Robert Shiller: "More Than a 50% Chance" for a Double Dip

It can't happen to us again. This time it's different. This is a popular attitude about the U.S. economy. As we watched bank earnings from Goldman Sachs (NYSE: GS  ) to JPMorgan (NYSE: JPM  ) to Wells Fargo (NYSE: WFC  ) rocket back from the depths of the crisis, and gross domestic product bounce back, victory was declared. The worst was over. And while growth wouldn't be as robust as traditionally seen coming out of such a sharp recession, we'd have sustainable growth.

But now the economy has decidedly slowed. Second-quarter GDP was revised downward to 1.6% from the initial 2.4% that compares with 3.7% in the first quarter. Companies aren't showing the same optimism as earlier in the year. Intel lowered its third-quarter revenue outlook on weakness in consumer demand for PCs, and Cisco's CEO expressed concern about an "unusual" uncertain economic outlook. Retailer J. Crew, which had been humming on all eight cylinders, lowered its full-year outlook.  

And still the prevailing view is that we will avoid a prolonged period of contraction.

But maybe it's not different this time. This is something Yale professor Robert Shiller is concerned about. It's this sense of perhaps faulty complacency that he says could make us prone to repeat the same mistakes of the Great Depression. In an interview, Shiller -- co-creator of the S&P/Case-Shiller Home Price Index, the Arthur M. Okun professor of economics and finance at Yale, and co-founder and chief economist of MacroMarkets -- shared why he thinks there is a greater than 50% chance our economy double dips, why our economy is marginally into a Japan-like deflation regime, and why our institutions are ill-prepared for deflation.

Here is an edited transcript of our conversation.

Jennifer Schonberger: Are you at all concerned about a double-dip recession, or do you think we'll muddle along with a slow-growth scenario, especially if home prices fall?

Robert Shiller: I've been worried about a double dip. ... I think the probability is greater than a half that we'll have another double dip.

Schonberger: Would that be precipitated by home prices, or just everything?

Shiller: Just everything. Everything is interdependent. That's the problem with economics -- everything depends on Barack Obama. I wrote this book with [George] Akerlof called Animal Spirits, and we were saying that the economy is essentially driven by ideas. People think, and they get ideas, and certain stories are amplified. The outcome is really uncertain.

I define a double dip as a recession that comes before we've healed from an earlier recession. I like [using the long-term unemployment rate as a sign for healing]. As the long-term unemployment rate goes down around 1%, that's a historical norm for good times. It's up at 4.3% now. I think that's more than a 50% chance, even though historically those things are very rare.

Schonberger: Some experts are concerned about the prospect of deflation. Certainly, we're seeing a good deal of rhetoric out of the Fed, and some big investors are positioning their portfolios accordingly. Do you think the U.S. is on the cusp of deflation, and if so, will it prolong the recovery of the housing market?

Shiller: We actually have seen a couple months [of declines in CPI and PPI, but then it's popped back up]. People forget. They talk about deflation in Japan, but that's what deflation in Japan mostly looked like. That kind of thing kept repeating, and they couldn't get out of that. There were some years when -- not home prices, consumer prices fell like 1%. There was never big deflation in Japan.

So we're already marginally in that regime, and the question is whether we'll get out of it. And that's an uncertainty. It's possible that we will have deflation. I think Ben Bernanke is really committed to avoiding that, and I expect that he probably will. But I think there's still a chance of deflation.

What bothers me is that we are not prepared in our institutions for deflation. So we could have a repeat of the same problem that we saw in the Great Depression. One of the major causes of the severity of the Great Depression was a lot of deflation -- cumulative of about 25% by 1933. That meant home prices went down with the deflation. It wasn't because real home prices declined. It was because there was just massive deflation. But people's debts didn't go down, and so it caused millions to go bankrupt.

Economist Irving Fisher wrote a famous article in the '30s called the Debt-Deflation Theory of Great Depressions. That was his model of the depression: It was caused by deflation, and the way you would prevent that is to have inflation protection built into mortgages and other debts.

Schonberger: Is inflation protection for mortgages and other debt something that you would advocate that the government undertake?

Shiller: Yes. It's in my book Subprime Solution. We should change our mortgages so that they protect people against this kind of nonsense. If prices fall, wages fall, home prices fall, and everything goes down together, it shouldn't mean anything. But it does if people are stuck in debt that doesn't protect them against deflation. It's called indexation. It was a concept that was brought out 100 years ago. It seems people just don't have enough imagination to realize that those things that happened in the past could happen again. So, they become complacent. The title of [Carmen] Reinhart and [Kenneth] Rogoff's new book is This Time Is Different. It's a syndrome. People think that errors of the past couldn't repeat themselves, so they don't even protect themselves against it. That's why we're poised to have the same issues again.

For more insight from Shiller:

Fool contributor Jennifer Schonberger does not own shares of any of the companies mentioned in this article. You can follow her on Twitter. The Motley Fool has a disclosure policy.


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  • Report this Comment On August 30, 2010, at 6:05 PM, dc46and2 wrote:

    "...everything depends on Barack Obama...the economy is essentially driven by ideas. People think, and they get ideas..."

    So lets hope Obama makes nice speeches and everybody thinks happy thoughts and everything will be just fine!

    I think there is "more than a 50% chance" this guy is "marginally" full of BS, but "that's an uncertainty." (Although he did get in some good plugs for his books!)

  • Report this Comment On August 30, 2010, at 6:50 PM, my2cents4u wrote:

    Ditto

  • Report this Comment On August 30, 2010, at 7:09 PM, tomd728 wrote:

    dc46and2...........I know he's b...s...t and not marginally so !

    When exactly did we emerge from the first recession ? Jobs numbers have continued to go

    south,,,,,,,,,,the real estate problem is rolling right along.........banks are looking at another avalanche of write-offs.........people are saving more which should be cheered but it simply means they are afraid to spend........durables are still under water.........foreclosures on non-commercial real estate is unabated.

    What is Obama going to do that the Administration would not have done already ?

    Man.... if I'm wrong please tell me in a harsh fashion ! I could use some cheering up.

    Tom

  • Report this Comment On August 30, 2010, at 7:34 PM, FinnMcCoolIRA wrote:

    Until Obama and his socialist hacks get 'out of the way' and allow American's to once again decide when and where to invest, spend and explore, there is NO hope for any meaningful economic or moral recovery.

    The Euro concept of an all knowing centralized controlled economy WILL destroy our country.

    "REMMBER IN NOVEMBER and OUT IN '12"

  • Report this Comment On August 30, 2010, at 8:05 PM, xetn wrote:

    Two observations:

    1st: You cannot have a double-dip recession because we haven't had a recovery yet. We will just have a deeper recession/depression.

    2nd: As long as the federal government keeps sucking all the capital out of the private sector, there will be little left for capital formation which is needed to start new projects. Every dollar the government spends is a dollar lost to the private sector. Only the very large companies, sitting on piles of cash until the next shoe drops, have the means for expansion. The next shoe being the next anti-business regulation or tax.

    We have never had a more anti-business environment in the history of the U.S. (except maybe FDR's). As long as there remains a "pretense to knowledge" by the administration (pretending to know what is best for us and the economy) we will remain in the deepening rut.

    I believe we will continue to see more companies moving off shore in order to stay competitive.

  • Report this Comment On August 30, 2010, at 10:56 PM, wtatm wrote:

    Shiller is off the mark on at least one point. He advocates the idea of "indexation" of mortgages. Basically, that is an attempt to protect consumers... from themselves and their own bad choices.

    In my Dad's day (shortly after WWII), it was not uncommon for folks to put 30-40% down on a house. When my wife and I bought our house (1987), 20% down was needed to avoid the PMI charges. The object was to pay off the mortgage as soon as possible. You didn't take out home equity loans.

    Granted, the consumer was not alone in this mess... the banks share plenty of blame in the housing meltdown. But I have to believe that if all consumers had needed 20% down to get a mortgage... and they hadn't used their homes as ATM machines... that there never would have been a financial crisis... or the "need" for a government bailout. Of course, the growth of the last decade would have been a lot less "robust"... but I think we're finding that "growth" was an illusion.

    Just my 2 cents...

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