The “Great Stagnation” sing-a-long

The “Great Stagnation” as the “New Normal” is becoming “conventional thinking”. Even a “Market Monetarist card holder” as Lars Christensen has advocated “forget-it, let´s go on from where we are”.

Two very recent examples of the new “state of mind” were given by James Pethokoukis in “A gloomy take on secular stagnation”, where he discusses a JP Morgan research note by economist Michael Feroli:

The term “secular stagnation,” first used during the Great Depression, re-entered the lexicon following a speech by former Treasury Secretary Lawrence Summer in late 2013. The concept begins with a simple observation: growth has been slow. Beyond that, theories of secular stagnation diverge.

For Summers, secular stagnation is an inability of the economy to get back on track toward operating at its full potential. We will refer to this as the cyclical view of secular stagnation.

For others, such as Northwestern University’s Robert Gordon, secular stagnation means that even if the economy were operating at its full potential, growth would still be slow. We will refer to this as the structural view of secular stagnation.

In this note, we will discuss how adherence to the cyclical view actually offers some reason for hope. This is so because, by some measures, economic growth is no longer being restrained by the inability of interest rates to fall below zero. For the first time since 2008, it appears short-term nominal interest rates are not higher than where they “ought” to be.

We would be remiss if we didn’t note that our own views align better with Gordon’s; research we published in the summer of 2013 discussed long-run, non-cyclical, factors that we see weighing on the economy’s potential growth rate. Evidence since then seems consistent with the idea that the economy’s full-employment potential growth rate is quite low. …

In his Washington Post column Robert Samuelson writes: “Has the U.S. economy entered a permanent slowdown?”:

You might compare the U.S. economy to someone who’s recovering from a serious illness. At first, everyone hopes the patient will return to normal. Then it’s gradually realized that the patient suffered permanent damage and will never be the same. So, perhaps, with the economy. Since the Great Recession, the bland (often unstated) premise has been that the economy would ultimately recover in full. Now, some economists question this and argue that the economic crisis created — or exposed — enduring weaknesses. We’re at a turning point. Even when producing at “full capacity,” the economy will grow more slowly than in the past or than had been expected.

But I got a “spiritual uplift” from this post by Josh Hendrickson who critically discusses a Mark Thoma piece on the failures of macroeconomics and the need for new thinking in macroeconomics in What Do We Want Out of Macroeconomics?:

So when Lucas says that the depression-preventing policy problem has been solved, he actually provides examples of what he means by depression-prevention policies. According to Lucas preventing severe recessions occurs when policymakers stabilize the monetary aggregates and nominal spending. This is essentially the same depression-prevention policies advocated by Friedman and Schwartz. Given that view, he doesn’t think that trying to mitigate cyclical fluctuations will have as large of an effect on welfare as supply-side policies.

Nonetheless, Thoma’s quote and his remark imply that Lucas was wrong (i.e. that we haven’t actually solved depression-prevention). Of course, in order for Lucas to be wrong the following would have to be true: (1) Lucas says policy X prevents severe recessions, (2) We enacted policy X and still had a severe recession. In reality, however, we never got anything that looked like Lucas’s policy. The growth in monetary aggregates did not remain stable. In fact, broad money growth was negative. In addition, nominal spending did not remain stable. In fact, nominal spending declined for the first time since the Great Depression. We cannot conclude that Lucas was wrong about policy because we didn’t actually use the policies he advocates.

The charts below illustrate the consequences of forsaking “Lucas policies”, which help understand how monetary policy was responsible for “deep shi…g” the economy.

In the first chart we glimpse monetary policy errors in the late 90s, when policy became excessively expansionary and then, from 2001 to 2003, excessively contractionary.  Both measured by the NGDP gap relative to the “Great Moderation” trend.

Note that what became known as the jobless recovery following the recession of 2001 was not due (mostly) to structural factors but mainly to the fact that nominal spending was distancing itself from the trend level. When the Fed adopted forward guidance in mid-2003, both spending and employment move up.

The next chart shows what transpired from the time Bernanke took over at the Fed, At first, when spending began to fall below trend, employment stopped rising and when monetary policy starts really tightening employment crashes.

The next chart, covering the so called “recovery period” from mid-2009 cannot make use of the NGDP gap because that has become “infinite”, Having allowed NGDP to fall so much and for so long below the “GM” trend, that trend level is likely not attainable anymore. But we see that employment picks up in tandem with the rise in spending (NGDP). The problem is that NGDP growth is too low, keeping the economy still well below a feasible alternative trend level. No wonder employment only recently surpassed the prior peak level and real GDP growth is low (with Fed and private forecasts being systematically lowered!)

But instead of identifying the source of the mistakes, people persist in developing “secular stagnation” theses. The bad news is that we´ll likely get what we wish for!