Christina Romer is back with her monthly opinion piece at the NYT:
RECESSIONS after financial crises are long and severe, and the subsequent recoveries are protracted. That is the bold conclusion of “This Time Is Different,” the book by Carmen Reinhart and Kenneth Rogoff, and it has become conventional wisdom.
Their title is meant to be ironic. “This time is different” is what policy makers always say before a bubble bursts. Yet each time, according to the authors, the results are fundamentally the same.
But while there are strong patterns in the authors’ mountains of data, this simple summary misses an important fact: There’s dramatic variation in the aftermaths of crises, and much of it is caused by how policy makers respond. This history has important implications today.
Oh yes, how policymakers respond makes a whole world of difference. After all why, if not for responding to “disturbances”, do we have “policymakers”?
And the response to the ongoing crisis has been dismal. Yes, the big banks were saved, so you didn´t experience a “bank fallout” like the one in the early 1930´s, which was certainly an important factor behind the depth and breadth of the GD. But even then, as Chris Romer reminds us:
There was even huge variation within the United States during this period. The Friedman-Schwartz study found four distinct waves of banking panics in the early 1930s. After the first three, output plummeted. But after the last one, in early 1933, output skyrocketed, with industrial production rising nearly 60 percent from March to July. That time was very different.
In the post WWII period, this time around is unique in the sense that it was the only time aggregate nominal spending (NGDP) was allowed to turn negative. I say “allowed” because that most encompassing nominal aggregate is controllable by the Fed.
Simply, I see that assets prices change at much more velocity than goods prices, and the influence goes from assets markets toward goods markets, and not the opposite.
To which SS responds:
We are closer than you think. I see the connection as follows:
1. Future expected monetary policy determines future expected NGDP.
2. Future expected NGDP determines future expected asset prices.
3. Future expected asset prices determines current asset prices.
4. Both future expected NGDP and current asset prices determine current NGDP, current AD.
Point 4 is similar to your argument.
And the biggest fall in NGDP since the Great Depression most certainly could cause a large fall in asset prices.
It could be interesting, in this context, to take a look at the big drop in stock prices (the largest proportional one day fall in history) and the impact it had on NGDP, if any.
The charts below put the 87-89 period side by side with the 07 – 09 period for ease of comparison.
Luis is correct about the speed with which asset prices can change, but as we can attest, nominal aggregate spending can change very quickly too! And that´s related, according to SS´s four points, to how quickly expectations of future monetary policy changes.
For example, in March 09 the Fed announced QE1. Asset (stock) prices immediately reversed, before the same move could be detected in NGDP, but consistent with a change in expectations of future MP.
In 1987 stock prices plunged (the reasons for that are still hotly debated), but note that NGDP kept growing, so future expected asset prices did not change much, inducing a reversal in current stock prices. We get the same “shape” in 2009, but we know, even in 2011, that there is much doubt about future expected NGDP, given that the Fed seems content in keeping the economy “crawling inside the hole”!