Are We Again Misdiagnosing The Problem?

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by: Scott Sumner

Back in 2008, most people misdiagnosed the economic crisis. A recession that was caused by tight money was wrongly assumed to be caused by a housing slump. The housing slump was partly exogenous (due to other factors) and partly endogenous (aggravated by tight money.)

Now we have a (much milder so far) global economic slowdown that is being attributed to the collapse of oil prices, a "problem" that is partly exogenous (fracking, the Saudis fighting back, etc.) and partly endogenous (slower NGDP growth reducing oil demand). Falling oil prices are clearly a problem for oil exporting countries, but they also benefit oil importers.

Is there a Keynesian savings/investment mechanism here? I don't see how, the oil exporters are massively reducing their saving rates. The only even halfway plausible story is "reallocation" as jobs are lost in oil production faster than they can be created elsewhere. That's possible, but that's a negative supply shock, which would raise inflation. Do you see inflation sweeping the globe? Me neither.

The following is from a Quartz article that attributes the global economic slowdown to falling oil prices:

We live in a time of bad forecasting of all types. Examples include the failed predictions of political pollsters gauging a host of critical elections around the globe, and the delusionary thinking that led to the last American economic catastrophe wreaked on the world-the 2008 mortgage crisis. It's hard to predict events, as Philip Tetlock described last year (paywall) in his book Superforecasting.

I would love for someone to explain how the American economic "catastrophe" wreaked havoc on the world back in 2008. The Great Recession ended up being worse in Europe than the US. The US housing shock might produce some incidental damage in other regions such as Europe and Asia, but surely not as bad as in the US. And if it were a negative supply shock then global inflation would have risen in 2009.

Most people, including me, strongly believe the global recession was a negative demand shock. But how could a subprime crisis in America reduce AD in Europe? The ECB controls the path of AD in Europe, and they didn't even hit the zero bound until 2013. Obviously the eurozone recession was mostly caused by tight money.

Falling oil prices didn't cause NGDP growth in the US to slow to 2.9% in 2015, the Fed did. Falling oil prices didn't cause China's official NGDP growth rate to fall to 5.8% in 2015, their decision to peg to a strongly appreciating dollar did.

This is a never-ending battle. There is an economic slowdown. At the same time one industry stands out because it is going through wrenching changes. Before it was housing, now it's oil. There's always something. Because pundits don't understand how monetary policy drives NGDP, they simply assume that whatever industry is in the headlines is what's causing the economic slump.

In some ways this is even worse than 2008. At least then the slumping housing industry was in the US, so you can sort of imagine how people would be fooled into thinking that it might directly impact our GDP. But regions like the eurozone import almost all of their oil. For decades we've been taught (correctly) that importing nations benefit from lower oil prices. And now we simply throw out mainstream theory and assume that for some magical reason importing nations are suddenly now hurt by cheap oil. Why are the stock prices of European firms that import their oil falling along with stock markets in the oil exporters?

At the beginning of 2014, the world was marveling in surprise as the US returned as a petroleum superpower, a role it had relinquished in the early 1970s. It was pumping so much oil and gas that experts foresaw a new American industrial renaissance, with trillions of dollars in investment and millions of new jobs.

Two years later, faces are aghast as the same oil has instead unleashed world-class havoc: Just a month into the new year, the Dow Jones Industrial Average is down 5.5%. Japan's Nikkei has dropped 8%, and the Stoxx Europe 600 is 6.4% lower. The blood on the floor even includes fuel-dependent industries that logic suggests should be prospering, such as airlines.

Heh world, don't abandon EC 101, it's the NGDP, stupid.

And please, can we have our NGDP futures markets now!?

PS. I have a new post at Econlog that addresses the question of why easier money sometimes raises long-term rates, and at other times lowers them.

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