Sudden, Unanticipated, Discrete Collapse
by J. Bradford DeLong
The Conversation
December 9th, 2008
Casey Mulligan wants to add another to my list of factors that might have been responsible for the steep and unanticipated decline in asset prices over the past year and a half: the pace of capital accumulation — especially the country’s residential capital stock — over the past five years. With every extra piece of capital comes a reduction in the average dividend it will pay and also a reduction in the present worth of that future dividend — so when there is more capital each unit of capital is worth less.
This channel produces a smooth and anticipated decline in the price p of capital goods — as we used to chant while studying for Olivier Blanchard’s midterm in Econ 2410b: “pdot = rp – d,” the rate of decline in the price of capital goods is the required ex ante rate of return r times the current price of capital goods p minus the current dividend d.
And this is, I think, a problem. For we have to account for not a slow, anticipated, continuous fall in the prices of risky claims to capital but for a sudden, unanticipated, discrete collapse in those values. Capital accumulation won’t do that for us: we need discrete and unexpected changes in resources, technologies, or preferences — and a collapse in risk tolerance, a sudden discrete change in marketwide preference for risk is that one that seems most plausible to me.
