16 January 2016
Economists generally agree that the worst recessions of the past century are the Great Depression that began in 1929, the Japanese recession that began in 1991, and the Great Recession that began in December 2007. The three share several features in common. They were all preceded by massive asset bubble collapses, they were stubbornly resistant to the remedial efforts of governments and central banks, and they set economists debating about the fundamentals of macroeconomics. But in one important respect Japan's "lost decade" is completely different from the other two. Indeed, it does not even deserve to be called a recession.
That is a strong claim to make, and we hope the reader will be patient while we explain. A good place to start our analysis is the recession of 1945. In 1943 Paul Samuelson, then a young but rising economist, predicted that if the US war machine was suddenly wound up "there would be ushered in the greatest period of unemployment and industrial dislocation which any economy has ever faced." No one paid heed to Samuelson's warning and the US war effort was brought to an end very rapidly. The result was a 12.7% peak-to-trough drop in output. To put that in perspective, the Great Recession saw only a 4.3% drop in output. But none of Samuelson's dire predictions came to pass. The Dow Jones industrial index rose by 20%. There was no pileup in inventory. Companies managed to sell all they could produce. In fact demand exceeded supply and inflation ran at 2.3%. Unemployment was around 5%.
The explanation is involved. During the war, through a combination of rationing and the sale of war bonds, forced personal saving rose to around 25% from less than 5% before the war, so pent-up savings were high at the end of the war. But it was not that people ran down their accumulated saving during the 1945 recession. If that were the case then the saving rate would have turned negative, which it never did. It was rather that people cut their saving rate sharply though it still remained higher than the level before the war. So although output and thus personal income fell by more than 12% this loss in aggregate demand was compensated by the fall in the saving rate. Thus aggregate income fell but not consumption demand. The 1945 recession was a GDP recession, and a very severe one at that, but it was not a consumption recession. There was no pain. That is why the history books refer to it as "technically a recession". My book Macroeconomics Redefined has a detailed model of what happened during the war and recession that followed.
The 1945 recession is a warning that in order to gauge the severity of a recession economists should be looking at consumption instead of GDP. The graph below shows year-on-year changes in real personal consumption expenditure in the US from 1960 to 2015. To calculate real personal consumption expenditure I have used Personal consumption expenditure from the St Louis Federal Bank site and adjusted for inflation using the consumer price index for all urban consumers. What is readily seen is that the recessions of 1960-61 and 2001 were very mild and hardly deserved to be termed recessions from the viewpoint of consumption. The 1973-75 recession, the Volcker recessions, and the Great Recession were very severe. The 1991 recession was moderately severe.
When Japan's equity and real estate bubbles burst around 1991, the principal blow fell on companies and banks. Consumers were comparatively unaffected. Companies that took hefty hits to their balance sheets responded by cutting output and investment. This meant a loss in aggregate income. But consumers responded by cutting their saving rate, which fell from 13.3% in 1991 to 6.3% in 2003 [The Causes of Japan's ?Lost Decade': The Role of Household Consumption by Charles Yuji Horioka, March 2006, National Bureau of Economic Research], and continued to fall thereafter. Unlike in the US during the Great Recession, where consumers raised their saving rate and thus caused a fall in aggregate demand, Japanese consumers mitigated the fall in aggregate demand (caused by a fall in investment and output) by cutting their saving rate. As a result, household consumption expenditure as a percentage of GDP rose from 52.82% in 1991 to 61.14% in 2013. (data from Index Mundi: Household final consumption expenditure in constant yen)
The graph below shows that the YoY growth rate of real consumption became negative only briefly in 1998, seven years after the crash, and then again during the 2008-09 global recession.
Upto this point the Japanese experience followed the pattern of the 1945 recession in the US. But there the parallel ends. US company balance sheets improved during the course of the war. So they could respond to increased consumption demand by stepping up investment. In Japan companies found their balance sheets ravaged by the combined equity and real estate bubbles. So even if they wanted to increase investment they could not because of the sheer absence of money. In Japan the fall in aggregate demand was caused by a fall in investment demand, not principally a fall in consumption demand. In the Great Depression and the Great Recession the fall in aggregate demand began with a fall in consumption demand to which companies responded by cutting investment sharply.
When one understands the mechanism of the Japanese recession it is also easy to understand why neither the huge fiscal spending nor the cut in interest rates to near zero levels had much impact. Fiscal spending works by reversing the fall in personal incomes (and thus consumption demand) caused by a fall in investment demand. In Japan there was never a sharp fall in consumption demand because the high saving rate enabled Japanese consumers to counter the fall in personal income by cutting their saving rate. So although pouring millions of tons of concrete put money into consumers' hands it did not help companies to raise their investment.
Monetary policy was ineffective for the same reason. A cut in interest rates works by cutting the cost of capital to below the expected return on capital and thus making more projects viable. But in Japan there was never a substantial fall in the return on capital. Consumers had all along been willing to buy whatever was available to be bought. The problem for firms was not the cost of money so much as the sheer non-availability of money. Companies had no money because they had lost gargantuan amounts in the crash. And they could not borrow because banks had been fellow victims of the crash.
The one piece of advice the Japanese central bank should have followed was that of Walter Bagehot, tendered in the 19th century: "Lend freely, at a high rate, on good collateral." But because it was not backed by the elegant mathematical models of the kind now favoured by economists no one paid it any heed.
11 January 2016
The St Louis Federal Bank web site has a paper entitled Why Did Loan Growth Stay Negative So Long after the Recession? by Maximiliano Dvorkin and Hannah Shell.
The first graph on it shows that QoQ loan growth turned negative soon after the start of the 2007 recession and stayed negative for a long time thereafter. This was in sharp contrast to the recessions of 1990-91 and 2001. The paper concludes that both the demand for loans and the supply of loans played a role in this behaviour.
One way of estimating the demand for loans is to graph the movement of Real Personal Consumption Expenditure. Below I have drawn a graph of Real PCE for the three recessions and it is noteworthy how closely the line for the 2007-09 recession follows the graph of loan growth in the above-mentioned paper compared with the previous two. It seems that the 2007-09 recession was much more a demand-driven recession compared with the others.
Why should Real PCE growth be related to the demand for loans? The reason is that capitalists make investments depending on the change in consumption compared with the previous time period. Remember that in Paul Samuelson's famous accelerator paper of 1939, I(t) is a function of C(t)-C(t-1).
05 December 2015
Most recessions in the US are triggered off by the Fed squeezing during a monetary contraction after permitting a long period of expansion. This time seems to be no different, as the graph below shows.
YoY monetary growth as on 1 October 2015 was down to 2.8%. If the fall continues at the same pace we should see signs of financial distress as early as the second half of next year.
14 November 2015
Most successful plays derive their success by inducing a willing suspension of disbelief in their audience. Bertolt Brecht's historical plays tried to do exactly the opposite. In the course of these plays members of the cast would hold up placards and engage in other disruptive acts intended to disabuse the audience of the idea that they could identify with the action occurring on stage.
Brecht was a Marxist. And his technique was based on the Marxist premise that man's consciousness is a product of the modes and relations of production of the period in which he lives. Therefore, it is impossible for us, who live in an era of advanced capitalism, to identify with people whose ideas and actions were shaped under different modes and relations of production. Although I am no longer a Marxist, I think that there is substantial truth in the idea, at least in the weaker notion that we cannot view the past through the lens of the present.
If A destroys a Hindu monastery we would think it safe to label A as anti-Hindu. And if B provides resources to rebuild the monastery we would similarly think it right to label B as pro-Hindu. But when the monastery in question is Sringeri, one of the four mutts set up by Adi Sankaracharya, we run into problems. The monastery was plundered by the Marathas and help in rebuilding it was provided by Tipu Sultan. That would make him pro-Hindu.
But historical records show that Tipu destroyed many temples (reports of the number run from tens to thousands), especially in Kerala. That would make him a rank communalist by our standards. On the other hand his prime minister and commander in chief, among many senior officers, were Hindus. Tipu is also said to have provided annual grants to 156 temples. The Sringeri mutt, mentioned earlier, was plundered by the Marathas in the course of the third Mysore war, which was fought by Tipu on one side and the East India Company on the other allied with the Marathas and the Nizam. The web site of the Sringeri Mutt says: "On several occasions Tipu sought the blessings of the Acharya. He once wrote that he depended upon three sources of the [sic] strength — God's grace, the Jagadguru's blessings and the strength of his arms. He requested the Acharya to perform Satachandi and Sahasrachandi japa and homa. In the subsequent letter the Sultan acknowledged the miraculous effects of the Yaga that led to success in his enterprise and how rains poured and the land flourished." That would make him distinctly unIslamic.
All in all, when we look at Tipu with 21st-century eyes it is difficult to make any sense of him.
But perhaps he was not so unusual by the standards of his own time. Economic productivity was very low, so it was at least as profitable to seize wealth produced by others as it was to produce wealth yourself. Hence the frequent wars of the era. For all kings, it also would have made economic sense to ensure peace and social harmony within their own realms. So Tipu, in keeping the temples of his own kingdom in good humour while destroying those outside, was not being very different from the Marathas, stories of whose depredations outside their own territory are legion.
How economics changes the nature of wars can be seen in the course of the past hundred years. World War I was fought over the question of colonies. Even in World War II lebensraum was an important motivation. Since then, however, most wars have not been fought with the intention of acquiring territory and permanently holding on to it. Two factors have come into play. First, wars now are expensive to fight and very destructive. Second, economic productivity is so high that it is cheaper to produce wealth yourself rather than try to forcibly acquire it from others. If wars are far less frequent now than in centuries gone by it is not because man's ethics have soared high, but because of economics.
In trying to understand Tipu, it is good to keep that in mind.
15 October 2015
When Samuel Johnson observed that "Patriotism is the last refuge of a scoundrel" he must have had someone like the Shiv Sena's Sanjay Raut in mind. After Shiv Sainiks smeared ink or paint on Sudheendra Kulkarni's face a few days ago Raut said: "Smearing ink is a very mild form of democratic protest. They are so upset over ink. Imagine when our soldiers are killed and their blood is spilled. It is not ink, it is the blood of our soldiers." (timesofindia.indiatimes.com/india/Kasuri-book-launch-We-will-continue-our-protest-Shiv-Sena-says/articleshow/49323040.cms)
I cannot think of a better way to malign our brave jawans. The jawans fight armed men and are often killed. The Shiv Sena through its long history has only targeted people who cannot hit back. When it is criticised by the media it attacks newspaper vendors, burns newspaper vans but is never around to face the consequences. Shiv Sainiks always attack in packs so that they cannot be identified. On the rare occasion that they are arrested they usually deny participating in the attacks. The jawan displays courage at every instant. The Shiv Sainik is cowardice personified.
Talking of jawans reminds me also of the Lata Mangeshkar song which brought tears to Nehru's eyes. Some of its most moving lines are these:
Koi Sikh, koi Jat Maratha,
Koi Gurkha, koi Madrasi,
Sarhad par marne waala har veer tha Bharatvaasi,
Jo Khoon giraa parvat par woh khoon tha Hindustaani
During its brief history, the Shiv Sena has targeted Gujaratis, south Indians, Muslims, north Indians and, most recently, Jains. If ever a party deserves to be called anti-nationalist it is this party which has arrogated to itself the right to issue labels of nationalism.
How cowardly can this party get? I quote from a 1999 article in a newspaper I used to publish: "One day .. [this was in 1986 or 1987] the Shiv Sena chief Bal Thackeray summoned some Sikh notables to a press conference. He said that he would not tolerate any more killings of Hindus in Punjab and told the Sikh leaders that they would have to go to the Golden Temple to convey Thackeray's message to the terrorists there. The Sikhs were of course worried. Given Thackeray's history he might order his Shiv Sainiks to ransack their homes. But the next week they turned the tables on him. Yes, they said, they would travel to the Golden Temple, but Thackeray would have to accompany them. That was of course the last that anyone heard from Thackeray on the Punjab problem. He is of course very happy to order his Sainiks to go on the rampage but when asked to demonstrate personal courage he simply placed his tail between his legs and ran for cover. When you stand up to bullies they back down." Cocooned within layers of state-provided security even an arthritic mouse can put up a good imitation of a tiger's roar.
As an aside, not long before Bal Thackeray decided that Punjab terrorism was best fought from within the safe confines of Matoshri, Sudheendra Kulkarni travelled in Punjab reporting on the anti-terrorist movement there, and running a real risk of being killed. If I recall rightly, he wrote mainly about the fight put up by the Communist Party of India; those were his leftist days. Wikipedia tells me that 200 members of the party were killed by terrorists. How many Sainiks have ever been killed fighting against people who could hit back?
It does not take much courage to wave a slaughtered chicken in front of a Jain temple in Mumbai. If Sanjay Raut really wants to offend people who will fight back, he should try carrying a pig's head to throw in front of the Jamia Masjid in Srinagar. He might want to persuade the little Thackeray to come along. Even if he refuses, it might get him thinking about the nature of courage, which would be a huge advance, considering that his grandfather did not, and his father does not, possess an atom of it.
P.S. Correction: Thackeray's press conference was in March 1988.