James Hamilton on Debt, Default, and Oil
Dec 21 2009

James Hamilton of the University of California, San Diego, and blogger at EconBrowser talks with EconTalk host Russ Roberts about the rising levels of the national debt and the growing Federal budget deficit. What is the possibility of an actual default, or an implicit default where the government prints money to meet its obligations and causes inflation? What might signal an impending default? And what is the long-range forecast for the U.S. government's obligations? Later in the conversation, the subject turns to oil prices, an area of Hamilton's research. Hamilton explores the causes of the increasing price of oil over the last decade and the implications for the economy.

Laurence Kotlikoff on Debt, Default, and the Federal Government's Finances
Laurence Kotlikoff of Boston University talks with EconTalk host Russ Roberts about the fiscal health of the federal government of the United States. Kotlikoff argues that the U.S. government is essentially bankrupt because future taxes will fall hundreds of trillions...
Leif Wenar on Blood Oil
Should the United States allow its citizens to buy oil from countries run by bad men? Is this a case where morality trumps the usual case for free trade? Leif Wenar, professor of philosophy at King's College, London and author...
Explore audio transcript, further reading that will help you delve deeper into this week’s episode, and vigorous conversations in the form of our comments section below.


Doc Merlin
Dec 21 2009 at 2:29pm

No, No, No!
The low interest rate on short term t-bills isn’t because of trust from other nations and such. It is because of the federal reserve buying them up.

Dec 21 2009 at 8:16pm

Great topic. I have a few of questions… related to Doc’s point above, actually.

– So, currently, the U.S. government can borrow at a very low short term rate, which some take as an indication that lenders in the market are not expecting short term default or devaluation. However, as Doc points out, the rate the government is receiving may not be the equilibrium market rate, since the Fed influences interest rates via open market operations. What exactly is the role of the Fed, both intentional and unintentional, in influencing the rate at which the Treasury can borrow?

– Assuming that the current short term rate is the natural market rate and that lender expectations are priced into the rate, isn’t this consistent with a sovereign debt and/or currency crisis? I.e. if there were to be a crisis, surely it would be proceeded by a period of lenders mis-appraising the risk of holding debt and then lending at inappropriately low rates. Of course, if the Fed has a large influence on the Treasury’s borrowing rate, this would exasperate the problem. The Fed’s bond purchases may send all sorts of false signals to other buyers; it may lead them to believe that a low rate is due to many buyers in the market having done due diligence and having agreed that the debtor is credit worthy, when in fact the low rate is the result of an agent of the debtor bidding down the rate… with a printing press.

– The government’s GDP numbers have risen recently. However, as I understand, the government’s tax revenue has not. How does nominal GDP growth coupled with shrinking tax revenue factor into the story about sovereign default and/or currency devaluation? Wouldn’t nominal GDP growth be consistent with a currency crisis? I.e. statistical measurements could continue to detect nominal growth, while real growth declines. Then when dollar holders realize the disconnect, there’ll be a run on the dollar.

– Speaking of oil, one big reason that the dollar is valued around the world is that it is one of the only currencies that can be exchanged for oil. However, recently OPEC nations have discussed the possibility of not pricing oil in dollars. Surely such a change would decrease demand for dollars. How would that effect the default/devaluation story?

Avi B
Dec 22 2009 at 5:25am

I totally agree with the last statment “Maybe can’t predict recessions any more than we can’t be able to predict stock prices.” .

Jim Labbe
Dec 22 2009 at 12:37pm

Supporting Hamilton’s view that rising gas prices were a catalyst in the recent economic recession is this study by economist Joseph Cortright (from my hometown of Portland, Oregon):


Cortright’s findings suggests rising gas prices played a key role in bursting the real estate bubble by increasing travel-costs in the low-density, car-dependent suburban areas where the housing prices were often the most inflated.

I wonder car-dependency of our housing stock, might not be a structural problem for economic recovery and dealing the toxic assets held by many banks and financial institutions.

Could the limits to new supplies of cheap oil make it more difficult to reinvigorate the housing market (at least with the existing car-dependent transportation system)? Does the constraints of oil supply mean the homes prices won’t be, to some degree, permanently devalued and unlikely to recover.

The limits to new supplies of cheap oil may also draw in question those elements of the stimulus package focused on building more freeways. Is this really a wise investment in our limited transportation dollars? Is investing in freeways really likely to catalyze the next growth economy?


Dec 22 2009 at 10:17pm

Do we really need to look at supply & demand to explain the oil markets? The combination of large, inexpensive reserves being mismanaged by autocrats, the constant chatter about taxing or penalizing carbon or the oil industry, and the increasing influence of China & other economies where government policy actively disconnects demand from the marketplace, together are MORE than enough to explain a long term trend in price appreciation & a lack of new supply.

If you were Exxon/Mobil, and you had a well that would give you oil at $30/barrel over 20 years, what market price would you need to see before you would be willing sink money into it? I’m sure it’s a lot more than $30, in the current context.

Dec 23 2009 at 8:04pm

Avi B – About predicting recessions.

Check out youtube (Peter Schiff was Right) if you haven’t.

He fights tooth and nail against the talking heads while being ridiculed for predicting the recession years in advance.

And not just that there will be one but what its shape will take. (Home price decline, credit, failed banks etc).

After following him for a couple years and reading his published works I would agree that you can’t predict stock prices but recessions are another thing entirely.

The point being is that artificial expansion must lead to real contraction.

arc of a diver
Dec 24 2009 at 8:43pm

James Hamilton said he saw nothing but a pretty grim outlook for health costs out to 2030.

I don’t see how so many economists can keep missing major technology and health stories. I guess it makes a little sense since almost none have any science background, but stories like the Glaxo pill likely out by 2012/13 are on 60 Minutes. Did any economist see the recent 60 Minutes story on growing body parts?

Health care in 2020 and more so in 2030 will look nothing like health care roday. So why do economists and politicians pretend they can extrapolate costs?

Dec 26 2009 at 2:03pm

“Element of recessions is missed expectations.”

In my opinion, thanks to automation in the factory and the 1980’s invention of “just-in-time” there really isn’t a business cycle of before. Manufacturing and goods generation is tightly coupled to demand. Thus, our recessions don’t look like typical “inventory recessions”. I think this go around, like the recessions before it, are largely debt based. Too much debt, too few people able to service their debt, and not until the consumer or debt holder is made better will a “credit recession” be fixed.

And that will take tax cuts. And nobody has the stomach for that since their too focused on the debt. Suffer more the debt holder.

Dec 26 2009 at 2:25pm

Russ–How about bringing on a neo-chartalist?

This point doesn’t seem to reconcile:

“True by definition–what the government owes is dollars and could create as many dollars as it needs to fulfill those obligations.”


“If government is having trouble borrowing, the rest of us will. When credit dries up, sends economy into nose dive.”

How can the government ever have trouble borrowing? You just said the government could create as many dollars as it needs. So how in the world could it have “trouble borrowing?”

Please, Russ, put a neo-Chartalist on the podcast. Someone like Warren Mosler or Randall Wray to help explain how non-convertible money and fixed exchange rates work in our economy.

Save the politics on what this would mean to government. Instead focus on the economics of the system and listen to the explanation of how this actually works.

We can never default on our national debt. It’s just not possible.

Jan 6 2010 at 12:09pm

Doc Merlin:

Yes the Fed is heavily influencing the t-bill interest rate. But if other sectors of that market decided for some reason (trust or other) that they no longer were going to supply funds, wouldn’t the interest rate necessarily rise? Barring, of course. the Fed making up the difference.

Jan 10 2010 at 8:52am

The Fed has printed 1.33 $trillion just to buy MBS. And it’s lending money to banks at near zero percent. How can you price inflation risk into the money you want to lend if the banks don’t have to? Ans: you can’t. So, if you can avoid it, don’t lend. Buy an inflation-hedging asset. And know that stated interest rates is the rate at which money is being lent by those who HAVE to lend and must accept any return simply because they don’t have the market power to price in the inflation that is anticipated.

Hamilton says at one point that the folks at the Fed would be insulted if it were implied they would just automatically monetize the debt. Well, either he or they or both are completely out to lunch. Of course Bernanke would buy up any T-Bills that needed to be sold that couldn’t find other buyers. It’s insane to think he’d let the government default because he refused to print up and lend the government all the Fed notes it wants. Or that Obama and the Congress would let him refuse. Anyway, Roberts suggestion that such a default is anything to worry about is absurd. Even a recalcitrant Fed board with absolute tenure couldn’t produce such a result. The dollar you get paid with when you cash your T-Bill is whatever the government decides to call a dollar. It doesn’t even have to come from the Fed. There were fiat dollars long before there was a Fed.

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Podcast Episode Highlights
0:36Intro. [Recording date: December 15, 2009.] Federal government's budget deficit and what that might mean for the future. Recent Econbrowser post reacted to Paul Krugman's claim that the deficit not really worrisome. Seem a little worried about it. In agreement with Krugman that we don't need to balance the budget right away. A large deficit in 2009-2010 is desirable and necessary. Would be counterproductive to the point of infeasible to try to balance it right now. Concern is with what's going to happen a couple of years down the road, longer term trajectory. Paul's position is we can grow our way out, just as at the end of WWII we had a debt/GDP ratio for the United States that got above 100%. Worked our way down with economic growth. A number of other countries in the world have also had those kind of debt levels and have worked out of them through economic growth. Debt-to-GDP ratio: Debt is a stock and GDP is a flow--a stock is at a point in time and a flow occurs over time. If you make $50,000 per year in income, that's an amount per year. If you owe $50,000, a stock without a time component--that would be a 100% debt to GDP ratio. Some might think that if you owe 100% then you are bankrupt. But you are going to repay it over time; and if you grow your ability to finance both the principal and the interest are feasible. Key question is the service cost, which is a flow--what do you owe in interest on that per year? With a given interest rate you are basically talking about the same comparison. Take the $50,000 debt and, say, with 5% interest that's $2500 per year--that's something you want to compare with your income. Debt and GDP are in different units, but it is a natural way to think about the overall burden. Referring to the historical norms is relevant: if it gets far out of line with things we've seen, wonder what is going to stabilize this? Are we out of line in peacetime? Yes--nothing apart from WWII that is like what we are getting into right now. This is an unusual development. Deficits this year and next on the order of about 10% of GDP. Mechanics: This past week the Senate voted to lift the debt ceiling from $12.1 trillion to something closer to $14 trillion. There is a political game that goes on that is very separate from the economics. Politically, we have separate votes in the United States on the spending and tax questions, which determine the deficit; and on the total allowable ceiling for the debt. From an economic perspective strange to separate those two questions because there is no way you can run a bigger deficit without increasing the debt. Politicians can say they voted against the tax increase and are trying to do something about it, but when it comes to spending they are the ones that created the basic need to do the extra borrowing. Concerned about the grandstanding by politicians.
5:46$14 trillion is a really big number, close to right above GDP now. Harder to do because there isn't a single interest rate; a lot of the debt was issued in the past at all different interest rates. Current rate that the Treasury has to offer to attract additional funds, very low. Practically free if you are looking at short term debt. Now we expect to borrow on the order of $1.5 trillion to finance the shortfall in the coming year of revenues to expenditures; but in addition, we have debt coming due because of the way the past debt was financed. So we have borrowing we have to do to pay off old debt and interest service costs. Change in the debt is equal to the deficit: have to roll over the old debt because you haven't done anything to pay it down, plus added new debt equal to this year's deficit. Another complication: who is holding the debt? A lot of that debt is not owed to the public. It's owed by one branch of the government to another branch of the government. Often net that out to talk about the net debt to the public, which is a little bit more modest number. How modest is it? Would be 60% of GDP instead of 100%. Sizeable sum. Federal Reserve owns a sizeable chunk of the government debt; and the Social Security Trust Fund is by far the biggest single holder. Money the government promises to pay to another entity of the government. Puzzle: the Fed is currently buying mortgages held by Fannie Mae and Freddie Mac--about $1 trillion on their books. Somebody said: that's nothing to worry about because they're guaranteed. Yes--but they are guaranteed by the government. How does that enter into the accounting? The mortgage-backed securities the Fed is buying are not so much owned outright by Fannie and Freddie as guaranteed by Fannie and Freddie; so the government is on the line for those. Conservatorship that Fannie and Freddie are operating under--their obligations have been assumed explicitly. There is potential liabilities on all kinds of fronts. Also Ginnie Mae, FHA, FDIC--huge numbers; future health care costs. Medicare. Money the government owes to itself, but it's money the government was going to make to the future retirees. Not part of that direct debt calculation, accounting identity; but they are part of what constitutes the solvency of the Federal government. But it's not necessarily generate the requirement for the Treasury to borrow in the coming year. Seductive aspect of these loan guarantees--totally off budget. Fannie and Freddie were collecting fees--relatively small fees--over the years for promising that they would make good on all these loans they were securitizing, but didn't have enough capital to do it. Still in that same business. Complex topic. According to the legislation there are certain promises on the books to retirees right now; also promises for medical care in the form of Medicare, under the current law. Assume that not all those promises are going to be kept--might turn out to be false. If the United States breaks those promises, changes the letter of the law, say with a later retirement age or an income means test, seems to be different than paying back the bondholders, Treasury Securities holders of last year, or the FHA mortgages. Totally different. United States has no legal obligation to have exactly the same retirement age or same health benefits it could cover 20 years from now as they are doing today; not going to be feasible. Project trends, nothing but trouble ahead. But if the United States were to default on its obligations to bondholders, that has dramatic repercussions in terms of our ability to borrow next time and the world financial system. Totally different, although you could say the government is in both instances reneging on something. Longer-run issue.
13:58Short and medium term, short being 2-3 months from now; medium being 2010-2013. Not too long, not dealing with demographic issues that will occur later. Just read Washington Post article detailing the nuts and bolts of the $31 billion sale of Treasuries. Tried to find the article; Googled it and also pulled up Freddie Mac will ask for $31 billion from taxpayers and GM lost nearly $31 billion in 2008. Got a lot of uncertainty. Article: the $31 billion was a four-week Treasury loan. Interest rate might have been literally zero. Park your money and if there's deflation you'll be covered; if there's inflation in four weeks you'll lose a little bit. Basically said we'll borrow under a short term period because it's cheap. People aren't too worried about default four weeks from now. That's what the investment banks did that went broke, though: they borrowed on very short terms because they could get a low rate of interest. When people start worrying, it can suddenly stop and you can't finance the next $31 billion. Worried about that? Not over two- month horizon--sending a signal that we won't have that problem by January 2010. Yield curve does slope up; but even long term rates surprisingly low. Argument that Paul Krugman makes: low rates at various horizons, doesn't look like markets are worried. Markets are not worried today. Could things change? Things could. Nature of that scenario: thing that's going to help is economic growth. If we continue to see growth like we did in the third quarter of 2009, that will help for all of these things, not just bringing in more tax revenue but reducing the risk of the government having to pay out more on these implicit guarantees, great stability to the financial system. Would see interest rates rise as they do normally in an expansion. If we had another recurrence of serious financial problems--commercial real estate--or if economy were to sputter from here, or if the politics were to play out in a way that the people become much more concerned about these longer run issues will be resolved, then could be a day coming when the short term rates will change very quickly. Could happen in two years or medium term horizon. Key policy for addressing that is for the government to take a more responsible stand on these longer run issues. Demonstrate that we do have a path that makes sense going into the future and that people can believe. 2010 is about two weeks from now; sounds far away as "twenty-ten," like Buck Rogers.
20:12Negative scenario for two-month thing. Russ a deficit dove in the past; would say that Milton Friedman's insight is not so much how you finance government spending--taxes today or taxes tomorrow--it's what you spend it on. If you finance it with taxes tomorrow it will cost you a little more so you want to be careful about what you spend it on; interest cost. No vague risk of default--just a luxury to run a deficit in the 1980s and 1990s. We're supposed to borrow about $3 trillion in the coming year. That magnitude borrowing and other things, like commercial real estate. Fannie and Freddie purchased about 600,000 mortgages in 2007 with less than 5% down. Those mortgages are probably not doing very well. Between 25-33% of mortgages today are under water. Some are adjustable rate mortgages that will reset in 2010, won't look so good. Combination plus magnitude of borrowing could be difficult to pull off. Conceivable the Chinese would say it doesn't look as safe as it used to. Would start with a rising interest rate. Is there a doomsday scenario like that that you can imagine and what would be the warning signs? Numbers: current baseline projection from the Congressional Budget Office (CBO) is for a total deficit for 2010 of under $1.4 trillion. For 2011, under $1 trillion. What growth rate are they assuming? Assuming continuing growth, don't know number. Markets don't seem to be expecting problem at the moment. Can't rule it out 100%. Low rates now reflect past responsible behavior with U.S. debt management. Tallest pygmy theory--the United States is struggling, but we are still a relatively safe place to park money, so we are the parking lot of choice. Fall of 2008--flight into dollars. Surprising because the United States was ground zero for the world's financial problems, yet people wanted to park their money in dollars. Even now despite concerns, short term borrowing rates are practically zero. Link between short and long run has to do with credibility; can't take for granted that we will always have that credibility as a nation. Possible to abuse the power. Details, specifics of where the recovery money got spent. Undermines the ability of the United States to weather a crisis. To the credit of the Administration, they have not proposed a second stimulus package of the same kind. What is the possibility that the debt will simply be monetized--that the Fed will simply print money? True by definition--what the government owes is dollars and could create as many dollars as it needs to fulfill those obligations. With a default we are not talking about failing to do that. Question is: can you do that without a dramatic deterioration in what the dollar can purchase? Doomsday scenario is joined with a currency crisis, collapse in the value of the dollar. Federal Reserve could defend the dollar by raising interest rates, letting the Treasury default; or could try to step into the gap. People within the Federal Reserve would be horrified by the presumption that they are going to bail out the Federal government and monetize the debt. Would be similar to what happened in the fall of 2008; Fed just decided somebody's got to solve the problem near term and we'll sort it out later; create reserves to whatever level we need; doubled the Fed's balance sheet, as a short run response to the crisis. Fed would be reluctant to knowingly go down that road. Could take a series of measures for auctions that would have a similar kind of effect. Standard problem with currency crises--no good option. Threats to real side of economic activity. Want to not get there in the first place. Snort not at analysis but that we find ourselves in it.
30:43Clarifying point: in other sovereign defaults, impression is that the signals come very late and very suddenly. Things look great and all of a sudden it's over. Is that accurate summary? Talking not just about sovereign defaults but also about currency crises. Latter is the key model for the United States; we are fortunate to be able to borrow in dollars; so don't need to go all the way to default here. Variety of experiences in either category, mistake to lump them all together and say they all follow this pattern. Often it is the case that you have a country that was seeing real growth and acquiring a lot of debt as a result; things looked very good before they looked bad. Run-up in the public debt is an element you'd find in many of the other episodes; if you took the name "U.S." off the current numbers and replaced them with some small developing country, you'd say this is the kind of situation that could go that route. On other hand, would see some movement in short term interest rates in advance. Remarkable how extremely low the borrowing costs for the United States are; don't think you'd find an analogous situation in the other experiences of a country that went from that kind of borrowing advantage to suddenly the sort of crisis we are talking about in the space of months. Different country's name--why does that matter? Is it just that it's "unimaginable"? Is it the past good will we've earned, trust and expectation that ship will find its way to a safe harbor? Combination and also sheer size of the United States. If it did happen it would be not just on us but on the whole world. Initial flight to the dollar; if you don't trust the United States, who else do you trust? Tradition. History of responsible management of the debt. Chinese: made some worried noises about the possibility of inflation that would reduce the value of the resources we return to them for the money they've given us. What are they thinking? No actual "they"--more complicated. What strategy? Keeping the yuan from appreciating and obtaining an export market. Has worked fairly well for them so far. In addition to accumulating huge dollar holdings, they are also accumulating holdings of physical commodities--gold, copper, oil, anything you can store. If these events happen, they will take a loss on their dollar holdings but a gain on their commodity holdings. Not totally exposed. Different theory or playing a different game. Any other economic forces alarming in short or medium run? Haven't mentioned that if you look at Federal tax receipts as a percentage of GDP, historically for the United States always has been below about 21%. Very flat, long term stability. Trends for medical expenditures growing much faster than GDP, so something's got to give. One way it could give is the world figures out it's not good to lend to us any more. Another way would be a big increase in the taxes the Federal government collects; would sacrifice our long run growth potential. Experience of last decade--we haven't created jobs, have invested in housing and productive capacity at the government level, not in infrastructure but basically increasing transfer payments. Worry about longer run trajectory for the United States--are we trying to make the world a better place in the next 20 years or just passing the problems along to the next generation? Theme that shows up a lot of places. Lloyd Blankfein, CEO of Goldman Sachs, quote: Doing God's work because they were channeling capital to its highest-valued use. So between 2004 and 2006, channeled about $1.5 trillion into subprime mortgages, people buying homes they couldn't afford, second homes, third homes. Don't think that was its highest-valued use.
40:22Oil prices. In the past decade, a long run-up in oil prices. Tend to bounce around a lot, but long, sustained trend. Debate over why. Focus on the last legs, from 2005-2008, saw real acceleration of that trend, which really goes back to 1997. World production of petroleum basically stagnated between 2005-2008, but in 2006-2007, world GDP increased by more than 10% in real terms. Would produce tremendous increase in demand for oil and other items. China increased its demand by a million barrels a day over that period. How can China be consuming another million barrels a day when the world isn't producing any more oil? The only way that can happen is for people in places like the United States and Europe and Japan to consume less. Could have drawn down inventories. Why do that? Not a temporary development. Did we consume less oil? Yes. Consumption of OECD countries was down about a million barrels a day. Takes a big increase in the price of oil for people to change consumption. It's highly inelastic in price over the short run, more so in 2005-2006 than historically, partly because the energy expenditures had become modest enough for a lot of Americans that you could just afford to ignore those initial price increases. Broader picture changing as well. Remarkable thing happening globally, with China being most dramatic example, but also newly industrialized countries--major change in standard of living within a generation. Those people want cars and other stuff that takes oil. Challenges world to increase production further. Complicated story. Bottom line is that it's not all that easy to keep increasing oil production year after year; challenge to try to keep up with the growing demand from the newly industrialized countries. Trend for next decade. Short run, other issues--world recession took a big bite out of world demand, and have been some adjustments to price increases. Still a lot of people in China, majority don't have cars yet; if their incomes keep growing more and more will want cars; so significant long-range challenge. Saudi Arabia: Supply and demand picture. Relatively vertical supply curve in the short run; relatively inelastic demand curve shifting out, will mainly be reflected in higher prices. Countries and individuals will respond differently; short and long run differences. More flexibility in the long run. Not quite a clean supply picture. One supplier, maybe more than one, that does have a massive inventory because their extraction costs are so low relative to the rest of the world, and that's Saudi Arabia. Is that still the right way to think about what complicates this picture? For years the Saudis were the world's swing producers in oil markets; had a lot of excess capacity and would change their production volumes on a monthly basis in response to market conditions. Would increase production when prices high, and vice versa. Claimed to have huge reserves and a lot of excess capacity. People assumed they would always play that role--which smoothes prices. As prices run up, they find it lucrative to respond with bigger production. Not doing that now? They did that up through about 2005; but then their production started to decline. Assumption had been that extra oil China wanted to consume would come from Saudi Arabia; but the facts were that it didn't. What explains those facts is more complicated issue. Do the Saudis have as much oil and capacity as they are claiming? Open question. May be that they perceived it wasn't in their interest to stabilize the price at a lower level; or may be that they found that they didn't. Even if they do have that kind of capacity--which they have never said that that's what they would do--it wouldn't take too many years of growth by China for that to get eaten up. Throw in India, too. And the oil-producing countries themselves are an important source of demand. Brazil will be a net exporter; another country in which there have been important new discoveries. New element in calculations: the pace of the growth in demand, and a lot of our traditional supplies are going into decline. In the United States, oil production has been declining for the last 40 years. Increased fraction coming from offshore. North Sea in decline now; Mexico in decline; Indonesia one of the original members of OPEC is now an oil importer because of declining production rates. There are some promising spots; Brazil, maybe Africa. But need a lot of extra production to keep up.
50:31What about the role of speculation? Any kind of price increase gets tied into speculators. Barro podcast--not just oil price that was going up, but almost every commodity. Harder to tell that story--all correlated with incomes, demand more of everything. Decade-long trend: for those purposes, above-ground inventories not particularly relevant. Separate question for month-to-month or day-to-day price fluctuations. On a daily basis, entirely speculation, people making guesses where those prices might be. If you look at 2009, U.S. inventories of oil were consistently above their trend throughout the year, so there is a case to be made that speculation is one factor in what's going on, and in correlation of daily price changes. But don't want to confound longer run reality. Mistake to say that all of that price increase of $50 up was just speculation. Correlation: on daily basis, speculation could be part of it; but also some commonalities. China is not just buying oil--they are buying copper, corn, increasing meat consumption putting pressure on grain. Common aspect. Agricultural production--we should be able to increase that. In case of oil, definite limitations at least in some traditional producing areas. Besides China, we have an ethanol mandate in the United States that puts pressure on corn; as more land went into corn, went into land that wasn't quite as good as previous land, making price higher certainly in the short run. As land pulled away from other products, like soybeans, would make those prices higher. But it's not just agricultural products. In the past we've had immense amounts of economic growth and they don't tend to get associated with long term price increases; in fact things tend to go the other way. Things get cheaper as technology improves. Short run phenomenon? Interesting time. Change in character of the growth. We went four years from 2003-2007 with 5% real GDP growth--pretty big deal. Historical precedent for that?
55:40Oil prices: What evidence do we have on oil prices causing the current recession? When oil prices were rising at the beginning of this decade, many said it would destroy the economy. Economy kept humming along. Got to 2001, tech boom collapsed, very short, didn't have a big impact on GDP or employment, started humming along again. What is the connection between oil price shocks--increases--and the economy? For much of that earlier period, increases in oil prices, but they came gradually. A few more cents on gas but income rising at the same time. Expenditure share had fallen from where it had been in 1980. Beginning in the fall of 2007-summer of 2008, big move-up in price of oil and at pump; now expenditure share significant, had to cut spending. Summer of 2008, 25% drop in purchases of SUVs and light trucks; same time purchases of lighter fuel efficient imports going up. Pretty strong case that what was happening to auto demand had a lot to do with sudden energy prices. Big deal for U.S. auto sector; lost jobs, lost income. Consumption spending generally slowed, in line with historical correlations between consumption spending and energy prices. One factor that were hitting some sector of the economy. At the same time we had housing, subtracting about 1% from real GDP growth during the first year of the recession, that and a little more the year before the recession. The energy price increases were the straw that broke the camel's back, tipped the scales into a recession. Fall of 2008, financial crisis; entirely new phase. Not directly caused by oil prices, but we were dealt a tougher hand by having gone through three quarters of a recession. Energy prices were a contributing factor to this and to a number of previous recessions. Default: transmission mechanism between financial markets and the real side of the economy. One view says that recession totally a result of financial issues; another view says it's more complicated. Hard to argue the latter because it started in December of 2007 by the official measure, so it would have to have some real side. Consequences for our lives if there were a serious Federal debt default? Any inherent real side implications for American life? If you don't trust your money being lent to the Federal government, how do you trust it being lent to the U.S. bank, U.S. firm, or U.S. consumer? If government is having trouble borrowing, the rest of us will. When credit dries up, sends economy into nose dive. Historical examples--joint with currency and overall banking/financial system. Historically United States was such a safe haven--what would replace that? Would be a global aspect.
1:03:25Causation in economics generally. Rise in price of oil; Ed Leamer paper on housing prices being a driver of recessions; many believe monetary policy is sufficient; Keynesians look at other factors, animal spirits. Data? What is the state of our knowledge about business cycles? Not what we'd like it to be. Element of recessions is missed expectations. If you knew a recession was coming in six months, the Fed and businesses and individuals would have acted differently. For something to go this wrong, something must have been very different from what was expected. Different recessions start to look quite different. But there is some common element--once enough sectors are having problems at the same time, a lot of sectors tend to go into reverse. We are a long way from being able to say we are about to have to have one of these things six months from now. Maybe be inherent in the nature of the beast. Maybe can't predict recessions any more than we can't be able to predict stock prices.

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