The Output Gap versus the "Wealth Shock"

Missouri gets two Federal Reserve Banks. One is in St. Louis, the other in Kansas City. James Bullard is the President of the St. Louis Bank. (Pizzaman and Lothario Herman Cain had worked at the Kansas City one.) Via Yglesias, Cowen, Thoma, and MacroMania, here is a speech Bullard gave in Chicago on inflation targeting.

The key to the large output gap story is the use of the fourth quarter of 2007 as a benchmark for where we expect the economy to be today. The idea is to take that level of real output, assume the real GDP growth rate that prevailed in the yearsprior to 2007, and project out where the “potential” output of the U.S. should be. By that type of calculation, we are indeed stunningly far below where we should be, perhaps 5.5 percent below, using data through the fourth quarter of 2011.

Is this really the right way to think about where the U.S. economy should be? I do not think it is a defensible point of view. Let me give you some of my perspectives. What is more, we have made little progress in closing the gap defined in this way, because real GDP has only grown at modest rates since the recession ended in the summer of 2009. And furthermore, using current GDP forecasts from, say, the Blue Chip consensus, we have little prospect for closing the gap any time soon.

As I understand it, the trend growth rate used by the Fed, the CBO and Blue Chip private forecaster consensus DOES NOT start in 2007 but starts back many years and even decades. If this is true the economic illiteracy demonstrated by Bullard is both shocking and galling. Or is he a fraud?

Most analysts seem to agree that the middle part of the 2000s was characterized by a “bubble” in the housing sector. Housing prices were high and rising fast compared to nominal GDP. It is not prudent to extrapolate a bubble into the indefinite future and claim that such a calculation provides a good benchmark. Yet, that is what we are doing when we extrapolate fourth quarter 2007 real GDP. Furthermore, we normally have the good sense not to do this in other economic situations.

But they aren't extrapolating from the bubble are they?

For those who take the “large output gap” view, the expectation is for real GDP to grow rapidly after the recession comes to an end, as the economy catches up to its potential. It is like a rubber band, there is supposed to be a bounce back period of rapid growth. In fact, most analysts have been looking for exactly this effect since the summer of 2009. It has not happened. This has led to a lot of analysis concerning special factors and headwinds that might be inhibiting the “bounce back” effect.

The wealth shock view puts a different expectation in play. The negative wealth shock lowers consumption and output. But after the recession ends, the economy simply grows from that point at an ordinary rate, neither faster nor slower than in ordinary times. It is more like an earthquake which has left one part of the land higher than another part. There is no expectation of a “bounce back” to a higher level of output after the recession ends. This is closer to what has actually happened since mid-2009. Output has grown at a moderate rate, but not a rapid rate, since the recession ended.

In the wealth shock view, there is no “large output gap” rationale for keeping interest rates near zero. There is only an economy growing at normal rates following a large shock to wealth.

The growth rates are determined by government policy. They're a political decision. The long term potential growth rate is not a political decision. It's a function of technology, organization, population growth, etc.

But the government determines credit conditions, fiscal stimulus, monetary stimulus, inflation rate, etc. They can bring us to our full potential growth rate more quickly or they can stagnate us at a lower equilibrium.

[I have to take a break. I can't keep reading Bullard's tripe right now.]

Obama's 2012 relection campaign playlist.

Wilco and Arcade Fire. Earth, Wind and Fire. E.L.O. REO Speedwagon. I like this one by the little-known Portland band AgesandAges:

Obama has good taste. His favorite character on The Wire was Omar Little, a gay vigilante. And his Firebagger critics on the Left always argue he wasn't tough enough. He's liberal on cultural issues and I suspect the positions he takes as a candidate and President are sort of politically calculated regarding gays and women's rights.

Noam Scheiber on Obama's Worst Year.

It's a replay of FDR in 1937 with Obama mistakenly listening to the advice of Orszag, Daley, Plouffe, Emanuel, and Geithner/Bernanke. He should have listened to Romer and Summers.

(Via DeLong)

Greta Gerwig will be in Whit Stillman's new movie Damsels in Distress.

She's in the new movie the Dish & the Spoon:

Rose’s description of Thanksgiving and the relationship of the Pilgrims to the Indians is probably a first for a fiction feature: “We gave them smallpox on purpose, and then we continued to sort of systematically kill them, but what we celebrate is the meal that we had before any of that happened, when everything was good.”

Ms. Gerwig, who has been called the queen of mumblecore, creates a slightly unnerving portrait of a vulnerable, high-strung woman on the edge. Rose is first seen sobbing her eyes out as she drives through a tunnel clad in her pajamas. Stopping at a convenience store, she buys doughnuts and a six-pack of beer but has only enough change to pay for five bottles. Upon discovering the boy, she insists on driving him to a hospital. She changes her mind en route, and they end up camping out in her parents’ vacant summer house.

Stillman wrote and directed Barcelona:

DeLong has put up his class materials on his blog for a little while now and recently put stuff up on iTunes. Krugman put up some stuff today on the welfare state.

What Does Wealth Have to Do with Output? by Yglesias

Sympathy for Bernanke by Ryan Avent

BINYAMIN APPELBAUM reports today from a meeting of the Senate Budget Committee, which played host to Federal Reserve Chairman Ben Bernanke:

“It seems to me that you care more about unemployment than about inflation,” said Senator Charles E. Grassley, Republican of Iowa.

“I want to disabuse any notion that there is a priority for maximum employment,“ Mr. Bernanke responded.

Instead, he told another questioner, Senator Patrick J. Toomey, Republican of Pennsylvania, that the Fed’s approach to its dual objectives is “fully balanced and symmetrical.”

Mr. Toomey responded that that was exactly what he had expected Mr. Bernanke to say, but he did not seem pleased about it.

The most that core consumer prices have risen in a 12-month period since Mr Bernanke took over is just 2.9%—and that was in 2006, when he'd had less than a year in the top job. Since the financial crisis of late 2008, core prices have risen no faster in a 12-month span than 2.2%. During the second half of 2010, annual inflation stood at its lowest level in over half a century. Unemployment, by contrast, peaked at 10.0%. Only once in the post-war period did the jobless rate rise above that level. Only twice in the postwar period has the country experienced a recession that brought the unemployment rate above its current level, at 8.3%—the downturns of 1973-75 and 1981-82. I'm left to muse that Mr Grassley must say good-bye when he enters a room and hello when he leaves, and wears his shoes on his head. 

Of course, Mr Toomey would be justified in being displeased with Mr Bernanke's "fully balanced and symmetrical" remark. It's wrong; for nearly four years the Fed has been at or below its inflation target while unemployment soared above the natural rate and stayed there. The Fed is failing to meet its dual mandate and deserves to be criticised. Yet these gentlemen aren't unhappy about the actual failures of Fed policy; they're angry about the statistics in some bizarre alternate reality in which the Fed has allowed inflation to run out of control in an effort to maximise employment. They might as well threaten to hold hearings on his troubling habit of hunting down and dining upon unicorns; it would make as much sense.

Onion review of the new Van Halen album.

Oh yes I will be going to the show at the end of the month.

Time for QE3 by Yglesias

Soul Train Host Don Cornelius Dies at 75 by Belle Warring

bad blog post by Krugman where he links to Digby, a biased critic of Obama. Comment section was closed after many smart comments made about the questionable scale used by Poole. Nixon was pretty liberal. Clinton deregulated the financial sector with dismantling Glass-Steagal, while Obama re-regulated with Dodd-Frank and the Consumer Financial Protection Bureau which Obama had Elizabeth Warren set up, even though Geithner didn't like Warren. I see this as Krugman pandering to the ultra-Firebagger left.

Good blog post by Krugman on non-existent Inflation.

Diapers and Deflation

Procter & Gamble Co.’s failure to raise the price of Cascade dishwashing soap shows why investors are buying Treasuries at the lowest yields in history, giving the Federal Reserve more scope to boost the economy.

The world’s largest consumer-products company rolled back prices after an 8 percent increase lost the firm 7 percentage points of market share. Kimberly-Clark Corp. (KMB) started offering coupons on Huggies after resistance to the diapers’ cost. Darden Restaurants Inc. (DRI) raised prices at less than the inflation rate as patrons order more of Olive Garden’s discounted stuffed rigatoni than it anticipated.

This is basic economics; prices tend to fall, or at least slow their rise, when there is vast excess capacity and weak demand. But where’s my hyperinflation?

Conservatives have been crying wolf over inflation for 4 years.

Things Are Not O.K. by Krugman

So, about that jobs report: it was genuinely good, certainly compared with the dreariness that has become the norm. Notably, for once falling unemployment was the real thing, reflecting growing availability of jobs rather than workers dropping out of the labor force, and hence out of the unemployment measure.

Furthermore, it’s not hard to see how this recovery could become self-sustaining. In particular, at this point America is seriously under-housed by historical standards, because we’ve built very few houses in the six years since the housing bubble popped. The main thing standing in the way of a housing bounce-back is a sharp fall in household formation — econospeak for lots of young adults living with their parents because they can’t afford to move out. Let enough Americans find jobs and get homes of their own, and housing, which got us into this slump, could start to power us out.

That said, our economy remains deeply depressed. As the Economic Policy Institute points out, we started 2012 with fewer workers employed than in January 2001 — zero growth after 11 years, even as the population, and therefore the number of jobs we needed, grew steadily. The institute estimates that even at January’s pace of job creation it would take us until 2019 to return to full employment.

And we should never forget that the persistence of high unemployment inflicts enormous, continuing damage on our economy and our society, even if the unemployment rate is gradually declining. Bear in mind, in particular, the fact that long-term unemployment — the percentage of workers who have been out of work for six months or more — remains at levels not seen since the Great Depression. And each month that this goes on means more Americans permanently alienated from the work force, more families exhausting their savings, and, not least, more of our fellow citizens losing hope.

Dean Baker on Robert Rubin:

This article also includes a bizarre quote from former Treasury Secretary and Citigroup honcho Robert Rubin on financial crises:

"But he [Gene Sperling] has a deeply internalized sense of the severe risk that an unsound fiscal regime presents with respect to markets and financial crises.”

Given that Robert Rubin's high dollar policy, coupled with a commitment to unregulated financial markets laid the basis for the economic collapse of the last decade, and that he personally pocketed more than $100 million from the excesses of the bubble years in his tenure at Citigroup, he would seem to be a strange person to quote as an authority on financial crises.

It Is Safe to Resume Ignoring the Prophets of Doom ... Right? by Adam Davidson.

Another lame installment by Davidson, but at least he mentions Krugman and Dean Baker in passing.

I've never heard of Richard Wolff.