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Conversation with Scott Sumner

As I mentioned in my previous post, over recent weeks I found myself in a conversation with Scott Sumner about the inevitability of debt-creation and debt-destruction cycles, and about what that means for effective monetary policy under today’s conditions.

Anyone who is interested in these questions may want to check out our back-and-forth in the comments section of this posting:

This conversation becomes even more interesting in light of the recent groundswell in support of Scott’s longstanding proposal that the Fed should shift its policy to one of explicitly targeting Nominal Gross Domestic Product (NGDP)as opposed to targeting some balance of low inflation and full employment. Scott has been pushing this idea for a long time, and now it seems the idea is quickly gaining traction on a lot of different fronts.

I think this is a HUGE deal, and a hugely positive turn of events (for reasons I will offer in a coming post).

As with any blog comments sections, there are comments a reader may want to skip over (comments that were all posted in the first few days). Within those early comments, though, Scott and I begin our conversation–a conversation that then continues to unfold after all the other commenters have moved on.

The discussion peters out a bit at the end… Actually, we picked it up again in a discussion surrounding one of his more recent posts about Matt Yglesius (, but I think there is a lot in here that people who care about this stuff might find interesting.

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Useful Charts

In the past few days I have found myself engaged in a conversation about (1) the notion that, at least under our current structures, our economy will inevitably see debt-creation and debt-destruction phases; and (2) my contention that unless we learn how to manage them more effectively, debt-destruction phases are exceedingly painful events.

Unfortunately, the commenting platform where the conversation is occurring does not support charts, so I decided to put up some charts that would inform the discussion here.

The first chart shows accumulated Household Sector Debt as a percentage of the US Gross Domestic Product from 1952 to the present. As one can see, prior to 2008, the only significant reduction in the ratio of household debt to GDP occurred in the recession that began in February of 1980. Other instances in which HH-Debt-to-GDP saw modest declines occurred either in a time of war (the late 60s to early 70s) or times of recession.

Interestingly, the one period in which economic growth was relatively robust while HH-Debt-to-GDP increased relatively modestly was the 1990s.

The next chart offers a different and, I believe, more interesting look at the relationship between changes in household debt and periods of recession.

This chart maps percentage changes in nominal household debt against periods of recession. Looking at this chart, the thing that immediately jumps out at you is the way that decelerations in household debt creation seem to almost inevitably lead into periods of recession. Eight out of the last nine recessions were preceded by decelerations in household debt creation. The one exception in the bunch was the recession that followed the events of 9/11.

There were also two instances where decelerations in household debt creation did not lead to a recession. The first of these was the deceleration that led into the 1967 economic slowdown. This was a significant slowdown, but it did not translate into a full-fledged recession. The second instance was a modest deceleration in the mid-1990s.

Another interesting thing to note from this chart is the way the ending of the recession was preceded by a reversal of the trend in household debt. In all recessions prior to the 9/11 recession household debt ceased decelerating and began to accelerate at least one quarter prior to the ending of the recession. This is not surprising, since the principal monetary tool used to end recessions is the lowering of interest rates to entice enterprises to begin borrowing again. And as Kydland and Prescott showed in their 1990 study Business Cycles: Real Facts and a Monetary Myth, household expenditures are the component that drives expansions and contractions in the overall economy (at least during the period we are looking at).

Note: This second chart reflect data from the Federal Reserves Flow of Funds tables, and in order to highlight the correlations, the first quarter of each year includes a seasonal adjustment. Without the seasonal adjustment, the chart takes on a gap-toothed look.

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