Aggregate Demand And Regional Demand Shocks

by: Scott Sumner

Here’s Jordan Weissmann:

The blue line traces the consumer-spending trend in states where home prices fell the least, while the red line traces it in states where they fell the most. Each group contains about 20 percent of the U.S. population. And as you can see, the crash states are still well behind. . . .

Sufi and Mian have made the academic case that spending before the recession really was driven by the “wealth effect” of rising home prices. People saw their housing values rocket up, and felt richer. Often, they took out second mortgages to spend. When the market crashed, so too did their finances. It may sound like an intuitive point to some, but it’s a key part of understanding why the recovery has been so underwhelming. The difference between states that got the full brunt of the housing collapse and states that didn’t, as shown in this chart, suggests that its scars are still very much with us. And they probably will be for a long while. (emphasis added)

It’s important to distinguish between regional shocks and aggregate shocks. All parts of the US use the same type of money, and hence all are affected by the same monetary shocks. On the other hand the relative performance of various regions is dependent on all sorts of real variables. The factors that cause some regions to do worse than other regions play absolutely no role in the slow growth in aggregate demand since 2008, which is 100% a monetary policy failure.

The following analogy might be helpful. Imagine a lake where the water level is controlled by the operators of a dam. Also assume that the surface of the lake is very choppy, due to high winds. The factors that explain the peaks and troughs of each wave have nothing to do with the factors that explain the average level of water in the lake. In the same way, Federal Reserve policy determines the rate at which NGDP rises in the typical state, whereas local real factors explain why NGDP grows faster in some states than others.