Did You Visit the Same Country?

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Atif Mian and Amir Sufi write,

we highlight the increasing body of macroeconomic evidence on the link between household debt and business cycles.

Dean Baker writes,

while it has become fashionable to cite the importance of debt in explaining the severity of the downturn following the collapse of the housing bubble, it really doesn’t fit. The severity of the downturn can easily be explained by the loss of wealth and the end of the construction boom, debt is at most a secondary consideration.

Pointer from Mark Thoma.

One point that Baker makes is that, in terms of employment, the recovery from the recession that coincided with the dotcom crash was very weak. What I would say, from a PSST perspective, is that we have had a lot of structural change over the past 20 years, and the process of creating new patterns of sustainable specialization and trade has generally operated more slowly than the process of making some old patterns unsustainable.

3 thoughts on “Did You Visit the Same Country?”

  1. “while it has become fashionable to cite the importance of debt in explaining the severity of the downturn”

    We are a decade from the peak of the housing bubble, how long do passing fads of economics last? I don’t know that it is fashionable to cite debt to explain the severity of the downturn. What does he mean by severity? There are certainly people who say that the duration of the slack recovery has to do with ongoing de-leveraging. It’s also interesting that he seems to set mortgages aside as not “debt” and doesn’t mention that the home “wealth effect” may have had something to do with evaporating house equity. What exactly allows house prices to rise so fast? The “one variable to rule them all” exercise in a system analysis is like chasing your tail.

  2. Debt leverage supports much larger swings in wealth and much more widely distributed ones which is why financial crises are worse. Risk adverseness also weighs losses more than gains and debt can make tangible net worth negative, spurring deleveraging.

    • So it wasn’t the actual losses and negative equities, but it was the wealth effect and liss aversion?

      How does one know?

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