The Balance Sheet Recession Is Really A Consumer Crisis

by: Cullen Roche

Paul Krugman doesn’t understand the position of Richard Koo or those that believe in the balance sheet recession. He says:

“Thoughts on the others: I really don’t understand Koo’s position. I agree with him that a lot of people are debt-constrained, and cannot respond to lower real interest rates by spending more. But not everyone is in this position — if nothing else, by definition there must be creditors as well as debtors, so someone is able to respond to interest rates. In general, it’s almost always a bad idea in economics to assume that incentives of some kind don’t matter at all.”

Now, I am not sure MMTers should be bunched in with Koo. We actually disagree on quite a bit, even though the basics of our arguments are the same. But that’s not entirely pertinent right now. What’s important is that we identify the crux of the problem in the US economy and attempt to resolve it. I think the BSR theory identifies that issue and applies the most direct aid in helping to resolve it.

What is occurring in the US economy is very specific, from our perspective. The US consumer, the undeniable engine of growth in this economy, is suffering from some sort of rare disease that has caused their spending to decline to unusually low levels. For instance, personal consumption expenditures have averaged 7.1% since 1960, but have notched just 2.2% gains per year since 2008. In addition, consumer borrowing has cratered and actually gone negative. This means the demand for more debt is just not there. These aren’t unusual events. They are flat-out anomalies. Events that do not exist in the post-World War II era.

The point that Dr. Krugman appears to be missing is the specificity of this being a consumer debt issue. Are corporations healthy? Yes. They’re making record profits. Are banks healthy? Yes. They’re also making record profits. So is there some level of cash hoarding going on in the US economy? Yes. But looking at the aggregate picture misses the entire point. What has occurred since 2006 is something quite extraordinary. Incomes have been stagnant, the unemployment rate has surged to 9.1% and the liabilities of US consumers are only back to 2007 levels. So what’s happening is that US consumers are servicing bubble era debts with post-bubble era incomes. Sentier Research estimates the real median income loss at a staggering 9.8%:

For the entire period from December 2007 to June 2011, real median annual household income has declined by 9.8 percent. A decline of this magnitude represents a significant reduction in the American standard of living.

So, what happened when the real estate bubble exploded was that debt-to-income levels reached a point of unsustainability and are now reversing. As a result, households are not hoarding cash. They are diverting an unusually high level of their income from spending to servicing debts or just trying to get by on necessities. So while there might be some level of cash hoarding at the corporate level, it is the consumer who is unusually distressed. After all, they’re not marching on Wall Street because they have an “excess money” problem.