If Noah Smith was A Betting Man…


…I would bet against him:

So while I also think the Fed has probably been a little too focused on inflation since the experience of the 70s, my gut tells me we need to look elsewhere for the source of the jobless recovery phenomenon. My own guess is that financial-based explanations, in particular the idea of “balance sheet recessions”, is more compelling. As Matt noted, recessions with “jobless recoveries” (really, just recoveries with sluggish growth) have tended to follow very different kinds of financial events than pre-1990 recessions. Some international comparisons find that recoveries tend to be anemic after a certain kind of financial crisis. If I were a betting man, I’d put my money on that explanation.

Noah Smith professes in the comments to have always been a “Koo-ian”, referring of course to Richard Koo, who coined the term “balance sheet recession”. Unfortunately for Koo and Smith; we haven’t had a “balance sheet recession”…ever. It is simply not the case that, in the aggregate, household balance sheets are in shambles. Nor is it the case that most businesses in the United States face adverse borrowing constraints (though that was true immediately after the 2008 crash when various paper dried up). In fact, increases in Tobin’s q, caused by a decrease in the cost of capital, would increase the incentive to invest. And of course, investment is spending.

But more importantly, the “balance sheet recession” view completely overlooks the fact that the other side of debt’s coin is credit. That is, for every debtor there is a creditor. If it is true that households are “retrenching” in order to “mend their balance sheets”, then there should be a creditor on the other side of that equation receiving the stream of payments. If it is true that both debtors and creditors have cut back on spending (and it is), then there has to be some other explanation for the sluggish recovery.

Noah is wise not to bet.

Update: For the record, Noah and I share the opinion that the most important answer to the question of why we experience jobless recoveries is that we don’t experience jobless recoveries.

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2 thoughts on “If Noah Smith was A Betting Man…

  1. Niklas, I would like to hear more about this creditor on the other side of the balance sheet. Who is it? Is it a bank? Where does the money go? Or are debts and money extinguished together?

    Your link, to me, makes the balance-sheet explanation look pretty good. A sudden 20% drop in household net worth (and corporate business), that has taken 5 years to recover (expected to meet the 2007 peak this year).

    1. Are you doubting the premise of the debtor:creditor accounting, or the homogeneity of the institutions? If it is the latter, I sympathize with your point.

      Also, the principal of a loan is extinguished upon the extinguishing of the debt, however the profit from the loan represents assets transferred from the debtor to the creditor.

      That loan activity dries up during recessions doesn’t point to balance sheet problems, it points to an unsatiated demand for liquidity.

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