Cyclical and Secular Trends
After saying
Ezra Klein's narrative and
tour d'horizon of Obama's economic policy is ultimately a white wash, I feel compelled to quote the parts which I thought were excellent. Afterwards I'll coment on David Leonhardt's essay "The Depression: If Only Things Were That Good." Leonhardt is writing for the New York Times and Klein is writing for the Washington Post so perhaps both felt the necessity to add some "balanced" comments so that their worthwhile insights don't appear too controversial or partisan. This is probably why Klein's piece ends up feeling like a white wash. Leonhardt's piece starts off shaky but gets better at the end. I'd cut the two some slack given the state of newspapers these days, but that's just me.
Let me first say I'm sympathetic to Obama and I admire the advisers he picked like Romer, Bernstein, and Goolsbee and I'm less down on Orszag, Summers, Geithner, and Bernanke than others have been.
First off, Klein is right to report that other respected forecasters were in agreement with the administration's analysis of the downturn.
But Romer wasn’t trying to be alarmist. Her numbers were based, at least in part, on everybody else’s numbers: There were models from forecasting firms such as Macroeconomic Advisers and Moody’s Analytics. There were preliminary data pouring in from the Bureau of Labor Statistics, the Bureau of Economic Analysis and the Federal Reserve. Romer’s predictions were more pessimistic than the consensus, but not by much.
Granted the "consensus" was all wrong about the housing bubble, but still. Klein could have pointed this out, but it would have called into question the authority of the Washington Post.
By that point, the shape of the crisis was clear: The housing bubble had burst, and it was taking the banks that held the loans, and the households that did the borrowing, down with it. Romer estimated that the damage would be about $2 trillion over the next two years and recommended a $1.2 trillion stimulus plan. The political team balked at that price tag, but with the support of Larry Summers, the former Treasury secretary who would soon lead the National Economic Council, she persuaded the administration to support an $800 billion plan.
So the damage was $2 trillion and they were going with 800 billion which was whittled down by the Senate to 700 billion with a large part being ineffective tax cuts? What if it was an "L-shaped" recovery as in the early 1990s and early 2000s, the last two recessions? What if recovery took longer because it followed a financial crisis as shown in Rogoff and Reinhart's book "This Time It's Different"? Klein writes that everyone underestimated the amount the economy shrank:
To understand how the administration got it so wrong, we need to look at the data it was looking at.
The Bureau of Economic Analysis, the agency charged with measuring the size and growth of the U.S. economy, initially projected that the economy shrank at an annual rate of 3.8 percent in the last quarter of 2008. Months later, the bureau almost doubled that estimate, saying the number was 6.2 percent. Then it was revised to 6.3 percent. But it wasn’t until this year that the actual number was revealed: 8.9 percent. That makes it one of the worst quarters in American history. Bernstein and Romer knew in 2008 that the economy had sustained a tough blow; t hey didn’t know that it had been run over by a truck.
So was Romer's $2 trillion estimate off the mark? What makes Klein's story better than most is the following:
There were certainly economists who argued that the recession was going to be worse than the forecasts. Nobel laureates Krugman and Joe Stiglitz were among the most vocal, but they were by no means alone. In December 2008, Bernstein, who had been named Biden’s chief economist, told the Times, “We’ll be lucky if the unemployment rate is below double digits by the end of next year.”
The Cassandras who look, in retrospect, the most prophetic are Carmen Reinhart and Ken Rogoff. In 2008, the two economists were about to publish “This Time Is Different,” their fantastically well-timed study of nine centuries of financial crises. In their view, the administration wasn’t being just a bit optimistic. It was being wildly, tragically optimistic.
He'll acknowledge the existence of "Cassandras" even if he doesn't highlight how the consensus - whose figures he's citing - had been wrong about the housing bubble and deregulation, etc. Klein quotes Orszag's mea culpa:
I don’t think it’s too much of an exaggeration to say that everything follows from missing the call on Reinhart-Rogoff, and I include myself in that category,” says Peter Orszag, who led the Office of Management and Budget before leaving the administration to work at Citigroup. "I didn’t realize we were in a Reinhart-Rogoff situation until 2010.
I like that Klein quotes critics who have been right about a lot like Stiglitz and Baker. Here they comment on Reinhart-Rogoff:
Yet even among economists who admire Reinhart and Rogoff’s work, there is skepticism.
One source comes in how Reinhart and Rogoff find the economic phenomena they’re trying to study. “There’s an identification problem,” Stiglitz says. “When you have underlying problems that are deep, they will cause a financial crisis, and the crisis itself is a symptom of underlying problems.”
Another is in their fatalism. “I don’t buy their critique in the sense that this was an inevitability,” says Dean Baker, director of the Center for Economic and Policy Research and one of the economists who spotted the housing crisis early.
Klein gets a gold star for that third paragraph. I remember very well when Bernanke was asked about Reinhart-Rogoff and he deadpanned in response "yes policy makers usually don't respond well to financial crises and their aftermath" which is why it takes a while for the economy to recover after they occur. He was probably thinking of Japan. I could be wrong but I don't believe Reinhart and Rogoff emphasized the failure of policy makers in their publicity for the book. They seemed fatalistic as Baker points out.
Klein reports that the stimulus was too small:
Critics and defenders on the left make the same point: The stimulus was too small. The administration underestimated the size of the recession, so it follows that any policy to combat it would be too small. On top of that, it had to get that policy through Congress. So it went with $800 billion — what Romer thought the economy could get away with — rather than $1.2 trillion — what she thought it needed. Then the Senate watered the policy down to about $700 billion. Compare that with the $2.5 trillion hole we now know we needed to fill.
Klein doesn't really emphasize the point, but the administration should have gone back for more or done more unilaterally or at least refrain from talking of green shoots and cutting government spending.
Some more good info Klein highlights is the Federal Reserve and inflation.
There was, however, one institution that some think could have reduced the debt overhang crushing the economy and that didn’t face such political obstacles: the Federal Reserve.
The central bank manages the nation’s money supply and credit and sits at the center of its financial system. Usually, it spends its time guarding against the threat of inflation. But in December 2008, Rogoff argued that the moment called for the reverse strategy.
“It is time for the world’s major central banks to acknowledge that a sudden burst of moderate inflation would be extremely helpful in unwinding today’s epic debt morass,” he wrote.
...
Rogoff scoffs at this. “Creating inflation is not rocket science,” he wrote. “All central banks need to do is to keep printing money to buy up government debt. The main risk is that inflation could overshoot, landing at 20 or 30 percent instead of 5 or 6 percent. Indeed, fear of overshooting paralyzed the Bank of Japan for a decade. But this problem is easily negotiated. With good communication policy, inflation expectations can be contained, and inflation can be brought down as quickly as necessary.”
Klein could have mentioned Volcker's success. In fact we need Bernanke to get some Volckerian resolve. But at least he discusses the Federal Reserve. Usually liberals and progressives neglect to mention it.
Another good idea Klein raises is Germany's work-sharing:
Germany’s response to the recession included a work-sharing program that subsidized salaries when employers trimmed the hours of individual workers to keep more people on the job. If workers attended job training, the government gave a more generous subsidy.
The program worked. Even though Germany’s economy was devastated by the recession — declining by almost 7 percent — the jobless rate fell slightly, from 7.9 percent at the start of the recession to 7 percent in May 2010.
There are reasons to question whether work-sharing programs would have been as effective here as they were in Germany. For one thing, they work best in sectors where jobs are bound to return after a recession — such as Germany’s export sector — rather than sectors that need to be downsized after being inflated by a credit boom.
Germany also has a different labor market. Employers, unions and the government work together with an unusual level of cooperation. The culture is much more hostile toward layoffs than the United States’ is, which has caused Germany problems in the past but has been a boon throughout this recession.
But paying the private sector to save jobs was not the administration’s only option. There was also the possibility of simply paying workers to work.
For one thing, the government could have refused to fire anyone. Says Baker, of the Center for Economic and Policy Research: “We’ve lost 500,000 state and local jobs, and before that, we were creating 160,000 a year. If we hadn’t had those losses and had done more to keep creation at that pace, we would have almost another million jobs.”
It also could have started hiring. Romer, for instance, proposed to add 100,000 teacher’s aides. Imagine similar proposals: Every park ranger could have had an assistant park ranger. Every firefighter station could have added three trainees. Every city could have expanded its police force by 5 percent. Everyone between ages 18 and 26 could have signed up for two years of paid national service.
Another idea Klein could have touched on is FDR's mistaken turn towards deficit cutting in 1937. Klein could have been clearer on the numbers, too. First Romer says a $2 trillion dollar hole. How does that relate to the shrinking economy in the last quarter of 2008? Then Klein says $2.5 trillion and finally he mentions the loss of $8 trillion in housing wealth.
However, if you read between the lines, it's quite a good article all in all, not perfect, but thorough.
------------------------------------------
Leonhardt's piece comparing the Great Depression with today is shorter but good also. Leonhardt starts off comparing the 1930s with today.
Economists often distinguish between cyclical trends and secular trends — which is to say, between short-term fluctuations and long-term changes in the basic structure of the economy. No decade points to the difference quite like the 1930s: cyclically, the worst decade of the 20th century, and yet, secularly, one of the best.
It would clearly be nice if we could take some comfort from this bit of history. If anything, though, the lesson of the 1930s may be the opposite one. The most worrisome aspect about our current slump is that it combines obvious short-term problems — from the financial crisis — with less obvious long-term problems. Those long-term problems include a decade-long slowdown in new-business formation, the stagnation of educational gains and the rapid growth of industries with mixed blessings, including finance and health care.
Together, these problems raise the possibility that the United States is not merely suffering through a normal, if severe, downturn. Instead, it may have entered a phase in which high unemployment is the norm.
I just don't agree with this. Christina Romer doesn't and I don't believe Leonhardt himself does either.
On Friday, the Labor Department reported that
job growth was mediocre in September and that unemployment remained at 9.1 percent. In a recent survey by the
Federal Reserve Bank of Philadelphia, forecasters said the rate was not likely to fall below 7 percent until at least 2015. After that, they predicted, it would rarely fall below 6 percent, even in good times.
Well they've been wrong before. Leonhardt discusses education:
Despite the media’s focus on those college graduates who are struggling, it’s not much of an exaggeration to say that people with a four-year degree — who have an unemployment rate of just 4.3 percent — are barely experiencing an economic downturn.
Maybe Obama is less concerned about unemployment than he ought to be because all of the states that voted for Obama in 2008
had high levels of college graduates, especially the new purple states like Virginia. (This is why they took out no insurance after passing the stimulus.)
They are counting on these states to win in 2012. (Granted Obama is more concerned than Republicans. Plus median incomes have fallen 10 percent or so since the beginning of the recession. That should hurt Obama's prospects. The one downside in an Obama victory will be the analyses of those who argue high unemployement doesn't matter.)
Economic downturns do often send people streaming back to school, and this one is no exception. So there is a chance that it will lead to a surge in skill formation. Yet it seems unlikely to do nearly as much on that score as the Great Depression, which helped make high school universal. High school, of course, is free. Today’s educational frontier, college, is not. In fact, it has become more expensive lately, as state cutbacks have led to tuition increases.
Beyond education, the American economy seems to be suffering from a misallocation of resources. Some of this is beyond our control. China’s artificially low currency has nudged us toward consuming too much and producing too little. But much of the misallocation is homegrown.
In particular, three giant industries — finance, health care and housing — now include large amounts of unproductive capacity. Housing may have shrunk, but it is still a bigger, more subsidized sector in this country than in many others.
This is the Leonhardt I've grown to admire. These are the long-term "structural" problems with the U.S. economy.
Health care is far larger, with the United States spending at least 50 percent more per person on medical care than any other country, without getting vastly better results. (Some aspects of our care, like certain cancer treatments, are better, while others, like medical error rates, are worse.) The contrast suggests that a significant portion of medical spending is wasted, be it on approaches that do not make people healthier or on insurance-company bureaucracy.
In finance, trading volumes have boomed in recent decades, yet it is unclear how much all the activity has lifted living standards. Paul A. Volcker, the former Fed chairman, has mischievously said that the only useful recent financial innovation was the automated teller machine. Critics like Mr. Volcker argue that much of modern finance amounts to arbitrage, in which technology and globalization have allowed traders to profit from being the first to notice small price differences.
IN the process, Wall Street has captured a growing share of the world’s economic pie — thereby increasing inequality — without doing much to expand the pie. It may even have shrunk the pie, given that a new International Monetary Fund analysis found that higher inequality leads to slower economic growth.
The common question with these industries is whether they are using resources that could do more economic good elsewhere. “The health care problem is very similar to the finance problem,” says Lawrence F. Katz, a Harvard economist, “in that incredibly talented people are wasting their talent on something that is essentially a zero-sum game.”
In the short term, finance, health care and housing provide jobs, as their lobbyists are quick to point out. But it is hard to see how the jobs of the future will spring from unnecessary back surgery and garden-variety arbitrage. They differ from the growth engines of the past, which delivered fundamental value — faster transportation or new knowledge — and let other industries then build off those advances.
Obamacare and Frand-Dodd are good steps in the right direction but not enough. The housing bubble was deflating on its own and jobs were moving to other sectors until the financial crisis hit.
The rate at which new companies are created has been falling for most of the last decade. So has the pace at which existing companies add positions. “The current problem is not that we have tons of layoffs,” Mr. Katz says. “It’s that we don’t have much hiring.”
If history repeats itself, this situation will eventually turn around. Maybe some American scientist in a laboratory somewhere is about to make a breakthrough. Maybe an entrepreneur is on the verge of creating a great new product. Maybe the recent health care and financial-regulation laws will squeeze the bloat.
For now, the evidence for such optimism remains scant. And the economy remains millions of jobs away from being even moderately healthy.
What is needed is more government spending to help with aggregate demand and for Bernanke to get some Volckerian resolve. Inflation will help with deleveraging and inflation will get those sitting on money to invest and spend. It will boost the velocity of money.
Ideally, we would have a 21st century WPA program which could be modeled on the way the National Science Foundation doles out grants.
