There is an op-ed at Bloomberg (hat tip: Bill McBride) from Amir Sufi and Atif Mian on what I think may be a very important study of theirs on the relationship between household debt and unemployment. Using county by county data they find a direct relationship between household balance sheets and unemployment:
The weakness in household balance sheets and the associated pullback in spending are directly responsible for the lion’s share of employment losses in the U.S. economy. This deficiency remains the most significant impediment to a robust recovery.
Our research suggests that 65 percent of the job losses from 2007 to 2009 came from the drop in household spending induced by the collapse in home prices and its effect on a highly levered household sector.
The declines in consumption are far too large to be explained by the drop in house prices alone. It was the combination of collapsing home values and high debt levels that proved disastrous. High-debt areas have been plagued with delinquencies, deleveraging, and the inability to refinance into lower rates — all characteristics of overleveraged households.
Further, low levels of consumption in high-debt areas continue to be a major drag. For instance, in the second quarter of 2011, auto sales in U.S. counties with the most debt remained a whopping 40 percent below their 2006 levels. By contrast, in areas that had healthy balance sheets before the recession began, the declines in spending were short-lived and a robust recovery is under way.
That would appear to provide more evidence for Richard Koo’s balance sheet recession hypothesis.
I think it’s pretty obvious that, if the problem is too much indebtedness, the solution is less indebtedness. A graph at something I linked to earlier today suggested an enormous distance yet to go. Tragically, the rate at which indebtedness is declining has actually slowed. Additionally, I can’t help but wonder if there’s a qualitative difference between a decline in indebtedness due to paying off a loan and a decline in indebtedness due to foreclosure. The preponderance of the decline seen so far has had the latter cause.
Canada’s fiscal progress didn’t happen because of the economy—that much is certain. It took years of painful retrenchment and tax increases, and it took public acquiescence to make it stick. For America, it will end up playing out much the same way. And the process will be contractionary, deflationary, and very bullish for the bond market as supply recedes, and ultimately pave the way for more sustainable economic growth, including the return of capitalism.
I don’t have a problem with first aid but it must be accompanied by treating the underlying problems or your efforts are futile. If the underlying problem is household debt, fiscal stimulus per se is no solution. I have heard very, very few proposals for reducing household debt. Presumably, the Powers That Be believe in the Think System. Think, men, think! That’s sure to do it.