Two Papers in Progress

There are two new papers on the articles page on this site. Both are work in progress – they haven’t been submitted anywhere yet.


[I’ve taken the debt-distribution paper down. It’s being revised.]

The Evolution of State-Local Balance Sheets in the US, 1953-2013


The first paper, which I presented in January in Chicago, is a critical assessment of the idea of a close link between income distribution and household debt. The idea is that rising debt is the result of rising inequality as lower-income households borrowed to maintain rising consumption standards in the face of stagnant incomes; this debt-financed consumption was critical to supporting aggregate demand in the period before 2008. This story is often associated with Ragnuram Rajan and Mian and Sufi but is also widely embraced on the left; it’s become almost conventional wisdom among Post Keynesian and Marxist economists. In my paper, I suggest some reasons for skepticism. First, there is not necessarily a close link between rising aggregate debt ratios and higher borrowing, and even less with higher consumption. Debt ratios depend on nominal income growth and interest payments as well as new borrowing, and debt mainly finances asset ownership, not current consumption. Second, aggregate consumption spending has not, contrary to common perceptions, risen as a share of GDP; it’s essentially flat since 1980. The apparent rise in the consumption share is entirely due to the combination of higher imputed noncash expenditure, such as owners’ equivalent rent; and third party health care spending (mostly Medicare). Both of these expenditure flows are  treated as household consumption in the national accounts. But neither involves cash outlays by households, so they cannot affect household balance sheets. Third, household debt is concentrated near the top of the income distribution, not the bottom. Debt-income ratios peak between the 85th and 90th percentiles, with very low ratios in the lower half of the distribution. Most household debt is owed by the top 20 percent by income. Finally, most studies of consumption inequality find that it has risen hand-in-hand with income inequality; it appears that stagnant incomes for most households have simply meant stagnant living standards. To the extent demand has been sustained by “excess” consumption, it was more likely by the top 5 percent.

The paper as written is too polemical. I need to make the tone more neutral, tentative, exploratory. But I think the points here are important and have not been sufficiently grappled with by almost anyone claiming a strong link between debt and distribution.

The second paper is on state and local debt – I’ve blogged a bit about it here in the past few months. The paper uses budget and balance sheet data from the census of governments to make two main points. First, rising state and local government debt does not imply state and local government budget deficits. higher debt does not imply higher deficits: Debt ratios can also rise either because nominal income growth slows, or because governments are accumulating assets more rapidly. For the state and local sector as a whole, both these latter factors explain more of the rise in debt ratios than does the fiscal balance. (For variation in debt ratios across state governments, nominal income growth is not important, but asset accumulation is.) Second, despite balanced budget requirements, state and local governments do show substantial variation in fiscal balances, with the sector as a whole showing deficits and surpluses up to almost one percent of GDP. But unlike the federal government, the state and local governments accommodate fiscal imbalances entirely by varying the pace of asset accumulation. Credit-market borrowing does not seem to play any role — either in the aggregate or in individual states — in bridging gaps between current expenditure and revenue.

I will try to blog some more about both these papers in the coming days. Needless to say, comments are very welcome.

3 thoughts on “Two Papers in Progress”

  1. I find your ideas on debt very interesting even if it pushes back against commonly held ideas among the left. I’m not an expert and will take time to delve into the numbers but my first thought is about the distinction between private and public debt.

    The common story is that private debt becomes a problem when too much of it is created and then there’s the Minsky moment when it can’t be serviced and the pyramid scheme collapses. (I know you’ve discussed Minsky and how for him the “ponzi” phase isn’t literally a ponzi scheme, etc.)

    But then the government comes in and takes over the debt, like with the Fed expanding its balance sheet. Does this enter your discussion?

    I’ve never quite gotten a handle on discussions of central’s banks balance sheets, but it seems to me they can hold on the liabilities for ever and keep printing money, etc. Advanced economy central banks are pretty far away from capital strikes or runaway inflation crises which mainstream economists and pundits always wring their hands about.

    Anyway, very interesting subject and I suspect you’re right. Maybe debt crises are like capital strikes: they are allowed to happen, like when capital strikes are assisted by a complicit central bank.

  2. I am glad to see empirical research regarding the balance sheet positions of governments and households.

    The paper on household debt concludes with this phrase “over the past generation, the monetary system has operated in such a way as to inflate the value of existing financial claims.”

    Table 1 shows the percentage of household debt for residence, vehicles, consumption, and education for years 1989, 2001, 2007, & 2013. Debt for vehicles goes down from 10% to 5% of the total and education debt rises from 3% to 7% of total household debt.

    Am I correct to assume that total household debt roughly doubles after 1983 even though the structure of debt for these categories is roughly similar? The asset counterpart would be rising valuation of homes and perhaps rising valuation of a college degree? The college degree would have a valuation based on expected future income flows and I doubt that everyone who borrows for a degree will be able to repay debt on schedule … even less so than for housing investments … the lack of bankruptcy protection has put the student borrowers in default to asset holders including the Department of Education … so some of these debts should be considered either uncollectible or inflated balances on defaults.

    So after those comments what is causing asset prices to rise, the low inflation rate? Do you think it would be helpful to look into changes in bankruptcy or debt discharge to see if bad loans could be charged off would account for changes in debt levels and asset valuations, such as the difficulty discharging student loans? What about a discounted cash flow model for the national student loan portfolio which now appears to be quasi-predatory like credit card balances that inflate after default?

  3. First of all, two typos:

    p.18: “2011-2007” should be 2001-2007 I suppose;
    p.21: “Their figure showing the key results is reproduced here as Figure 7” I think it’s figure 3.

    Then, my personal opinion about your paper:

    I think that while you correctly show many errors in the most usual DDD story, your narrative is still consistent with underconsumption due to increased inequality.

    You say, at p.9: “This means that even when increasing consumption spending does increase the stock of debt (the numerator of the debt ratio), it also increases aggregate income (the denominator of the ratio)”.

    But increased spending can increase aggregate income only on the condition that the economy is not at potential; in other words this keynesian framework that you are applying already implies underconsumption.

    In a situation of underconsumption, the economy COULD produce 100, but only buys 80, so 20 are not produced (thus productivity is underestimated).
    In this condition an increase in spending causes an increase in realised income: for example if the government deficit-spends 20, this “creates” an increase in income, but this happen only because previously there was unused productivity, some slack in the economy.

    If we speak of underconsumption we can have 3 situations:

    1) Actual underconsumption: Workers can produce 10 muffins, his wage is 6, capitalist only eats 2, so we have a realised productivity only of 8, an apparent wage share of 75%, and a general stagnation in the economy as capitalists have small reason to ramp up production, realised profits are low (2/8 or 25%);
    2) Potential underconsumption: Worker still has a wage of 6, capitalist still consume 2, but someone increases consumption through debt, so all 10 muffins are produced, profits are high (40%), but the economy depends on a continuous increase in leverage;
    3) Something in between when there is an increase in leverage, but not enough to consume all the “slack”.

    Note that it isn’t important that the debt is incurred by workers, or directly in order to fuel consumption: even if middle-class guys are buying houses as capital assets, this increases demand for some sectors of the economy and helps going from 1 to 2.

    Finally, you say that the increase in debt ratios is caused mostly by low inflation and low growth; but this is exactly what we would expect if the economy was stuck in 1 or in 3 (as the low inflation is caused by low demand).

    Basically the underconsumption theory says that, as long as the wage share on productivity (not on realised income) is low, we can choose only between stagnation or financially induced booms, but both states are possible under an underconsumption situation.

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