Consumption and credit constraints during financial crises

ESRI researchers (Petra Gerlach, Rossana Merola and Conor O’Toole) have a new VOX article here.

Two other new VOX articles are also of note –  on migration flows here;  on Italian productivity (co-authored by my TCD colleague Fadi Hassan) here.

9 replies on “Consumption and credit constraints during financial crises”

The authors ask “Why does consumption decline during a crisis?” and offer two explanations:

“One explanation is that permanent income has declined, causing a decline in consumption as posited by the permanent income hypothesis (Friedman 1957).”

“A second explanation suggests that consumption has fallen because of credit or liquidity constraints (Aron et al. 2012; Jappelli and Pistaferri 2010).”

The second explanation is obvious. Money is constantly being deleted from the economy via loan repayments. To replenish the money supply we need some entities within the economy to acquire credit and when insufficient numbers are not willing or able to take on more debt the M1/M2 money supply dwindles. When the velocity of money cannot increase and prices reluctantly decrease, consumption must reduce.

I think the explanation demonstrates how inappropriate for its purpose this system is. There’s no reason economically speaking or otherwise why the entirety of the M1 money supply should be created by the commercial banks. Why don’t we have the central banks create some/all of the money supply? If only to resolve the crisis, but I would anticipate beyond that too.

I agree there is a problem.
By now it should be clear that the usual nostrums are ineffective. We are left with massive public works planned, designed, contracted out and funded directly by national Governments.
Have a look at the Bill Abram video, a retired high school teacher who was bothered by the status quo in Central banking.
The NYTimes is leaning toward a tepid recovery.

Re: The IMF paper on migration comes to a very questionable conclusion.

“Migration also remained high among European regions, though perhaps fell short of what was needed given the magnitude of the differences in inter-regional shocks. Overall, the results suggest that Europe has been moving to strengthen one of the adjustment mechanisms needed for a successful currency union.”

Get a grip. The unemployment differentials between peripheral countries and core countries have barely moved an inch.
Secondly, how one can discuss migration of unemployed in Europe without referring to language and the language competency of the potential migrants, really surprises me. Language is by far the biggest obstacle for an unemployed to transfer his/hers skills within the EU.
Indeed, how one can realistically compare US and EU migration patterns, the US being almost a one language country, and the EU comprising different nationalities with, by and large, entirely different languages, really bemuses me.

One other comment in the IMF paper really surprised me, but perhaps it is true.
For the EU:
“That is, out of every ten workers that lose employment, one worker becomes unemployed, six drop out of the labour force, and three workers migrate out of the region within the first year following the shock.”
The comparative for the US:
“Put in terms of numbers of people, out of every ten workers who lose jobs in a US state as a result of an adverse shock, two workers become unemployed, two workers drop out of the labour force, and six workers move out of the state.”

Perhaps the Europeans are just plain lazy. So when a ‘shock’ occurs, they ‘drop out of the labour force’. Whatever that means!
So 60% of Europeans who lose jobs, drop out of the labour market?

I doubt these figures to be accurate.

re: ESRI paper:

Interesting graphs, showing different age group effects:
15-24 years; got it in the neck in income drops. They could no longer afford to spend.

35-54 years; Suddenly realised that their kids could could left without food or education, and started to save like hell.

55 + years ; Marched to the Dail, held onto their money, and continued to spend it. And pilfered the next generation’s pockets.

On consumption, for Ireland at least, tax and repayment of foreign debt would be relevant, wouldn’t it? The apparent immunity of the older generation to change is staying too, although the data’s only up to 2010.

Also on the migration paper, it’d be nice to see country by country data. I’d expect to see quite different response rates by country, but perhaps I’m wrong. Also if expect to see different compositions of migration, e.g immigrants returning home rather than natives emigrating.

Emigration feeds on itself with the primary source being youth unemployment. Overseas Irish associations which had been in decline are now thriving. I attended a rehearsal of the Irish Choral Society a thirty member group in Toronto where I was invited to attend a Gaelic speaking group and an Irish theatrical group. As critical mass builds places like Toronto become more like home which draws more immigrants in. The Mass was said by an O’Rourke with the speaker being a woman from Cavan who in a thick Irish accent pronounced every word clearly and perfectly to my ears. The Church, St Patrick’s is German/Irish (some masses in German). After that I attended a book fair at the Goethe Institute which has been in decline since the drying up of German immigration in the 1960s’. Still a class act with complimentary Stollen, Chocolates, proper coffee and tea done the way only Germans can do it. I just hope that the present influx have the foresight to get Canadian passports for themselves and their children before returning during the next boom. Yes, we too will emerge from the gloom into the sun.

@ JR: “55 + years ; Marched to the Dail, held onto their money, and continued to spend it. And pilfered the next generation’s pockets.”

55+: Yep! Marched to Dáil: Nope! Spending: Yep! Pilfering my kids inheritance: Yep! – have supported two un-employed adults for 7 years so far (mortgage + some monthly divvies). Thankfully, one is back in full-time work. Other is part-timer. Interesting times.

The ESRI Report raises some challenging matters. Credit is one. Why are we so reliant on something which produces a toxic financial product (debt) which requires a mandatory, annual incremental increase in ‘income’ to service that debt. Bye-the-bye could those critters just use some plain vanilla language here: paid back principle + interest. Deleveraging sounds goofy, and is goofy!

Income: Here’s another goofy one. Plain vanilla folk know that ‘income’ means your weekly/forthnightly/monthly wage or salary check. QED. But, Permanent, Transitory, Temporary. Goofy stuff for goofy folk. Simple it up goofy folk! That is if you want to get the attention of policy makers. If that is in fact, your intention.

Rebuild Balance Sheets: Re-build, like a collapsed garden wall? My accountant knows what a Balance Sheet is. Any simple (ie: non-goofy) definition of Balance Sheet? You know, one that would be immediately understandable to plain vanilla folk. Like, you have a positive sum of cash constantly, and readily, available either in your wallet, or in your mattress – but preferably not in bank deposit. Or what?

In most countries, households’ consumption expenditure accounts for more than half of GDP. And Irish household consumption has regressed to Q3 2001 level. Gee, that cheerful news.

“Once households have rebuilt their balance sheets, future consumption can again be financed by new credit …”

You’d have to read this several times, then wonder. New credit? How about some new income? The underlying (foundational) economic concept is … ? This would not be stagnating, now would it?

“One policy measure to reduce the impact of credit constraints is, thus, to limit the exposure households can take, i.e. to enforce a regulatory maximum loan-to-value ratio.”

Oooops folks! That’s not exactly PC. How about all credit cards are withdrawn – unconditionally. What would be the outcome here?

@Brian Woods Snr.

Like yourself, I have been contributing towards unemployed/partially next generation over the past four years.
Nevertheless, the greatest act of pilfering young people’s pockets, is by depriving them of jobs.
To me, the worst aspect of this recession, has not been falls in income or increased taxes. It is watching the next generation being deprived of a decent future and watching them put the normal progression of work, house and children on hold.

That is what has happened both in Ireland and in lots of peripheral states.

Is credit growth necessary for employment growth under the present? I would unequivocally say yes, though caution that I am not an economist. Germany is currently trying to prove the opposite, despite all evidence to the contrary.

And Germany’s solution is working, for Germany, because it is in surplus. Their lack of spending is exporting unemployment, while their surplus is sucking demand out of the deficit countries.

And I do understand you frustration at comments such as;
“Once households have rebuilt their balance sheets, future consumption can again be financed by new credit..”

I advise not to keep reading that line, one could go insane before one detected the inane stupidity of deleveraging so that one could leverage up again!

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