Depression

Mark Thoma elaborates on this post by David Altig (Head of Research at the Atlanta Fed). The centerpiece of both posts is this graph:

According to Altig:

The bottom line of this chart is that there has been a pretty reliable relationship between sustained bouts of sub-2 percent growth and U.S. recessions (indicated by the gray shaded areas). In fact, over the entire post-World War II era, periods in which year-over-year real GDP growth below 2 percent have been almost always associated with downturns in the economy.

Which leads Thoma to ask; “How close are we to a second recession”?

The White House and Congress are devoting all of their energy to deficit reduction rather than job creation. As highlighted by yesterday’s horrid jobs report the fact that deficit reduction will place an additional drag on the recovery, that’s something they may come to regret.

All the emphasis that is being put on rates – be it growth or inflation – is very misleading. According to the criteria put forth in the book “Great Depressions of the Twentieth Century” edited by T. Kehoe and E. Prescott and published by the Minneapolis Fed:

The US is in a depression relative to itself

So, why worry about a “second recession” if we are in a “depression” as clearly illustrated by this picture.

Amazingly the main argument to counter the possibility of a “second recession” is “fiscal policy”. To Thoma, “deficit reduction will place an additional drag on the economy”. Paul Krugman focuses on the rising interest rate argument of those that advocate in favor of “expansionary austerity”. He shows this picture:

And comments sarcastically:

The Very Serious position has been that government borrowing will drive up rates, crowd out private investment, and impede recovery. A Keynes-Hicks analysis by contrast, says that when you’re in a liquidity trap, even large government borrowing won’t drive up rates — and hence won’t crowd out private investment. In fact, it will promote private investment by raising capacity utilization and giving firms more reason to expand.

You know what has actually happened.

Impressively, no mention at all about what monetary policy could do!

Altig, a Fed insider, tries to “lessen” the problem by appealing to the experience we now have with “advances in output that are accomplished without much progress on the job front. In other words productivity driven growth has been and may still be the story of the day”.

He goes on to show this picture as “evidence”:

His choice of words is a sick joke: “Advances in output”! “Without much progress on job front”! “Productivity-driven growth”! All of those things must be “fantasies” in his mind.

His own graph shows that “advances in output” are on the verge of disappearing. In the job front there´s been no “advance”, only a steep retrenchment and productivity has not driven growth at all.

Equivalent pictures for other periods show that you can have a jobless (note, not jobloss) recovery with strong productivity growth. You can also have strong job gains with strong productivity growth.

As the last set of pictures show, the common factor in all these productivity growth episodes is a drop in inflation.

Which leads me to conjecture that under present circumstances a monetary policy geared to take the economy away from the depression – by targeting a nominal spending level, say – would be mostly reflected in real output gains. This contrasts with the “we are on the brink of exploding inflation” view.

But Altig has an “optimistic” message, despite the “structural changes” (always the cop-out) in play”, that message being:

our own thinking here on the staff in Atlanta has been that real signs of improvement will only become apparent as the summer progresses—we have already conceded the second quarter.

Yes, maybe the summer sun will “heat up” the economy!