The Debt Story: AD or PSST?

At the macroeconomic level, shouldn't you be able to test that with some kind of cointegrating relationship? For instance, a long-term relationship between household debt and median income or GDP (or some kind of relation to unemployment).

What do you think?

In the AD paradigm, what is sustainable and what is not is directly affected by the Fed and it is almost inconceivable it is not affected at the margin, so the difference is really one of sensitivity.

So you're saying:

1. There were unsustainable PSSTs everywhere, but those areas with high debt had their pants pulled down.

or:

2. Areas with low debt also (coincidentally) had more-sustainable PSSTs.

#2 would be very surprising, because the low-debt areas are also generally those with lower GDP/capita, lower GDP/capita growth, less education, less VC investment and innovation, less high-tech industries, etc. etc.

http://www.washingtonpost.com/rf/image_606w/WashingtonPost/Content/Blogs/ezra-klein/StandingArt/debt3.jpg?uuid=2J3YxMjmEeCBn7Qf3SCQ3w

That's not what you would expect if they have strong, sustainable PSSTs. If anything you'd expect them to have more backwards, unadapted PSSTs.

So it's #1. Given that: how do you explain the different impacts on the tradeable and non-tradeable sectors?

I haven't fully grasped the importance/implications of that myself, so I'm really asking.

Steve,
I am thinking that if your local economy was unsustainable (based on borrowing that could not continue), that would lead to a cutback in the non-tradable sector. It's classic expenditure-switching, where you maintain exports but reduce consumption of domestic goods, in order to reduce your debt-financed trade deficit.

'kay, I get that. But then doesn't this study tell us exactly nothing about the relative quality of PSSTs? The quality of PSSTs across counties might have been randomly "equal," uncorrelated to debt levels. So the debt variance caused the tradeable/nontradeable effect. End of story.

Yes, the study doesn't contradict the PSST theory, but it does nothing to support it either. (Unless one asserts that the high-debt counties *also* had unsustainable PSSTs, which 1. doesn't seem likely based on the comparative pre-crash indicators and 2. receives no support from this study, is simply not addressed.)

Sure, this study gives good evidence that weak consumer demand caused by Fisherian/Minskyan debt deflation has reduced employment (as predicted, in nontradeables). But you're not really claiming that debt deflation is immaterial to the current slump, are you? (Above: it will "lead to a cutback.") Just that it's not the whole story.

I think this makes sense...

Expansion should work under the PSST model, too, because the expansion causes inflation. Inflation transfers wealth to those with weak balance sheets from those with strong balance sheets. This is because the value of debt falls which means the value of loans falls too. The low level of trade due to weak balance sheets isn't sustainable because once the balance sheets are normalized, more resources will be available for consumption and investment.