It’s a good question that someone asked me to speak to the other day, and here’s what I’ve got so far:
–Not because it was bigger: according to established bubble-ologist Dean Baker, the 1990s dot.com bubble was, if anything, larger than the 2000s housing bubbles: he has the former at $8-$10 trillion of bubble-induced wealth and the latter at $8 trillion. I don’t think anyone, including Dean, would swear by those numbers, but I don’t think there’s much of a case that the housing bubble was worse because it was a lot larger.
–Relative wealth effects from the housing bubble: Yes, there are a lot of people who own shares of stock but the vast majority of stock market wealth is concentrated at the top of the wealth scale: 80% of stock market wealth accrues to the top 10%; over a third to the top 1%. Housing wealth, however, became much more pervasive among the broad middle class as that bubble inflated, so the wealth effect was more diffuse. Thus, when it fizzled, the demand contraction was more broadly generated across both income and geography.
–Equity bubbles versus debt bubbles: Exploding debt bubbles just take a lot more time to mop up than equity bubbles. Simply put, “mark-to-market” recognizes asset losses much faster than “extend-and-pretend.” As I wrote of few years ago, “The fact that your pet rock shares go from valuations of $1,000 on Friday to $1 on Monday rips the bandaid off in a way you don’t get when banks can inflate for months on end their balance-sheet value of non-performing loans.”
As Bob Hall put it recently, in a very on-point discussion of the question of this post:
The contrast between the 2001 recession and the Great Recession in 2007 to 2009 illustrates the difference [of the impact on the US financial system]. In 2001, the value of business assets, especially tech-related assets, fell dramatically, but the financial system showed no signs of stress. Financial institutions had little exposure to business assets. The stock market communicated losses directly to investors with no bank-like intermediation. In the Great Recession, banks and other financial institutions became insolvent or nearly so because of direct and indirect exposure to real-estate values. The stock market fell by about the same percentage in both recessions. In the Great Recession, the fall occurred because the adverse forces from the real-estate crash appeared to threaten a collapse of the whole economy.
It’s a bit tangential, but this also reminded me of a segment in an NYT piece the other day about ongoing weakness in the European economy:
The state of banks in Europe is crucial for the economy because European companies are more dependent on bank credit than American businesses. Unlike the United States, Europe lacks a vibrant market for corporate bonds issued by smaller, riskier companies.
In other words, Europe’s taking even longer to pull out of the last downturn in part because their still-recovering banks intermediate more credit flows to businesses than ours do.
–ZLB and inflation: The fact that the Fed’s main interest rate—the federal funds rate, or FFR—has been at the zero-lower bound since around 2009 has of course been a primary constraint on a policy-driven recovery. The 2001 recession never hit the lower bound, but the figure below suggests that this was in part due to the fact that it was much shorter.
Since at the ZLB, the real interest rate is the negative of the inflation rate (real int rate=nom rate – inflation rate), another suspect as to why this recovery’s been more of a slog (though see last point below on this) is our low inflation rate. Though the numbers jump around a bit, there’s something to this. As the figure at the end shows, inflation (core PCE) looks to be about a point lower now, give or take. The policy implication is that had the Fed targeted higher inflation in recent years, a lower real interest rate could have hastened the recovery.
—Fiscal Policy: That’s monetary policy. What about fiscal policy? The output gap was so much larger in this downturn than the last one (see “Part II” here), due in part to the differences noted so far, that you’d expect a lot more stimulus in the recent downturn. According to (pretty outdated) CBO data on this question, that is in fact what happened, but as I and others (particularly Krugman) has endlessly stressed, our policy makers recently pivoted way too quickly to deficit reduction and that too has made it much harder to repair the damage from the housing bubble.
–It wasn’t! That is, maybe the housing bubble wasn’t more damaging than the dot.com bubble. Since in many ways, it clearly was (the output gap, job losses), let me explain what I mean here.
The 2000s was a uniquely bad economic recovery—it was the weakest jobs recovery on record going back to the 1940s. GDP growth was relatively weak, as was business investment (as distinct of course from housing over-investment). Potential GDP growth slowed significantly. Productivity growth started strong and ended weak. Median household incomes for working families fell sharply in real terms. Larry Summers weaves a compelling story about secular stagnation in these years.
It’s also the case, btw, that the rate of employment growth in this recovery is about the same as that in the last one, though this time, of course, we’re growing out of a much deeper hole (see payroll employment figure here, comparing job growth over past recessions/recoveries; note similar slopes to yellow and red lines).
I don’t want to oversell this point, because of the relative magnitudes of the output gaps: they’re so much larger this time around. And the differences underscored above regarding debt versus equity bubbles, the scope of the wealth effects, the ZLB and the austerity pivot, are all important.
But the point is that bubbles are deeply damaging. Some less so than others maybe, but even there, a longer term perspective of the lasting damage is sobering. No one’s saying we shouldn’t have a business cycle. They’re endemic. But there’s no reason why it has to be a shampoo cycle: bubble, bust, repeat.