The International Economy

At the International Economy: What’s Wrong with Abundant Liquidity?

(I am an occasional contributor to roundtables of economists in the magazine The International Economy. This month’s topic was the possible dangers of “today’s giant swirling ocean of liquidity”.)

Imagine a city that experiences a miraculous improvement in its transit system. Thanks to some mix of new technologies and organizational improvements, the subways and buses are now able to carry far more passengers at lower cost and the same level of service. Would we see that as good news, or as bad? It’s true that Uber drivers and gas station owners would be unhappy as abundant public transportation reduced demand for their services. And retailers and restaurants might face challenges in managing a sudden flood of new customers. But no one, presumably, would think the city should deliberately give up the improvements and return transit service back to its old level.

The point of this little fable should be obvious: liquidity, like transportations services, is useful. Having more of it is better than having less.

What liquidity is useful for, fundamentally, is making promises. It functions as a kind of collective trust. The world is full of socially useful projects that can’t be carried out because even a well-grounded expectation of future benefits can’t be turned into a claim on resources today. Liquidity is the fuel for these transactions. In a world of abundant credit and low interest rates, it’s easier for me to turn my future income into ownership of a home, or a business to turn future profits into new plant and equipment, or a government to turn future revenue into improved public services.

Someone with a great business plan but no capital of their own might try to get the labor and inputs they need to bring it about by promising workers and vendors a share in the profits. Unless the business can be launched with just the resources of immediate family and friends, though, it’s not likely to get off the ground this way. The role of the bank is to allow strangers, and not just those who already know and trust each other, to contribute to the plan, by accepting — after appropriate scrutiny — the entrepreneur’s promise, and offering its own generally-negotiable promise to the suppliers of labor and other resources.

Yes, when you make it easier to make promises, some of them won’t pan out. But we would like people to make more provision for future needs, not less, even if our knowledge of those needs is less than perfect. The most dynamic parts of the economy are the ones where there are the most risky projects, some of which inevitably fail.

Of course asset owners are unhappy about lower yields. But that’s no different from the complaints we always hear from incumbents when production improvements make something cheaper. Asset owners’ complaints are no more reason to deny us the socially useful services of liquidity than those of the proverbial buggy-whip makers were to deny us the services of cars. (Less reason, actually, given the concentration of financial wealth among the wealthiest families and institutions.)

Interest rates today are lower than at almost any time in history. So are the prices of food or clothing. We should see abundant liquidity the same way we see these other forms of abundance — as the fruit of the technological and institutional that has made us so much materially richer than our ancestors.

At The International Economy: How Worried Should We Be about Asset Bubbles?

(I am an occasional contributor to roundtables of economists in the magazine The International Economy. This month’s topic was “What about the Risk of a Bursting Asset Bubble?”, with corporate debt and equity mentioned as possibilities. Contributors were asked to rank their level of concern from 1 to 10. My response is below.)

Any time you have an asset held primarily for capital gains, a story that allows people to extrapolate from recent price increases to future ones, and a reasonably elastic credit system, you have the ingredients for a bubble. The question is not whether there will be bubbles, but how damaging they will be, and what steps we should take if we think one is developing in a particular asset market.

Corporate debt is an unlikely asset for a bubble. Unlike with equity, real estate, or currency, there are clear limits to potential capital gains. High levels of stock buy- backs are problematic for a number of reasons, but they don’t particularly suggest a bubble. When a greater share of corporate value added is paid out to shareholders rather than retained and invested or paid to workers, that may be bad news for the economy in the long run. But it is good news for owners of corporate stock, and there’s nothing strange about it being priced accordingly.

Cryptocurrencies are a better candidate for a bubble. It’s safe to say they are mostly held in expectation of capital gains, since they pay no income and, despite the promises of their boosters, have limited utility for transactions. It wouldn’t be surprising if their value fell to a small fraction of what it is today.

But that brings us to the question of how damaging a bursting bubble will be. The housing bubble was exceptionally damaging because housing is the main asset owned by most middle-class families, housing purchases are mostly debt-financed, and mortgages are a major asset for the financial system. It’s hard to see how a collapse of bitcoin or its peers would have wider consequences for the economy.

The other question is what to do about a bubble if we have reason to believe one is forming. One common answer is to raise interest rates. The problem is that, historically, there’s no sign that low rates are more favorable to bubbles than high ones. The 1980s savings and loan crisis took place in an environment of—indeed was driven by—historically high interest rates. Similarly, Sweden’s great real estate bubble of the late 1980s took place when rates were high, not low.

And why not? While productive investment may be discouraged by high rates, expected capital gains at the height of a bubble are too high for them to have much effect. This was most famously illustrated in the late 1920s, when the Fed’s efforts to rein in stock prices by raising rates did a great deal to destabilize European banks by reversing U.S. capital outflows, but had little or no effect on Wall Street.

A better policy in the face of a developing bubble is to directly limit the use of credit to buy the appreciating asset. Tighter limits on mortgage lending would have done far more than higher rates to control the housing bubble of the 2000s.

In other cases, the best policy is to do nothing. As economists going back to John Maynard Keynes have observed, a chronic problem for our economy is an insufficient level of investment in long-lived capital goods and new technology. To the extent that inflated asset values encourage more risky investment—as in the late 1990s— they may be even be socially useful.

By all means, let’s take steps to insulate the core functions of the financial system from speculation in asset markets. But holding macroeconomic policy hostage to fears of asset bubbles is likely to do more harm than good.

Weighing the chance of a major bubble along with its likely consequences, I’d put my concern over asset bubbles at three out of ten. The biggest danger is not a bubble itself, but the possibility that a fear of bubbles will prompt a premature tightening of monetary policy.

Is Productivity Being Undermeasured?

(I am an occasional contributor to roundtables of economists in the magazine The International Economy. This month’s topic was: “What are the policy implications if productivity growth is being under-measured in the official data?” My answer is below.)

How many hamburgers equal one haircut?

In itself, the question doesn’t make sense. They’re just different things. What we can compare, is how much they cost. This is true across the board: The only way we can convert all the endlessly varied objects and activities that make up “the economy” into a single number, is through their market prices. Markets are what let us express all the various products of human labor as a single quantity we call output.

This means that productivity is only meaningful in the context of market prices. There are lots of things that people do that are useful, important, even essential to economic life, from raising children to following the law, that can’t be expressed as output per hour.

So it doesn’t really make sense to ask if the nonmarket effects of technological change mean we are undermeasuring productivity. A new technology may transform our lives in all sorts of ways, but we can’t talk about its effect on productivity except insofar as its products are sold. There’s no other basis on which productivity can even be defined – we have to go by market prices. And what market prices are telling us is that productivity growth is slower than it used to be.

This slowdown is not really surprising. Manufacturing – where the transformation of work by technology has gone farthest, and where productivity growth almost always fastest – is steadily shrinking as a share of the economy.

It is true that we often think of economic growth as something broader than market prices. It’s supposed to describe a more general rise in living standards. So a more meaningful way to ask the question might be: Does measured productivity growth accurately reflect the material improvements in people’s lives?

The answer here is indeed no. But unfortunately, in the rich countries at least, the mismeasurement probably goes the opposite way as the question suggests.

Measures like life expectancy used to be closely linked with economic growth. In poor countries, this is still the case – higher GDP is associated with longer lifespans, lower child mortality, and similar improvements in health and wellbeing. If anything, today’s GDP growth may be associated with even faster improvement than we would expect based on the historical record. But in richer countries the opposite is true – higher GDP no longer translates reliably into better health outcomes. In some places – like the UK, and much of the US – life expectancy is actually falling, even as income per capita continues to rise.

Leisure time is another measure of wellbeing — presumably if people were having an easier time meeting their material needs, they would choose to take more time off work. (Adam Smith once suggested that the amount of leisure people enjoyed was the only meaningful standard of economic value across countries.¹) On this measure too, living standards seem to be falling short of GDP growth rather than running ahead of them. Between the end of World War II and the early 1980s, the average weekly hours of an employed American fell by about 15 percent. But since then, average hours per worker have been essentially flat. This makes the postwar growth performance look even better, and the more recent performance worse, than the headline numbers suggest.

It seems likely that measured productivity overstates, rather than understates, our real improvement in living standards, at least in the US. If so, the policy implications seem clear. Policymakers should worry less about growth, and more about concrete interventions that we know improve people’s lives – things like universal access to childcare and health care, high-quality education, and paid time off for all.