I get nervous when I read Keynesians claiming that the real rate of return is negative these days. Is civilization moving backwards? (And if so, don’t we really have a budgetary problem?) I prefer instead to think about segmented rates of return and wonder why that has come about, and if so how we actually measure opportunity costs for projects. If the risk premium on private projects is quite high, motivating a rush to T-Bills, is then the risk premium on government projects high or low? Does “the chance that the government repays my loan,” as measured by bond rates, equal “actual comovement consumption risk of the government project itself”? I see those two variables confused all the time.
He refers to a long post by John Cochrane on New Keynesianism vs. Old Keynesianism. Trying to avoid the math, I think of old Keynesianism, new Keynesianism, and real business cycle theory in terms of their answers to two questions:
1. Is there market clearing in the aggregate labor and product markets?
2. Do consumers base decisions on permanent income (rather than one year’s income)?
The real business cycle theory answers “yes” to both. Old Keynesians answer “no” to both. New Keynesians answer “no” to (1) and “yes” to (2).
Cochrane writes,
Now, a spontaneous outbreak of thrift, to the point of valuing the future a lot more than the present, seems a bit of a strained diagnosis for the fundamental trouble of the US economy.
I think that the (New) Keynesian view is that the outbreak of thrift is due to the collapse of house prices. People who had bought homes see a decline in permanent income, so they try to spend less and save more. This saving, rather than being channeled into capital investment, gets put into the mattress. To answer Tyler’s question, there is a huge mismatch between what consumers want to hold in order to assure future consumption (riskless assets) and the risky projects that are available to entrepreneurs. This lowers the demand for aggregate output and, with sticky wages and prices, this leads to low output and high unemployment.
To me, this is a just-so story for the current recession. If we are going to tell just-so stories, I prefer a PSST story. A lot of patterns of trade that were not really sustainable in 2006 became blatantly unsustainable in 2008 and 2009. Construction employment is a tiny part of that. A lot of it is jobs in firms that were not well suited to the Internet era, from labor-wasting manufacturing firms to retailers like Borders Books.
Circling back to Tyler’s question, perhaps the bailouts had the ironic effect of making investment seem much riskier. As Holman Jenkins points out,
In the Chrysler and General Motors GM -0.60% bankruptcies, government played the role of “debtor-in-possession” financier, then behaved as no DIP financier would, using its leverage to do favors for an important Democratic constituency group, the United Auto Workers, at the expense of debt holders.
The regulator of Fannie Mae FNMA +1.79% and Freddie Mac FMCC +2.11% trumpeted them as solvent and well-capitalized amid the crisis, then gave their boards immunity from shareholder lawsuit in the government takeover that followed a short time later, wiping out their shareholders.
Not directly related to the financial crisis but coming in the same moment of untrammeled government discretion was the BP oil spill. The White House dictated a $20 billion compensation program, funded by BP shareholders, without benefit of any legal process at all.
A big increase in the uncertainty of property rights should raise the risk premium on private-sector projects, making government debt relatively low risk.