Playing safe (and absolving the Fed)!

Mark Thoma comments on this piece from the Fed Board of Governors: “Potential Output and Recessions: Are We Fooling Ourselves?”:

The economic collapse in the wake of the global financial crises (GFC) and the weaker-than-expected recovery in many countries have led to questions about the impact of severe downturns on economic potential. Indeed, for several major economies, the level of output is nowhere near returning to pre-crisis trend (figure 1). Such developments have resulted in repeated downward revisions to estimates of potential output by private- and public-sector forecasters. In addition, this disappointment in post-recession growth has contributed to concerns that the U.S. economy, among others, is entering an era of secular stagnation. However, the historical experience of advanced economies around recessions indicates that the current experience is less unusual than one might think. First, output typically does not return to pre-crisis trend following recessions, especially deep ones. Second, in response, forecasters repeatedly revise down measures of trend.

Back in January, I wrote a post titled “WILL BERNANKE´S LEGACY BE HAVING INTRODUCED A “UNIT ROOT” IN US RGDP?

Contrary to early research on deterministic versus stochastic trends, it appears the US economy followed a deterministic RGDP trend path, in which case after being buffeted by shocks the economy went back to trend. One of the charts follows:

Unit Root

At the end the authors consider:

Although these calculations are simple, they raise deeper questions about the impact of recessions on trend output. The finding that recessions tend to depress the long-run level of output may imply that demand shocks have permanent effects. The sustained deviation of the level of output from pre-crisis trend points to flaws in the way the economics profession models the recovery of output to economic shocks and raises further doubts about the reliance on measures of output gaps to determine economic slack. For policymakers, the results also point to the cost of recessions, especially deep and long ones, and provide a rationale for strong and rapid policy responses to economic downturns.

Not to be upstaged Mark Thoma adds:

One note: I want to emphasize that “the results also point to the cost of recessions, especially deep and long ones, and provide a rationale for strong and rapid policy responses to economic downturns.” An important question is how much of the permanent effect can be avoided with a correct and timely policy response — something we surely did not get with fiscal policy in the most recent episode.

And I add: Something we didn´t get from monetary policy either!

One thought on “Playing safe (and absolving the Fed)!

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