Leverage/Deleverage: The Timing’s Off…

February 8th, 2013 at 7:22 pm

For a while, you couldn’t read an economics’ blog without running into a figure like the one below on the leveraging and deleveraging dynamics of the federal government and household sectors.  Each line shows the change in debt (household or gov’t) to GDP, smoothed over four quarters.

In defense of the budget deficits that built up over the Great Recessions (and are now receding—Fig 4 here), the figure made the important point that as the household sector aggressively deleveraged, the public sector needed to leverage up to replace some of the lost demand.

But what’s happening now looks to me to be a timing problem: the pace at which the government is deleveraging (reducing deficits) is too fast relative to the household sector getting back in the game.

I’m not saying the slopes should be equal (in absolute value) and I can’t honestly say what a healthy rebalancing would look like (i.e., in this type of picture–re other indicators, it would clearly mean moving towards full employment much faster than we are).  But I think the end of the picture, where I drew the arrows, is at least suggestive of the federal sector prematurely turning to deficit reduction while the household sector is too mired in high unemployment and weak paychecks to pick up the slack.  My sense is you’d want to be where we are now well after we’d worked off the large output gaps that still persist in the macroeconomy, with GDP about 6% below potential and unemployment at least 2.5 percentage points above full employment.

This issue of the timing of government policy over the crash has perhaps gotten too little attention relative to the issue of magnitudes.  I always thought the problem with the stimulus, for example, was less its size and more its duration.  Part of that was a function of policy makers thinking we could go back to the well if needed, only to find that path blocked by anti-Keynesians.


Sources: Flow of Funds, NIPA

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3 comments in reply to "Leverage/Deleverage: The Timing’s Off…"

  1. Misaki says:

    By that logic, the government clearly should have been deleveraging during the 2000~2004 time frame, since the household sector was going into debt at an increasing rate then.

    The reality is that neither the household nor the government needs to be going into debt to have a strong economy. If people have jobs, they don’t need to go into debt.

    And by working less we could create jobs.

  2. Tom M says:

    Hi Jared,
    While I haven’t studied your analysis closely, I would make 2 observations:

    1) is it possible the spike to nearly +3.5% in early 2009 for the government sector includes the TARP program, which boosted government debt at the most inopportune time, and then offset the increase in debt as the banks (most of them, anyway) paid it off? Of course, this swing won’t change the level of the federal debt we now have, but it seems it will affect the slope of the downward line you have for the government.

    2) are you including the central bank as part of the “government,” or just the Treasury? In it’s most basic form — and probably, from the markets’ point of view — quantitative easing (aka QE or LSAP) is probably not that much different from fiscal stimulus.

    As I see it, the HH sector is shrinking the size of its aggregate balance sheet (whether it is from paybacks or write-offs, matters not much except to the lender) while the “government” (i.e. both the Treasury and the Fed) are expanding the size of their balance sheets. One (over)simplified way to think about the Fed is that it is “just another arm of the government that is spending more than it is taking in,” and thus cushioning the households who — after leveraging up big time from 1980 to 2005, have been deleveraging since the financial crisis.

    As (I think I remember back that far) we learned in Econ 102, monetary policy is probably better than fiscal policy, because it is more responsive and easier to reverse when appropriate. Add to that another benefit: they don’t have to spend a lot of time arguing about exactly where the stimulus will be spent.

    Hopefully, as someone who worked so hard to ensure that the 2009-11 stimulus was targeted at useful and deserving targets, you will appreciate the advantage. In the case of the Fed, it is the “invisible hand” of the market that determines which enterprises are able to borrow and invest into the economy because of the Fed’s purchases. Not saying you didn’t do a great job with the stimulus .. I believe you did. But every dollar that the Fed expands its balance sheet offsets a dollar of delevergaing in the economy … “what is not seen …”

    • Tom M says:

      After re-reading my own comment, I want to mention that I didn’t mean to say that TARP was a mistake because it happened at the most I opportune time, but rather that the 4 period MA spikes in early ’09 because of the $800 B TARP payments that basically all hit in 4q08-1q09.

      These payments (to bolster bank balance sheets at a very scary time) were warranted by the need to avoid bank runs. They occurred because the banking sector was already over leveraged in policy makers’ view, and were reversed relatively quickly.

      My basic point remains: I think the analysis might be more accurate if one removed the TARP payments and repayments from the debt increase, and also considered the Fed’s increase in its own balance sheet (from $800b at the start of the crisis to over $3t now) as just as important … in cushioning the deleverging by the HH sector.