A ‘Balance Sheet’ Recession or an Unemployment-Based One?

I’ve decried before the lack of natural history in economics, and I’m thinking Mark Thoma, with whom I usually agree, seems to be doing just that. Thoma on the ongoing recession:

There are different types of recessions, and this one can be termed “a balance sheet” recession. It had a big impact not just on bank balance sheets, but on household (and, for that matter firm) balance sheets as well. Households were particularly hard hit due to declines in stock prices and declines in the value of housing. These losses were large, they upset plans for things such as retirement, and households needed to refill the holes in their balance sheets that had been created (this includes paying off debt).
How do they refill their balance sheets? By saving more and consuming less (paying off debt is a form of saving). Thus, as the recession took hold, we saw a large increase in the saving rate and a corresponding fall in consumption. The tax cuts were an attempt to reverse the decline in consumption, but instead they mostly raised the amount that went into saving.
But that has a benefit. Households are not going to start consuming normally again until their balance sheets are repaired. The faster the holes in their balance sheets are refilled, and tax cuts can help with this, the faster the households can return to their normal rates of consumption — a prerequisite for the economy to return to normal.
So the targeting of the tax cuts that was OK after all. You don’t see the effects of balance sheet rebuilding in the data initially because the tax cuts are being used to fill up balance sheets, there’s no immediate effect on consumption, output, employment, etc., to observe in the data. But since balance sheets are refilled faster, we will emerge from the recession sooner, and that’s an important benefit of tax cuts that’s often overlooked.

I disagree agree with Thoma on two points.

First, most households, even if you include their housing, don’t have a lot of assets. Young households, while potentially hammered in Big Shitpile, lack savings (i.e., they’re not thinking about retirement). Older households typically haven’t been hit hard by the housing decline (they got in early enough not to be underwater), although their 401(k) accounts have been hurt (keep in mind, most households, even older ones, have very little in their 401(k) accounts, and this was true pre-Big Shitpile). In other words, retirement concerns aren’t anything new.
Second, as Elizabeth Warren has noted repeatedly, in books and articles (along with her co-author Amelia Warren Tyagi), households often go into debt, not because of consumer purchases*, but due to ‘life emergencies’: a healthcare crisis, your car blows up and you need a car, a job loss or reduction in salary. While tax breaks would help these people somewhat (flood the economy with enough money, and some of it will eventually slosh around to the right places), what would help more is directly reducing unemployment and underemployment, as well as helping people with healthcare crises (oh yeah, that won’t kick in until 2014… go RomneyObamacare!). It’s not clear how much a tax cut will help someone whose earnings have dropped (or disappeared), since they won’t be paying very much in taxes anyway. (Of course, some additional microeconomic data about credit patterns would be nice to observe how people are handling debt).
But this recession seems to me to be driven far less by individual concerns about ‘balance sheets’ and more about concerns over unemployment–current or future. With U6 unemployment near twenty percent, how could it not be?
It’s a pretty story though.
*I’m not referring to transactional credit–paying off the balance in full, and just avoiding the inconvenience of carrying around cash.

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4 Responses to A ‘Balance Sheet’ Recession or an Unemployment-Based One?

  1. Nick says:

    Or its caused by people realising just how far up the proverbial creek governments have gone with their accounting fiddles.
    All those off balance sheet liabilities such as pension and social security.

  2. Eric Lund says:

    I don’t think these two possibilities are mutually exclusive, and your perspective depends on where you live.
    Here in New Hampshire the extent to which house prices have fallen depends strongly on your address. Just this morning an article in the Portsmouth paper said that the just-completed revaluation has some properties in that city increasing by up to 50%, with prices rising in certain close-in neighborhoods and falling in outlying parts of the city. Other New Hampshire towns, especially towns which are not near job centers, have seen declines of as much as 40%. Unemployment would be the big worry in Portsmouth, but balance sheet issues are out there in many other towns.
    You live in Boston, which has not seen the steep declines that the sand states (CA, AZ, NV, FL) have seen. Lots of people in those places bought homes they never could plausibly afford (and would have been prevented from buying had there been even minimal quality control in underwriting). Even the ones who got in “early enough” often took out a HELOC for one of life’s little emergencies, or something more routine like money to pay for the kid’s college (student loans, unlike mortgages, cannot be discharged in bankruptcy) or to pay off the debt accumulated in a previous emergency.
    Also, lots of people were planning to retire on the proceeds of selling their house. Oops.

  3. Kaleberg says:

    There is a movement toward post autistic economics. Unfortunately, not all that many economists have signed on. That’s why you get nonsense like this. The problem is that macro-economics doesn’t gibe with accounting. Thoma doesn’t seem to realize that the nation’s bookkeeping is quantized by household. Bill Gates can save all he wants, but that doesn’t let me spend an extra penny. Yes, a tax cut allow multi-billionaires to increase their savings, but it won’t make jot of difference to the typical Joe whose mortgage is upside down. Money, like energy, is the ability to get work done, but we are facing the equivalent of economic heat death.

  4. FrauTech says:

    Great points Mike. Though Eric has some good ideas, I’d still argue household equity/debt has never been important to the average American household. Yes boomers wanted to sell off their homes and pay for retirement, but prior to them it was pretty common for most people to carry that debt to their graves, and not to “upgrade” or “downgrade” in the meantime.
    Definitely degree all tax cuts do is help rich people and add to the deficit. But what’s the alternative? I’d love to see some sort of crazy New Deal style employment programs, but I begin to doubt whether there are any liberals left in America when all the left can do is propose different kinds of tax cuts or temporarily stimulus programs.

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