Pointing to the need for supply-side reforms should not forget demand-side “deficiencies”!

A recent piece by RBC theorists Ohanian and Atkeson and investment manager Wlliam Simon Jr – 4% Economic Growth? Yes, We Can Achieve That – says:

It is no secret that the recovery from the recession that ended in June of 2009 has been virtually non-existent. More striking, however, is the impact that this recession and its aftermath have had on the conventional wisdom in Washington regarding America’s long-term economic future.

This is clearly seen in current forecasts of America’s future economic potential from the Congressional Budget Office (CBO), which predict that a large portion of America’s economic potential has been permanently lost.

We believe that this remarkably pessimistic forecast is wrong. An economic policy agenda aimed at restoring the American economy back to the growth path that we were on before the recession can lead to much higher economic growth than is expected in Washington.

………………………………………………………………………

Our long-run historical trend, in which real GDP has grown about 3.5% per year on average, has accurately characterized trend growth of the U.S. economy as far back as economic historians Simon Kuznets and John Kendrick were able to construct detailed estimates of national economic activity that date back before 1900.

Following every historical economic shock, including the tremendous dislocations of the Great Depression and World War II, every postwar recession, various oil shocks and international crises, and the vast demographic changes associated with women entering the labor force in greater numbers, the U.S. economy has always returned to this trend path of output.

This means that the economy always grew more rapidly than average following periods of below normal economic growth, and that economic disruptions — no matter how severe — did not permanently affect U.S. prosperity.

…………………………………………………………………………..

Expecting more from our economy, however, means expecting more from our policymakers, and policies will need to change considerably to job opportunities and raise productivity.

Safety-net policies should not discourage work through high implicit tax rates resulting from means-tested programs. Regulatory policies should not erect barriers to competition and raise costs. Education policies should expand competition and reward the most successful teachers. Immigration policies should expand the number of skilled workers and immigrant entrepreneurs. And tax policies should simplify the tax code, reduce business and personal marginal income tax rates and broaden the tax base.

Getting people back to work and boosting productivity should lie at the heart of the next president’s economic agenda.

In “Historical Fiction“, John Cochrane debunks Keynesian “myths” and points to a possible “supply-side” explanation for the post 1982 boom (with falling/low inflation):

Steve Williamson has a very nice post “Historical Fiction“, rebutting the claim, largely by Paul Krugman, that the late 1970s Keynesian macroeconomics with adaptive expectations was vindicated in describing the Reagan-Volker era disinflation.

The claims were startling, to say the least, as they sharply contradict received wisdom in just about every macro textbook: The Keynesian IS-LM model, whatever its other virtues or faults, failed to predict how quickly inflation would take off in the 1970, as the expectations-adjusted Phillips curve shifted up. It then failed to predict just how quickly inflation would be beaten in the 1980s. It predicted agonizing decades of unemployment. Instead, expectations adjusted down again, the inflation battle ended quickly. The intellectual battle ended with rational expectations and forward-looking models at the center of macroeconomics for 30 years.

……………………………………………………………………………………….

I don’t want to fully endorse the classic resolution of 1984. Lots of other things changed, in particular deregulation and a big tax reform in the air. There was a lot of new technology. Financial deregulation was kicking in. We may find someday that such “supply side” changes were behind the 1980s boom. And we may jettison or radically reunderstand the Phillips curve, even with the free expectations parameter to play around with. It certainly has fallen apart lately (herehere and many more). But ISLM / adaptive expectations as an eternal truth just doesn’t hold up. It really did fail in the 70s, and again in the 80s.

I have no beef with those considerations (I live in a country that needs a complete overhaul of the supply-side). Nevertheless, for the cases considered by Ohanian et al and Cochrane, there´s a big difference.

In the 1980s, supply-side reforms were successful in large part because the demand-side (i.e. the Fed) was doing a decent job. That continued into the 1990s and first half of 2000s, until it was no more! The charts provide an illustration.

No Comeback

Leave a Reply

Fill in your details below or click an icon to log in:

WordPress.com Logo

You are commenting using your WordPress.com account. Log Out / Change )

Twitter picture

You are commenting using your Twitter account. Log Out / Change )

Facebook photo

You are commenting using your Facebook account. Log Out / Change )

Google+ photo

You are commenting using your Google+ account. Log Out / Change )

Connecting to %s