The Austrian theory of the business cycle emerges straightforwardly from a simple comparison of savings-induced growth, which is sustainable, with a credit-induced boom, which is not. An increase in saving by individuals and a credit expansion orchestrated by the central bank set into motion market processes whose initial allocational effects on the economy's capital structure are similar. But the ultimate consequences of the two processes stand in stark contrast: Saving gets us genuine growth; credit expansion gets us boom and bust.Today Paul Krugman discusses why the boom is about to bust in Intimations of Recession
The key point is that the forces that caused a recession five years ago never went away. Business spending hasn't really recovered from the slump it went into after the technology bubble burst: nonresidential investment as a share of G.D.P., though up a bit from its low point, is still far below its levels in the late 1990's. Also, the trade deficit has doubled since 2000, diverting a lot of demand away from goods produced in the United States.
Nonetheless, the economy grew fairly fast over the last three years, mainly thanks to a gigantic housing boom. This boom led directly to unprecedented spending on home construction. It also allowed consumers to convert rising home values into cash through mortgage refinancing, so that consumer spending could run far ahead of families' incomes. (Americans have been spending more than they earn for the past year and a half.)
Even optimists generally concede that the housing boom must eventually end, and that consumers will eventually have to start saving again. But the conventional wisdom was that housing would have a "soft landing" - that the boom would taper off gradually, and that other sources of growth would take its place. You might say that the theory was that business investment and exports would stand up as housing stood down.
The latest numbers suggest, however, that this theory isn't working much better on the economic front than it is in Baghdad.
Deflating Bubble #2
Signs of a deflating housing bubble began appearing a year ago, but for a while it was possible to argue that eliminating a bit of "froth" in the housing market wouldn't do the overall economy much harm. Now, for the first time, problems in the housing market are starting to seriously reduce economic growth: the latest G.D.P. data show real residential investment falling at an accelerating pace. The latest job numbers show falling employment in home construction, and retail employment has fallen over the past year, suggesting that consumer spending is running out of steam. (Gas at $3 a gallon doesn't help, either.)
Meanwhile, neither business investment nor exports seem to be growing fast enough to make up for the housing slump.
Now maybe we'll still manage that soft landing despite a rapidly rising number of unsold houses; or maybe there's a boom in business investment and/or exports just over the horizon. But based on what we know now, there's an economic slowdown coming.
This slowdown might not be sharp enough to be formally declared a recession. But weak growth feels like a recession to most people; remember the long "jobless recovery' that followed the official end of the 2001 recession?
Is that it?
And what will policy makers do about a slump, if it happens? A snarky but accurate description of monetary policy over the past five years is that the Federal Reserve successfully replaced the technology bubble with a housing bubble. But where will the Fed find another bubble?As I having been saying for the last two years this was a magic - smoke and mirrors - recovery and the illusion could only be sustained so long. It's looks like the clock may have finally run out for the "Bush Recovery".
And with the budget still deep in deficit and the costs of the Iraq war still spiraling upward, it's hard to see Congress agreeing on any significant fiscal stimulus package - especially because history suggests that the Bush administration and Congressional leaders will turn any debate about how to help the economy into yet another attempt to smuggle in tax cuts for the wealthy.
One last thing: the real wages of most workers fell during the "Bush boom" of the last three years. If that boom, such as it was, is already over, workers have every right to ask, "Is that it?"
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