Discussion of household leveraging and deleveraging Discussion by Gauti B. Eggertsson Brown University

This paper (from my perspective) Can a deleveraging cycle generate the great recession in a standard DSGE mode? (paper addresses other issues too!) Ask this questions in a quantitative model. Early models (e.g. Eggertsson and Woodford (2003)) model trigger of the crisis as preference shock. Free variable, little discipline Recent work aimed at modeling the origin (debt- deleveraging). Why? – Puts more discipline on the shocks (can model it to match features of the data rather than a residual). – Important? Yes may have important interaction with policy Mortgage write-downs, Fisher Debt deflation, fiscal multipliers, etc etc. This paper is one of the first to deliver on this promise. First order importance, exciting stuff.

This paper Can a household debt-deleveraging cycle generate the great recession in a standard DSGE model? Answer: No But not the last word … Focus here on plausible change so that the answer is “yes”. Build on Eggertsson and Krugman (2012) (web Appendix)

Story in Eggertsson-Krugman Part of the economy “need” to cut down spending For output to be at potential somebody need to make up for it Who? Those unconstrained. How? By a drop in the real interest rate

Thought experiment Imagine an endowment economy. One agent more patient than the other. Impatient (borrowers) subject to a debt limit. At steady state at the limit. Now

Basic mechanism EK Some part of the population stops spending (“deleveraging shock”) Somebody else needs to make up for it. How do we make those other guys “make up for it”. By a drop in the interest rate. Can trigger a zero bound. With nominal frictions: Big problem! Liquidity trap. Show this also in a “standard looking” NK model

This paper Augmented by housing sector. Deleveraging happens via deleveraging of the households. Model drop in D more seriously. Can it generate a meaningful response? Answer: No Why? Because even if households are cutting down their spending on housing ….  Somebody else is making up for it even without a reduction in the real interest rate.

This paper Very little drop in real interest rate Unconstraint agents (savers) don’t need to see much of a drop in interest rate to start spending. Why? Because they will start investing in productive capital. Investment is tied to the real interest rate via marginal productivity of capital. Question: What happens to investment in the model?

Main comment A key feature of the recession is the drop in investment and real interest rate. You want to make sure that your model delivers this. How to do this? One approach: Eggertsson and Krugman - web appendix

Eggertsson and Krugman – web appendix Does incorporating productive capital change the result? Yes, if savers can invest, drop in the real interest rate small. Similar to Christiano (2004) result in discussing Eggertsson and Woodford (2003) – same preference shock will mean the zero bound no longer binding. My response at the time – Introduce shock to the “capital adjustment function”. – Not really a convincing thing to do here.

We should think of “investors” as constrained? How to do it? Most obvious way: Eggertsson and Krugman make the constrained agents the ones that have access to capital investment. Deleveraging now applies not only to “household” but also the “investors” – they are the same person. Eggertsson and Krugman Web Appendix

Result form EK Now deleveraging shock has an even bigger effect. Investment responds by even more than “regular” consumption”

Fraction of savers is 0.7 with fixed capital stock It is 0.9 with flexible Bigger effect with flexible investment

Suggestions for next paper Introduce entrepreneurs (use e.g. Iacoviello (AER, 2005)). The entrepreneurs are also constrained. Conjecture: Deleveraging will make zero bound binding and effect can be quite big. Details will of course matter (does land show up in collateral constraint – housing prices etc) Bottomline: – Can deleveraging explain crisis,? – Might make sense to have an alternative, e.g. households vs. entrepreneurs?

Conclusion Exciting research agenda. Discipline models with data on deleveraging to search for the origin of the crisis. – Can we use the Mian-Sufi evidence to impose some discipline? Result so far: Difficult to put the usual leveraging-deleveraging stories into a quantitative model and get much action. For story to fly need to add more features.