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Wednesday, August 29, 2012

Government Policies and the Delayed Economic Recovery

A year ago, when the economic recovery had already been delayed two years, Lee Ohanain and I got the idea for a book on the role policy in the delay.  To make the idea operational we invited people who were working on the topic to a conference and to write chapters. The book Government Policies and the Delayed Economic Recovery  is now available as an ebook with printed copies on their way to Amazon and other booksellers.With yet another year of delayed recovery and growing debates about the cause, the topic is more relevant than ever.

Here is how Lee Ohanian, Ian Wright and I summarized the papers and their implications in the Introduction:

The contributors to this book consider a wide range of topics and policy issues related to the delayed economic recovery. While their opinions are not always the same, together they reveal a common theme: the delayed recovery has been due to the enactment of poor economic policies and the failure to implement good economic policies. The discussion at the conference where some of the papers were presented—summarized by Ian Wright—reveals a similar theme.

The clear implication is that a change in the direction of economic policy is sorely needed. Simply waiting for economic problems to work themselves out, hoping that growth will improve as the Great Recession of fades into the distant past, will not be enough to restore strong economic growth in America.

And here is the Table of Contents:

Economic Strength and American Leadership
George P. Shultz
Uncertainty Unbundled: The Metrics of Activism
Alan Greenspan
Has Economic Policy Uncertainty Hampered the Recovery?
Scott R. Baker, Nicholas Bloom, and Steven J. Davis
How the Financial Crisis Caused Persistent Unemployment
Robert E. Hall
What the Government Purchases Multiplier Actually Multiplied in the 2009 Stimulus Package
John F. Cogan and John B. Taylor
The Great Recession and Delayed Economic Recovery: A Labor Productivity Puzzle?
Ellen R. McGrattan and Edward C. Prescott
Why the U.S. Economy Has Failed to Recover and What Policies Will Promote Growth
Kyle F. Herkenhoff and Lee E. Ohanian
Restoring Sound Economic Policy: Three Views
Alan Greenspan, George P. Shultz, and John H. Cochrane
Summary of the Commentary
Ian J. Wright

Monday, August 27, 2012

Which Simple Rule for Monetary Policy?

The discussion of "Simple Rules for Monetary Policy" at last week’s FOMC meeting is a promising sign of a desire by some to return to a more rules-based policy. As described in the FOMC minutes, the discussion was about many of the questions raised in recent public speeches by FOMC members Janet Yellen and Bill Dudley. A big question is which simple rule?

Yellen and Dudley discussed two rules. Using Yellen’s notation these are

R = 2 + π + 0.5(π - 2) + 0.5Y
R = 2 + π + 0.5(π - 2) + 1.0Y

where R is the federal funds rate, π is the inflation rate, and Y is the GDP gap. Yellen and Dudley refer to the first equation as the Taylor 1993 Rule and the second equation as the Taylor 1999 Rule, though the second equation was only examined along with other rules, not proposed or endorsed, in a paper I published in 1999.

The two rules are similar in many ways. Both have the interest rate as the instrument of policy, rather than the money supply. Both are simple, having two and only two variables affecting policy decisions. Both have a positive weight on output. Both have a weight on inflation greater than one. Both have a target rate of inflation of 2 percent. Both have an equilibrium real interest rate of 2 percent.

The two rules differ substantially, however, in their interest rate recommendations as this amazing chart constructed last April by Bob DiClementi of Citigroup illustrates. The chart shows two rules along with historical and projected values of the federal funds rate. The rule labeled “Taylor” by DiClementi is the rule I proposed. The other rule is labeled “Yellen” by DiClementi because it corresponds to the rule apparently favored by Yellen. The projected values are the views of FOMC members.

Observe that the first rule never gets much below zero, while the second rule drops way below zero during the recent recession and delayed recovery. The difference continues though it gets smaller into the future. Note that the projected interest rates by FOMC members span the two rules.

This big difference between the two rules in the graph can be traced to two factors: (1) The second rule has a much larger GDP gap, at least as used by Yellen. (2) The second rule has a much bigger coefficient on the GDP gap.

In my view, a smaller value of the GDP gap and a smaller coefficient are more appropriate. This view is based on a survey of estimated gaps by the San Francisco Fed and simulations of models over the years. But given the striking differences in DiClememti's chart, more research on the issue by people in and out of the Fed would certainly be very useful.

Thursday, August 16, 2012

Democracy is Not a Spectator Sport, Even for Economists

It’s good news that economic issues are now getting more attention in the presidential campaign. More than 400 economists have signed a statement on the differences between the Romney economic program and the Obama program—the numbers are growing each day—and economic commentators including on CNBC and the Wall Street Journal (here and here) are discussing it. Judging by the hits on this post on Economics One, there’s a great deal of interest in the issues rasied in the economic white paper—authored by Kevin Hassett, Glenn Hubbard, Greg Mankiw and me—comparing the effects on economic growth of the Romney program and the Obama program. Of course, the selection of Paul Ryan has set off a huge number of articles on economics from budget policy to monetary policy.

It’s already clear to most voters that the presidential candidates have vastly different approaches to economic policy. But many people are still not informed about the implications of these two approaches. In my view the more voters get informed, and the more their votes are based on that information, the more likely the officials they elect will be able to revive the economy.

But this will not happen if the political campaign drifts back away from substance as campaigns so often do. Keeping the debate focused on economics requires that economists participate and not merely sit back and watch. To remind myself of this, I like to wear this "Democracy is not a spectator sport" tie a lot during the election season.

Monday, August 13, 2012

Paul Krugman is Wrong

Paul Krugman took time off from his vacation last Friday to take a shot at a paper by Kevin Hassett, Glenn Hubbard, Greg Mankiw and John Taylor on the growth and employment impacts of Governor Romney’s economic program in comparison with President Obama’s program. Though flaming with vitriolic rhetoric, his shot misses the mark.

Half of Krugman’s piece strays away from the paper, so focus on what he actually says about the paper.

First, he says that that the “work of other economists” cited in the paper does not support its position. But the research papers and books that are cited are quoted correctly and do provide supporting evidence. As Scott Sumner reports “when I looked at the paper I couldn’t find a single place where they had misquoted anyone.” And Jim Pethokoukis shows not only that the evidence cited in the paper is supportive, but also that Krugman is on record as previously agreeing with the cited work on the 2009 stimulus package.

Second, Krugman claims that the authors whose work is cited in the paper have also done other work which is not supportive of other aspects of the paper. The example he mentions is the work of Atif Mian and Amir Sufi showing that the slump is “demand-driven” in addition to their cited work on the cash-for-clunkers program (and much other work by the way). But work showing that the slow recovery is demand-driven is not evidence that the Romney program will not increase economic growth. As the paper on the Romney economic program states, the program works in two ways: "It will speed up the recovery in the short run, and it will create stronger sustainable growth in the long run."  Demand and supply are at work.

Third, Krugman asserts that the “Baker et al paper claiming to show that uncertainty is holding back recovery clearly identifies the relevant uncertainty as arising from things like the GOP’s brinksmanship over the debt ceiling — not things like Obamacare.” Well there is nothing about “the GOP’s brinkmanship” in the Baker et al paper; those are Krugman’s words. And the paper on the Romney economic program does not link Baker et al to Obamacare. The Baker et al paper uses an index of policy uncertainty which has been very high in recent years for many reasons including uncertainty about future taxes and the debt problem, as exemplified by the 2011 debt dispute, which had its origins prior to 2011, including in 2009 and 2010. That is exactly the point: Policy uncertainty is high now for a number of reasons, and reducing it with a long-term strategy rather than more short-term fixes will increase economic growth and create jobs.

Friday, August 3, 2012

It’s Still a Recovery in Name Only--A Real Tragedy

I have been regularly charting the path of real GDP and employment during the recovery from the recession as new data are released. From the start it was clear that the recovery was very weak. By its second anniversary the recovery was weak for long enough to call it “a recovery in name only, so weak as to be nonexistent.” Now we are just past the third anniversary, and it is still at best a recovery in name only. It’s now the worst in American history—a tragedy that should not be minimalized.

Here’s an update of the charts using the latest data through the second quarter or through July for monthly data. The first one shows real GDP in this recovery. You can see that the gap between real GDP and potential GDP (CBO estimates) is not closing at all. That is the main reason why unemployment remains so high.


Second is the comparison chart with the recovery from the previous deep recession in the early 1980s.That is a typical recovery from a deep recession. The gap closes.


Some say that recoveries from deep U.S. recessions--or from financial crises--are usually slower, but this is simply not true. Below are similar charts from the 1893-94 recession

and from the 1907 recession,

both associated with severe financial crises. You can see the sharp rebounds, nothing like the terrible recovery we have seen recently. This does not imply that the period after these recoveries was smooth; indeed a double dip followed the recovery in the early 1890s.

Of course potential GDP is difficult to measure so it is important to look at alternative charts. The next one used GDP growth rates. The average real GDP growth rate in this recovery has been only 2.2 percent, even lower than the 2.4 percent before the data were revised.

Finally, with today’s July employment numbers you can see the extraordinarily weak employment record in this recovery. The employment-to-population ratio is still lower than at the start of the so-called recovery. We now know that it fell in July as shown in the lower right part of the chart.