Economic Chalk Talk

I think Christina Romer is doing a great job as Obama's Chairman of the Council of Economic Advisors.

Here's a bit from her testimony in Congress today:

Understanding the sources of the crisis is critical to crafting the right policy responses for recovery. In thinking about the causes, one needs to begin with the extreme fall in house and stock prices over the last eighteen months. Housing prices, as measured by the Case-Shiller index, have fallen by 27% since July 2007. Stock prices have fallen roughly in half since their peak in October 2007.

Why these two key asset prices have fallen so much is a topic that we could spend hours discussing. Was there a bubble? If so, what caused it, and what caused it to burst? But, regardless of their cause, the falls in asset prices have had a direct impact on consumer behavior. Consumers have substantially less wealth than before. By one measure, household wealth has fallen by $13 trillion, or 20%, since its peak. Consumer spending depends on many things, including income, taxes, confidence, and wealth. Studies suggest that when consumer wealth declines by a dollar, annual spending falls by about four cents. So, a decline in wealth as large as the one we have experienced has led to a large decline in the aggregate demand for goods and services.

Another factor to consider is the uncertainty created by the gyrations in asset prices. In a paper I wrote many years ago, I argued that the main effect of the crash of the stock market in 1929 on spending operated not through the direct loss of wealth, but through the enormous uncertainty it created. The initial crash in October was followed by wild fluctuations of stock prices. This volatility led consumers and firms to be highly uncertain about what lay ahead. I found narrative and statistical evidence that this uncertainty led to large drops in consumption and investment spending. This makes sense: when you don’t know what is likely to happen, the best thing to do may be to simply do nothing as you wait for more information.

The same factor may be at work today. While house prices have been steadily down, stock prices have been on a wild ride. Volatility, according to some measures, has been over five times as high over the past six months as it was in the first half of 2007. The resulting uncertainty has almost surely contributed to a decline in spending, especially in the last few months.

The decline in asset prices and the rise in uncertainty have also been critical to the defining feature of this recession: the drying up of credit.

...

The result of our current credit disruptions and the drop in spending has been a very painful contraction in the economy. Total output of goods and services has now fallen for three consecutive quarters, after barely rising at all over the previous three. The unemployment rate has risen from 4.7% in late 2007 to 8.5%, and payroll employment has fallen by 5.1 million.

Rising unemployment and falling home values have intersected to greatly increase home foreclosures.

She goes on to talk about actions being taken by the Obama government to get the economy up and running again.