Is RBC Theory winning out?

Commenting on a paper presented at the Jackson Hole gathering, Benyamin Appelbaum writes:

The paper, presented Friday morning at the annual gathering of economists and central bankers at Jackson Hole, Wyo., argues that the share of Americans with jobs has declined because the labor market has stagnated in recent decades — fewer people losing or leaving jobs, fewer people landing new ones. This dearth of creative destruction, the authors argue, is the result of long-term trends including a slowdown in small business creation and the rise of occupational licensing.

“These results,” wrote the economists Stephen J. Davis, of the University of Chicago, and John Haltiwanger, of the University of Maryland, “suggest the U.S. economy faced serious impediments to high employment rates well before the Great Recession, and that sustained high employment is unlikely to return without restoring labor market fluidity.”

At the end:

In the view of Mr. Davis and Mr. Haltiwanger, the recession just made a bad situation worse.

The economy clearly had problems before the crisis. Indeed, those problems contributed to the crisis.

But economists and policy makers will have to reconcile the assertion that these trends were the dominant factors with the reality that the employment rate rose in the years before the recession, then dropped sharply during the recession.

The new paper, like others of its genre, basically requires belief in a big coincidence: that a short-term catastrophe happened to coincide with the intensification of long-term trends — that the economy crashed at the moment that it was already beginning a gradual descent.

Tyler Cowen commented on Benyamin Appelbaum last paragraph saying:

I view this somewhat differently.  Very often trends accumulate, often without much notice, and then a cyclical event causes that trend to explode into full view.  Such a coincidence of cycle and trend is very often no accident and in fact the two are closely related.

Let’s say, as seems to be the case, that wages stagnated, labor market mobility slowed down, and non-outsourcing productivity was slow during 2000-2007 (or maybe longer).  Those are all long-term economic trends and they are all bad news.

During 2000-2007 most Americans acted as if were are on a good trend line when in fact they were on a less favorable trend line.  This influenced spending decisions, borrowing decisions, real estate decisions, and so on.  People overextended themselves and they also created unsustainable bubbles.  Sooner or later the debt cannot be rolled over, the bubbles pop, the crash ensues, AD falls, and so on.  This often takes the form of a discrete cyclical event, as indeed it did in 2008.

One point — still neglected in much of today’s macroeconomic discourse — is that the mis-estimated trend was a major factor behind the cyclical event.  But there is yet more to say about this interrelationship between cycle and trend.

The arrival of the cyclical event, in due time, makes the negative underlying trend more visible.  At first people blame everything on the cycle/crash, but a look at the slow recovery, combined with a study of pre-crash economic problems, shows more has been going on.

Which reminded me of the RBC view that:

…the old view that long term (“potential”) growth was something smooth and slowly changing that could be analyzed separately from cycles (the ups and downs of everyday life) is probably not true. The economy should be viewed as an optimizing dynamic system constantly buffeted by shocks. In this sense, what is popularly called cycle is nothing more than the manifestation of the economy’s search of its new equilibrium growth path. If that happens to be below what many conventionally define as potential, it does not follow that the economy has somehow to rise back to it.

I don´t buy Tyler Cowen´s arguments. To me they are mostly rationalizations!

Two illustrations:


4 thoughts on “Is RBC Theory winning out?

  1. “I don´t buy Tyler Cowen´s arguments. To me they are mostly rationalizations!”

    Ditto! Especially since wages didn’t stagnate before the recession. They kept right on going at a quickened pace right up through “the crash”. The minutes from the FOMC meetings from just prior even mentioned the risks of “cost-push” inflation because wages were rising so fast. I’m not sure but the quoted narrative appears to have its own set of facts.

  2. There seems to be a growing “defeatist” camp in economics. We have to accept the new norm of very low growth, very low interest rates and inflation. You know, like Japan.

    You know, things in the USA were a lot crappier back in 1976. Both 1974 and 1975 had been recession years. But then, the USA economy turned around.

    Then we had 5.4 percent real GDP growth in 1976, 4.6 percent in 1977, 5.6 percent in 1978, then 3.1 percent in 1979—a 20 percent total expansion of real GDP in four years, after the two-year recession. These are the much-maligned “Carter Years,” btw. That is called “stagflation.” The inflation yes, the “stag” part is pure revisionism, obviously.

    The 1976-9 four years boom was pre-Internet, before much international trade, and when the top marginal tax rate was 70 percent! Unions were still powerful. The federal budget, as a fraction of GDP was not markedly different from now.

    This enormous growth happened when Jimmy Carter was president. It is true in that same time frame, consumer prices did reach a double-digit rate of increase in 1979–this was when William Miller was Fed Chief. He is not notable as a great fed chief.

    In that 1970s-era economy with many structural impediments, and starting from inflation in the 5-6 percent range, yes Miller overdid it. He was too easy. Well, unless you got a job then. Then maybe you thought Miller was okay.

    But today the USA economy is marked by global competition, far lower marginal tax rates, no unions, and inflation at 1-2 percent.

    What would it feel like to have the USA economy expand by 20 percent in the next four years? Would inflation in the 4-5 percent range be “worth it” to get there?

  3. These people seem very talented, talent I think would be put to better use figuring out whether the shift of the supply side to being global has any implication to the conduct of monetary policy. Since there are more than 7.2bn people on the planet with new emerging markets breaking out every year, the old explanation of the cause of inflation might be entirely inadequate, and instead explaining a phenomenon more heavily linked to inefficient supply side policy with inflation targeting being more of a destructive relic from yesteryear than anything particularly useful to globalization.

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