the Great Recession. Like all such numbers, foregone consumption is open to the usual criticisms I offer on DOTE. For example, Gallup polling reveals that self-reported spending by everybody is way down compared to 2008 levels, but those making more than $90,000/year are still spending about twice as much as those making less (graph below). Referring to aggregate consumption without differentiating between the well-off and those living paycheck to paycheck is meaningless, and seriously misleading, if your intention is to gauge the health of the economy.
Daily spending by those making less than $90,000 per year, which is approximately 88% of the working (or not) population. Gallup refers to this flat, depressed trend as the "New Normal" range.
Despite such criticisms, Lansing rises above the mundane falsehoods peddled by most economists.
Economic theory assumes that consumption is a key determinant of personal well-being.
Well, we could argue about the validity of this assumption as stated, but let's continue
Many households became accustomed to the consumption trend established before the recession and expected it to continue. From that perspective, the amount of foregone consumption might be viewed as a measure of the recession’s cost for the average person. However, the pre-recession consumption trend was almost surely not sustainable because much of the household debt that helped finance that spending was collateralized by bubble-inflated housing values. Consumption was bound to slow sooner or later. Indeed, the average annual compound growth rate of real consumption per person since the recession ended in June 2009 is 1.15%, well below the 2% rate before the recession.
Not only was the phony, bubble-inflated consumption trend not sustainable, it wasn't even desirable.
Moreover, it is unclear whether continuing the pre-recession consumption trend was economically desirable. Many households might have continued saving too little for retirement while becoming more burdened with debt. When the housing bubble was expanding, former Fed Chairman Paul Volcker (2005) noted several “disturbing trends,” including that “personal savings in the United States have practically disappeared,” and that “home ownership has become a vehicle for borrowing.” He called for federal policies to “forcibly increase” the saving rate as a way to address the growing imbalance between domestic spending and production.
This manifest undesirablity leads naturally to a discussion of whether the Fed could have done something to "forcibly increase" the savings rate by pricking the bubble.
The extensive harm caused by the Great Recession raises the question of whether policymakers could have done more to avoid the crisis. Specifically, should central banks take steps to prevent or deflate asset price bubbles (see Lansing 2008, 2003b). The mainstream view prior to the crisis was that central banks should not attempt to prick a suspected bubble. Instead, according to former Fed Chairman Alan Greenspan (2004), they should follow a “strategy of addressing the bubble’s consequences rather than the bubble itself.” This view is predicated on the idea that it is difficult for policymakers to identify a bubble in real time.
However, central banks regularly respond to economic variables that are difficult to measure in real time, such as the “output gap,” defined as the difference between actual and potential GDP. Moreover, some economists argue that bubbles can be identified in real time if central banks look beyond asset prices to other variables that historically have signaled threats to financial stability, such as sustained rapid credit expansion. According to Borio and Lowe (2002), when faced with a suspected bubble, bubble-popping skeptics fail to sufficiently account for the asymmetric nature of the costs of policy errors: “If the economy is indeed robust and the boom is sustainable, actions by the authorities to restrain the boom are unlikely to derail it altogether. By contrast, failure to act could have much more damaging consequences.”
More recently, the U.S. Financial Crisis Inquiry Commission (2011) concluded, “Despite the expressed view of many on Wall Street and in Washington that the crisis could not have been foreseen or avoided, there were warning signs. The tragedy was that they were ignored or discounted.” The commission lists such red flags as “an explosion in risky subprime lending and securitization, an unsustainable rise in housing prices, widespread reports of egregious and predatory lending practices, (and) dramatic increases in household mortgage debt.”
It wasn't particularly difficult for an army of bloggers to identify the Housing Bubble in real time, but bloggers are unencumbered by self-interest in judging the situation. They do not have corn-pone opinions about the health of the economy. I first discussed this in Ben Bernanke Week, a post I wrote when this blog was only a few weeks old. That older post is based on the views of John Kenneth Galbraith concerning the Fed's failure to act in a similar situation prior to the stock market crash of 1929 and subsequent Great Depression.
In short, it is in the Nature of policymakers (the Alan Greenspan, the Ben Bernank, The William Dudley, All Politicians—the usual suspects) to assume that The Boom Is Good, and Not A Bubble, and The Boom is undoubtedly due to their Wise Policies. To this day, the Bernank can hardly bring himself to use the word "bubble" in a sentence. It is not necessary for policymakers to avert future disasters in any case, since These Can Not Happen due to the aforementioned Wise Policies, inevitable, never-ending Economic Progress expressed through the Business Cycle, and the General Goodness of all Human Designs.
And of course policymakers must never, ever, admit they made an Error In Judgment.
Bonus Video — An old favorite (xtra-normal)
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