Calling the Downturn the “Household Debt Crisis”

Ezra Klein has jumped on the “balance sheet recession” bandwagon

The utility of calling this downturn a “household-debt crisis” is it tells you where to put your focus: you either need to make consumers better able to pay their debts, which you can do through conventional stimulus policy like tax cuts and jobs programs, or you need to make their debts smaller so they’re better able to pay them, which you can do by forgiving some of their debt through policies like cramdown or eroding the value of their debt by increasing inflation. I’ve heard various economist make various smart points about why we should prefer one approach or the other, and it also happens to be the case that the two policies support each other and so we don’t actually need to choose between them.

suggesting that it’s becoming prevailing Democratic Party wisdom.

The effectiveness of the former strategy (conventional stimulus policy) depends on the degree to which those who are reached by the policy are also those who are most indebted. That’s a question of facts, not politics, and as I read the facts the groups aren’t very closely related. Unless you believe that the form that “conventional fiscal policy” is likely to take will be large cuts in the marginal rates on personal income taxes. Cue Paul Krugman’s head exploding.

The latter strategy has two different substrategies, one monetary in nature and the other requiring what for lack of a better word I’ll call “banking reform”. As John Taylor recently noted monetary policy and the strategy of banks have, unfortunately but predictably been working at cross-purposes. The harder the Fed tries to create inflation, the more the banks resist, largely because they’re being allowed to.

It all comes down to the banks. Which is why I’ve been pounding on them so mercilessly for the last few whiles.

3 comments… add one
  • PD Shaw Link

    The McKinsey report points to one of the problems. Half of the increase in debt during the oughts was in the top quintile for household income. With a pure balance sheet problem, you would expect more filing of bankruptcies; the implication to me is that people can’t afford their mortgage payments, but also have assets they want to shield. Attempting to correct this problem would entail wealth transfers to the highest income earners.

  • Or, we could have allowed the banks to go bankrupt, which would have cleared the markets and the debt in about a year, allowing recovery to take place.

    Not as much fun as having silly economists manage the economy with trillions of dollars, and people like Ezra Klein wouldn’t be able to sound so smart, but at least the recession would have been sharp and abbreviated, and we would have long ago been on the road to recovery.

  • steve Link

    Going on three years and they still have not settled Lehman’s holdings and debts. Small potatoes compared with the big banks.


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