What´s “cramping” the pluck?

I see that John Taylor thinks it´s economic policy – policy uncertainty and increased regulation – that´s holding back a repeat of Friedman´s “plucking model”:

Milton Friedman’s “plucking model” should be back in fashion now because it reminds us of the historical fact that throughout American history—until now—the deeper the recession, the faster the recovery. I like to bring a guitar to talks and lectures to illustrate this: Like a guitar string, when the economy is “plucked” down or pulled down, the “string” or the economy always springs back up. The more the economy is “plucked” down, the faster it springs back up. This has been true throughout recorded American history, and it holds whether or not there has been a financial crisis. Here is a link where you can find Hoover Institution Working Paper E-88-48 in which Friedman described the model. (He also envisioned a board on top of the guitar string to prevent a reverse action on the upside, which he argued was not in the data).

Of course something is now interfering with the usual economic response, because our current recovery is certainly not springing back to normal. I have argued that economic policy is holding the economy back, and I think recent research by Ellen McGrattan and Ed Prescott (on increased regulations) and by Scott Baker, Nick Bloom, and Steve Davis (on policy uncertainty) supports this view. Their work is part of a forthcoming book (Government Policy and the Delayed Economic Recovery) edited by Lee Ohanian, Ian Wright and me.

Several months ago I did a post on Friedman´s “plucking model”. The picture I copy over here gives you a good idea of what it´s about.

And there I wrote:

After the strong bounce back from the deep 1981/82 recession the economy enters a period that came to be known as “Great Moderation”, that lasts through 2007. This period was characterized by an almost complete absence of “plucks” and, therefore, of “big bounce backs”. The defining characteristic of the period is the maintenance, for most of the time, of a stable spending growth along a level path.

This comes to an end in 2008, when the Fed allows nominal spending to tank, to a degree not seen since the 1930´s! The reasons have been exhaustively discussed by the group of Market Monetarists. The question is: why was there no vigorous “bounce back” from such a strong “pluck”?

The figure below illustrates. While from the recession through in late 1982 nominal spending (well controlled by the Fed) rebounded strongly – and this is a characteristic of all the observed “bounce backs” – following the through of the 2007/09 recession nominal spending growth, despite the previous “off the charts” drop, has been constrained by “inflation hawkishness” and other fears. The result, no “bounce back”, so the economy stays inside the hole and unemployment “up in the clouds”.

So which is it? I believe excess regulation and such mostly have an effect on the long run possibilities of the economy and very little effect on its capacity to “bounce back”. That´s mostly dependent on monetary policy, in particular the Fed´s willingness to bring nominal spending back to a “reasonable” trend level.

On that regard, as additional evidence that “lack of demand” is the major factor, David Beckworth has a nice post, where he shows that, according to the National Federation of Small Business (NFIB) survey of Small Business Economic Trends, the single most important problem is “sales” (i.e. demand).