His post is here. I will insert my answers.
Why is housing investment still so far depressed below any definition of normal?
In the U.S., politicians shifted from punishing mortgage lenders for making type II errors (turning down borrowers for loans that might have been repaid) to punishing them for making type I errors (lending to borrowers who might default). In addition, politicians interfered with the foreclosure process. This kept markets from returning to normal, and it further discouraged mortgage lending. What good is the house as collateral for a loan in a world where the government keeps the lender from getting at it?
Why has labor-force participation collapsed so severely?
I believe that this is a trend, amplified by the cycle. Many workers are facing stiff competition from foreign labor and from capital. At the same time, the non-wage component of compensation has gone up, because of health insurance costs. These factors put extreme downward pressure on take-home pay for many workers, and they have responded by dropping out of the labor force.
Why the very large spread between yields on safe nominal assets like Treasuries and yields on riskier assets like equities?
I lean toward a Minsky-Kindleberger answer. During the Great Moderation, confidence in financial intermediation grew. We thought that banks had discovered new ways to manufacture riskless, short-term assets out of risky, long-term investment projects. Then came the financial crisis, and distrust of financial intermediation soared. This made it harder to convince people that you could provide them with riskless, short-term assets backed by risky, long-term projects.
Why didn’t the housing bubble of the mid-2000s produce a high-pressure economy and rising inflation?
It took place in the context of the long-term trend to displace many American workers with capital and with foreign labor. The bubble took us off that trend and the crash put us back on it.
To what extent was the collapse of demand in 2008-2009 the result of the financial crisis and to what extent a simple consequence of the collapse of household wealth?
Great question. It appears that the collapse of household wealth is a sufficient explanation. But if so, then what was the point of TARP and the other bailouts? Of course, putting on my PSST hat, I would reject a phrase like “collapse of demand.” I would say instead that in the wake of the financial crisis, the psychology of existing businesses was that it was a good time to shore up profits by trimming the work force, and the psychology of entrepreneurs was that it was not a good time to try to obtain funding for new businesses.
Why has fiscal policy been so inept and counterproductive in the aftermath of 2008-9?
Not a question that I can answer, given that we disagree on what constitutes inept and counterproductive.
Why hasn’t more been done to clean up housing finance (in America) and banking finance in Europe)?
Politicians care about what happens on their watch. That is why you can count on them to bail out failing financial firms (“Yes, we should worry about moral hazard. But risk some sort of calamity because of a visible financial bankruptcy? Not on my watch.”) That is why you can count on them not to institute major financial reforms. (“Of course, we need a new design here. But do something that could cause short-term disruption to some constituents? Not on my watch.”)
Incidentally, I diagnosed the “not on my watch” bias toward bailouts way back in 2008. Also in September of 2008, I wrote,
Five years from now, we could find ourselves with no exit strategy. My guess is that we’ll be pretty much out of Iraq by then. But it would not surprise me to see Freddie and Fannie still in limbo.
You can read Robert Waldmann’s answers here. Pointer from Mark Thoma.
“Why didn’t the housing bubble of the mid-2000s produce a high-pressure economy and rising inflation?”
The housing bubble WAS inflation: more money was made available to a single asset class via credit, and its price rose. That’s inflation. Just because economists measure inflation incorrectly doesn’t mean it didn’t happen.
And then we used the home equity loans to finance the building of offshore factories to feed our trade deficit…it seems. We should have known that didn’t make any sense.
Why does a bubble have to cause an overheated economy? This is the question of the day for the stock market.
Actually, the better response to Brad DeLong via Dave via ASK is that inflation didn’t happen because of the housing bubble because if properly measured inflation would have been recognized they might have done something about it sooner.
That doesn’t really answer the question because it’s simply claiming semantic authority. Even if you believe that the rising price of housing is a better measure of inflation, it still doesn’t answer the question of why such inflation did not radiate through CPI/PCE/Deflator measures in the form of heated level rises. Where was the generalized effect?
One of the generalized effects was to finance the creation of the offshore factories that kept prices of consumer products and labor down.
Dave:
The term, “inflation”, is associated with consumption goods, not investments/investment goods – and housing is considered an investment good. So the mid-2000s housing bubble is more accurately thought of as a mal-investment, rather than an inflation – where a mal-investment is defined as an investment which fails to deliver anticipated (at time of purchase) future gains or cash flows.
If you are okay with that description/framework, the answer to DeLong’s question is obvious – mal-investments don’t produce the returns/cash flows anticipated, and required, to fuel a “high pressure economy and rising inflation”.
Inflation is an expansion of the money supply (including credit). CPI and other inflation measures are attempts to measure it. My point is simply: there was clearly inflation in housing due to an influx of credit to housing which raised prices. Second, housing is, at least in part, consumption, even when you purchase rather than rent.
Your narrative about labor force participation seems plausible, but it’s not borne out by the data. There was a one time bump in female participation and there are small cyclical fluctuations, but within age groups, the trend has been very linear for decades, with a drop of about 1% per decade. This probably has more to do with rising wealth than competition.
“Why the very large spread between yields on safe nominal assets like Treasuries and yields on riskier assets like equities?”
Treasurys aren’t safe assets. The risk has been foisted over the wall. So, while the government might bail out banks, it will even more certainly bail out itself. When was the last time the scale of the government was a good thing for it’s ‘financial intermediation’? Let’s start the bidding at 50 years ago, and I’m not sure which way to proceed from there.
This is, of course, where the PSST shines. Even if you know what lies past the tumult of the recalculation sea, you won’t know which ships will have made it to the other side. Paper assets, first of all must be backed up by actual assets, and secondly have to be enforced by the government.
Demographics and the financial crisis are also linked to the downturn in the housing market. Older people are trying to make up for their retirement fund losses by tapping the value of their houses. Housing demand decreases with age. Since they are more likely to own more of their houses they have more room to drop prices when they sell. I think this is going to be a long-term trend and will only get worse as the children start inheriting these houses.
It’s pretty clear that boomers overconsumed housing, and that will reverse as they age and move from 3br houses to apartments and retirement homes. But crisis stopped residential investment, creating a potential shortage as the millenials start to form households. Millenials are larger cohort than boomers.
“Why didn’t the housing bubble of the mid-2000s produce a high-pressure economy and rising inflation?”
We DID observe rising inflation*, in house prices.
We all need to forget the notion that inflation is even. It’s not. Money is non-neutral in the short run and where new money enters the economy matters. In this case it entered into the economy via residential lending, and so the main effect was felt on house prices. There was some secondary outward radiation of inflation pressure through the channels of cash-out refis and increased household (paper) wealth. That secondary inflation was far too general to show up in any particular sort of goods, rather it showed up unevenly with respect to geography. Vegas. Miami. Phoenix.
The idea that inflation was low because the core CPI was low is asinine. Money was being pumped into the economy and it was having all the predictable effects thereof. We just chose definitions that blinded us to those facts.
* Dave’s point above about “inflation” being a change in the money supply rather than prices is well put. The subtle redefinition of this term in the early 20th century has done incalculable damage to our understanding of monetary economics. I use the modern definition here only reluctantly.