What´s the story? Slow growth reflects Policy incompetence or is it a “fact of life in the post-crisis world”?

To Blanchard, it´s the latter:

Once the acute phases of the financial and euro crises were over, it was clear that it would take time for advanced economies to recover. The history of past financial crises gave a clear warning that recovery would typically be long and painful.

Today, the scars are largely healed but growth is still slow. Before the crisis, any economist would have predicted that an economy with interest rates close to zero and no other major brakes on demand would see high growth rates and quickly overheat. Yet this is not what we have seen. The reason, I believe, must be found in mediocre medium term prospects, which in turn affect current demand and growth.

Low potential growth is bad news for the medium term. But it may explain what is happening today. A main finding of a paper that Eugenio Cerutti, Lawrence Summers and I wrote in 2015 was that, over the past 40 years, recessions in advanced countries have been associated surprisingly often with lower growth following the recession.

Let´s examine this last point – fundamental for his “fact of life” argument – for the case of the US.

The chart shows clearly that since the mid-80s and up to 2006, real growth was much more stable. The two recessions over the period were much shallower than average. In other words, “boom & busts” were much more contained, with growth keeping close to the long term average value.

What´s the story_1

This is not exactly an original view. The same mistake was made following the 1990/91 recession, the first during the Great Moderation.

In the summer 1992 issue of Challenge Magazine, Robert Brusca, at the time chief-economist at The Nikko Securities Co., wrote a long piece entitled Recession or Recovery? This is a good example of the often committed mistake of gauging the present (and forecasting future developments) using old barometers. He writes: “… by all historical standards there should be a strong recovery (following the 1990/91 recession). But the economy is now so uncertain, we could be in for a triple-dip recession rather than a recovery…” and there follows several pages of comparative statistics on the behavior of all kinds of economic variables following a recession, with the conclusion being that since the economy had not yet shown the strong rebound that historically follows a recession, his view was that the recession had not yet ended, “appearing to be the longest since the Great Depression” (at about the time the article was published, the official date for the end of the recession was put at March 1991).

In the Fall 1992 issue of The Federal Reserve Bank of Minneapolis Quarterly Review, David Runkle (a senior economist in the research department) wrote: “… the current recovery is the weakest in the post war period in all measures of economic activity. This means that the current recovery is most appropriately viewed as a continuation of a long period of below average growth”.

Now, the recovery from the 2007/09 recession has been very slow, indeed. But let´s not make the mistake of saying this is “a fact of life”!

I favor the “policy incompetence” argument. The charts illustrate.

While the Fed was correcting for the monetary policy mistake of letting nominal spending (NGDP) growth fall causing the 2001 recession, the economy was impacted by the first leg of the oil price shock (yellow band). In the case of a negative supply shock you expect a reduction in real growth (and some increase in inflation). The best that the Fed can do is to keep NGDP growth stable. This is what Greenspan did.

What´s the story_2

As soon as Bernanke takes over, nominal spending growth begins to falter. Real growth falls some more. When the second leg of the oil shock hits (green band), the Fed´s “inflation concern” additionally constrains NGDP growth and so increases the fall in real growth. When NGDP tanks after mid-08, both real growth and oil prices tumble.

This was surprising because 10 years earlier, in 1997, Bernanke had stated the “blueprint” for monetary policy in the event of an oil shock, concluding:

Substantively, our results suggest that an important part of the effect of oil price shocks on the economy results not from the change in oil prices, per se, but from the resulting tightening of monetary policy. This finding may help to explain the apparently large effects of oil price changes found by Hamilton and many others.

Either he forgot about it, or weak leadership made him sound “unconvincing” to the majority of the Board!

Oil prices rebound when nominal spending picks up in mid-09, following the introduction of QE1 ending the recession.

But, as the pink band shows, the recovery was “aborted” before nominal spending had picked up sufficient speed to bring the economy nearer the previous levels.  This is illustrated in the pair of charts below, which clearly illustrates how the “slow growth fact of life” came into being!

What´s the story_3

This echoes Runkle´s conclusion from 1992:

This means that the current recovery is most appropriately viewed as a continuation of a long period of below average growth”

It did not have to end this way!


One thought on “What´s the story? Slow growth reflects Policy incompetence or is it a “fact of life in the post-crisis world”?

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