Many are quick to shout “it´s structural”

But Ryan Avent does a great job in setting the record straight. It´s a must read. The conclusion:

So let’s be clear; the primary evidence for permanent loss of potential is the slow recovery in the size of the labour force, which would appear to be largely due to cyclical variation. We are not seeing a surge in labour costs, or prices generally, indicating that the economy is actually running up against capacity constraints. The Fed could have taken the approach that it would seek above-trend growth, as one normally expects to see after a recession (especially a deep one), and then step on the brakes if it became apparent that potential had been lost, that real growth was falling consistently short of trend while inflation was accelerating. That would have made a lot of sense, given the real economic costs of prolonged high unemployment.

That’s not what the Fed has done. Instead, it’s been happy to accept at- or below-trend growth, despite the fact that the large remaining output gap has quickly translated shocks into worrisome disinflationary pressure. Now the public is increasingly willing to read Fed failure as a loss of potential. If the Fed comes to agree, it may begin to fear that it has less room to boost the economy, it may consequently boost the economy less, and it may therefore ensure that the output gap persists until it does indeed become permanent.

This is self-induced paralysis: the fear that trying to do things to fix current problems will generate consequences worse than the present problems, all evidence to the contrary. It’s frustrating—galling, even—though I suppose at this point we shouldn’t find it surprising.

One last point: a country to which tens of millions of people around the world—including highly skilled, ambitious, educated workers—would gladly move is one that never has to worry about slowing labour force growth. If we’re going to diagnose America’s ills, let’s diagnose them correctly.

I´ll just “nitpick” on the highlighted sections of the paragraphs below.

On Friday, I tweeted that there was no structural unemployment in America that couldn’t be eliminated in a late 1990s-style labour market. This prompted a wave a responses from individuals arguing that if America has to count on a once-in-a-lifetime internet boom for such growth, then it rightly should be called structural. This, however, confuses the macro with the micro. There were a number of microeconomic trends underway, including the first stirrings of the internet economy, that made the late 1990s a prosperous era. What made the period a job-rich time was accommodative Fed policy; nominal GDP growth averaged well above 6% from 1997 to 2000. After falling about 2.5% in 2009, by contrast, it rose just over 4% in 2010 and just below 4% in 2011. That’s below trend at a time in which the economy ought to be catching up to where it previously was.

The Fed allowed such rapid growth in the late 1990s because unusual macro circumstances at the time placed substantial downward pressure on broad prices: oil was dirt cheap, a strong dollar was reducing import costs, and China was a net disinflationary force at the time—its cheap products dominated its impact on commodity prices. Core prices hung just a shade over 2% for much of the period. In the absence of those disinflationary forces, a rate of nominal GDP over 6% would probably correspond to a higher inflation rate. And since the Fed seems to have, if anything, become more intent on maintaining a strict 2% limit on inflation, it has been unwilling to do more, leading to disappointing nominal (and real) GDP growth, and correspondingly disappointing employment and labour-force growth.

The late 1990s was certainly an interesting period. 1997-98 were the “crises years”. First Asia, notably Korea, and then Russia and Brazil. They were deflationary/recessionary shocks. Output growth in Korea was negative 8% in 1998! And there was the Russia spillover on LTCM. Concurrently, in the US a positive productivity shock was taking place. In such a case, real output growth increases and inflation falls. If you are targeting inflation this indicates (wrongly) that monetary policy has to “ease up”.

Maybe it was all those different things happening at the same time, but the fact was that US monetary policy was expansionary in 1998-99. That can be gleaned from the behavior of the “NGDP Gap”, i.e. the difference between the level of NGDP and it´s “Level Target”. The chart illustrates.

The other charts show the positive productivity shock, reflected in the increasing growth of output per hour, the fall in unemployment and the drop in inflation.

Even without the “unusual circumstances” mentioned by RA, which directly affected the conduct of monetary policy, inflation in the US would have come down at the same time that growth rose and jobs would be “rich”. More than 10 years into the “Great Moderation”, and being fortunate to be buffeted by a positive and significant productivity shock, the US economy was strong enough to be the “buyer of last resort” to the world, significantly reducing the pain of adjustment in the crisis-impacted economies.

Now it is unwilling to “ease the pain” within itself!

About these ads