“Heads or Tails”

From a recent Vox post: “The tail that wags the economy: The origin of secular stagnation”:

The Great Recession has had long-lasting effects on credit markets, employment, and output. This column combines a model with macroeconomic data to measure how the recession has changed beliefs about the possibility of future crises. According to the model, the estimated change in sentiment correlates with economic activity. A short-lived financial crisis can trigger long-lived shifts in expectations, which in turn can trigger secular stagnation.

The typical post-WWII recession has a distinct trough, followed by a sharp rebound toward a stable trend line. Following the Great Recession, however, this rebound is missing. The missing recovery is what Summers (2016) and Eggertsson & Mehotra (2014) call ‘secular stagnation’ (see also Teulings and Baldwin 2014).

And show a version of this chart


Why did the dysfunction in credit markets impact the real economy for so long? Many explanations for the real effects have been advanced, and these are still being compared to data (e.g. Gertler and Kiyotaki 2010, Brunnermeier and Sannikov 2014, and Gourio 2012, 2013). Existing theories about why the crisis took place assume that the shocks that triggered it were persistent. Yet such shocks in previous business cycle episodes were not so persistent. This differential in persistence is just as puzzling as the origin of the crisis. What most explanations of the Great Recession miss is a mechanism that takes some large, transitory shocks and then transforms them into long-lived economic responses.

Perhaps the fact that this recession has been more persistent than others is because, before it took place, it was perceived as an extremely unlikely event. Today, the question of whether the financial crisis might repeat itself arises frequently. Financial panic is a new reality that was never perceived as a possibility before.

I believe there´s a simpler and more direct explanation – or mechanism – consistent with the changes in “beliefs, expectations or sentiment” which, in addition to helping understand the fall in productivity growth, is also consistent with the post war history of the behavior of RGDP depicted in the chart above.

That alternative explanation relies on observing that what is manifestly different in the present cycle is the behavior of monetary policy, if you understand monetary policy to be the main determinant of aggregate nominal spending (NGDP).

My strategy divides the post war period (actually the period after 1953, to avoid complications from the immediate post war years and the period of the Korean War) in four parts. The “low inflation” 1950s and early 1960s, the “rising-high inflation” of the late 1960s to the early 1980s, the “falling-low inflation” years from the mid-1980s to 2006, and the “Great Recession/Great Stagnation/Too Low Inflation” years thereafter.

In this story, it´s not “the tail that wags the economy”, but the “hydra-head” of the FOMC, who wields close control of aggregate nominal spending in the economy.

The panel depicts NGDP and RGDP during the four episodes. All corresponding charts have the same scale and they cover the period from the peak of the cycle to 28 quarters from the trough (which is the time span since the Great Recession ended in June 2009).



From looking at the behavior of NGDP and the associated behavior of RGDP during the episodes, it becomes clear why we´re living a Great Stagnation. For the past 60 years, monetary policy has never been this tight! That´s the mechanism that transforms transitory shocks into long-lived economic responses.

And on the productivity implications of inadequate AD growth, this was tweeted by Adam Tooze:

Keynes on the aggregate demand context necessary for rapid productivity growth


When the Fed killed growth

Neil Irwin writes “We’re in a Low-Growth World. How Did We Get Here?”:

One central fact about the global economy lurks just beneath the year’s remarkable headlines: Economic growth in advanced nations has been weaker for longer than it has been in the lifetime of most people on earth.

This slow growth is not some new phenomenon, but rather the way it has been for 15 years and counting. In the United States, per-person gross domestic product rose by an average of 2.2 percent a year from 1947 through 2000 — but starting in 2001 has averaged only 0.9 percent. The economies of Western Europe and Japan have done worse than that.

His “Tell-Tale” evidence comes from this chart

Fed Killed Growth_1

He certainly could have done a better reading of the evidence. First of all, the very high (but falling) average growth, especially in Europe and Japan before 1980, is a reflection of the catch-up growth following the end of WWII. This can be clearly seen by comparing real per capita output in Japan and the US from 1950 onwards shown in the chart.

Fed Killed Growth_2

By the early 1970s, Japan´s catch-up growth petered out. After 1990, per capita growth almost completely disappeared. In Irwin´s chart we see 10-year average annual growth in Japan falling off steeply.

Meanwhile, observe that per capita growth in the US and Europe during the period between the two vertical bars (“Great Moderation”) is very stable and only falls off fast with the onset of the “Great Recession”. In that sense, the low per capita growth phenomenon is “new”.

What happens when we look at real per capita growth for a long span of time. For the US the table gives the summary statistics for growth over 1850 to 2015.

1850 – 2006 1985 – 2006 2009 – 2015
Mean=2.1% Mean=2.1% Mean=0.6%
St Dev=4.9 St Dev=1.2 St Dev=1.9

During the Great Moderation (1985 – 2006) real per capita growth was the same as the previous 156 years, but growth volatility (Standard Deviation) was lower by a factor of 4, a much more “pleasant” life experience. During the recovery that began 7 years ago, it is growth itself that was reduced by a factor of almost 4.

At times during the long period of 2.1% growth, we observe periods of deep penury. For example, in 1934, in the midst of the Great Depression, the average annual 10-year per capita growth reached a minimum of -0.9%!

Then, that was the result of a massive monetary error. You wouldn´t be off to conclude that the steep drop in per capita growth at present is also the result of a less massive, but more persistent monetary error. From looking at Irwin´s chart, it almost looks like “everyone wants to be Japan”, a risk Bernanke himself warned about as far back as 1999.

How a myth is born

Bernanke HeroFirst, you get a “The Hero” magazine cover


Bernanke Person of the YearThen you get to be Person of the Year

Bernanke Hero1

And finally, you write a memoir titled “The Courage to Act”



and voilá, the myth is born!

The latest invocation comes from Simon Wren-Lewis:

Here is an extract from an interview with Ben Bernanke by George Eaton in the New Statesman:

Though a depression was averted in 2008, the recovery in the US and the UK has been slow. Bernanke partly blames the imposition of fiscal austerity (spending cuts and tax rises), which limited the effectiveness of monetary stimulus. “All the major industrial countries – US, UK, eurozone – ran too quickly to budget-cutting, given the severity of the recession and the level of unemployment.”

Partly thanks to Bernanke’s leadership (and knowledge), the Great Recession was not as bad as the Great Depression of the 1930s. Monetary policy reacted much more quickly, and financial institutions were (nearly all) bailed out. In 2009 we also enacted fiscal stimulus, but in 2010 we reverted to the policies of the early 1930s with fiscal austerity. That mistake was partly the result of panic following events in the Eurozone (see the IMF analysis discussed here), but it also reflected political opportunism on the right.

However, as Scott Sumner concludes in a recent post:

That’s why it’s so important to get the facts right. Just as the Abe government showed the BOJ was not out of ammo in the early 2000s, a close examination of what the Fed did and didn’t do, and a cross country comparison of monetary policy during the Great Recession and recovery, shows that monetary policy is always and everywhere highly effective.

What are the facts?

The chart shows that during the first few months of the Great Depression (GD) and the Great Recession (GR), the behaviour of NGDP was similar.


After that, things were very different. What Bernanke´s knowledge did was to apply the results from his “made my name” 1983 article “Nonmonetary effects of the financial crisis in the propagation of the Great Depression”, by going on a bank bail-out spree, thus avoiding the propagation factors that were very “active” in 1931/32.

The charts from the Great Depression indicate what Bernanke avoided. They also show that to get the economy to “turn around” and take a path back to the previous trend, monetary policy has to be really expansionary. That was true even with interest rates at the ZLB, as happened when FDR made a significant change in the monetary regime, cutting the link to gold in March 1933, almost four years after the start of the depression! NGDP growth went up by enough to put the economy on the path back to trend.


The next charts show what happened now. Notice that in the early 2000s, Greenspan also allowed NGDP to drop below trend, but that mistake was fully offset, and by the time Bernanke took the Fed´s helm. NGDP was back on trend.

Without going in to all the details, the fact is that Bernanke allowed NGDP to fall in “Great Depression style”. As mentioned, he avoided a second “GD” by bailing-out the financial system. In addition, by introducing QE in March 2009, monetary policy reacted much more quickly than in the “GD”.


However, notice the difference. In Bernanke´s case, monetary policy was just sufficient to put the economy on a growing trend along a lower level path. It never tried, as happened after March 1933, to get back to the original trend path. Thus, the economy is stuck in a “lesser depression” a.k.a. “Great Stagnation”.

And that really has nothing to do with fiscal policy.

Denying the monetary solution

Noah Smith has an interesting piece in Bloomberg View: Big Economic Discovery! Booms Might Cause Busts:

Paul Beaudry and Franck Portier are two such researchers. They are famous for a 2006 theory saying that news about future changes in productivity could be what cause recessions and booms. That model never really caught on — it always had some issues with the data, and it definitely didn’t seem to be able to explain the Great Recession. But it inspired further research, and it was an interesting and novel idea.

Now, Beaudry and Portier, along with co-author Dana Galizia, are going after bigger fish. They want to resurrect the idea that booms cause recessions.

In a new paper called “Reviving the Limit Cycle View of Macroeconomic Fluctuations,” Beaudry and Portier try to think of reasons why booms might cause busts. The mechanism they come up with is pretty simple. You have a whole bunch of people — basically, companies — who invest in their businesses. The amount other people invest affects the amount I want to invest, but I can only adjust my investment slowly. When you have feedback effects like this, you’re going to get instability in your model economy, and that’s exactly what the authors find — the economy experiences booms and busts in a chaotic, unstable way. To reproduce the randomness found in the real economy, the authors simply add in some random “shocks” to productivity

BP&G´s latest seem to be a variant of RBCT, where the “trend is the cycle”, or where growth and fluctuations are one and the same.


“For the past half-century, the academic macro story has gone something like this: There is a general trend of rising growth and prosperity in the U.S. economy, caused by steady improvements in technology. But this steady course is disturbed by unpredictable events — “shocks” — that temporarily slow growth or speed it up. The shocks might last for a while, but a positive shock today doesn’t mean a negative shock tomorrow. Recessions and booms are like rainy days and sunny days — when you look back on them, it looks like they alternate, but really, they’re just random.”

I find the fact that economists tend to move away from monetary explanations of cyclical fluctuations hard to explain .In a recent paper by Roger Backhouse and Boianovsky – “Secular Stagnation: the History of a Macroeconomic Heresy” – we read on page 5 that:

The economist who introduced this idea into economic theory was Alvin Harvey Hansen. Born in 1887 in rural South Dakota to immigrants from Denmark, he came from the frontier that according to Jackson was ending. After majoring in English, he moved to the University of Wisconsin to study economics and sociology, before moving to Brown and writing a thesis on business cycle theory, in which he became a specialist. His early work, Cycles of Prosperity and Depression (1921) was empirical. Believing the British economist, John A. Hobson, to have rebutted the charge that under-consumption was impossible, Hansen explained cycles of prosperity and depression as the result of changes in money and credit.

However, on the next page we read:

During the 1920s, turning to the ideas of Albert Aftalion, Arthur Spiethoff and other continental European writers, he began to see fluctuations in investment, driven by population changes and waves of innovations, as the root cause of the cycle. He still thought monetary factors played a role, but they merely served to magnify other forces rather than being an independent factor.

Recently, Brad DeLong went “ballistic” in his critique of Friedman´s monetary view of the Great Depression:

These questions can be debated. But it is fairly clear that even in the 1970s there was not enough empirical evidence in support of Friedman’s ideas to justify their growing dominance. And, indeed, there can be no denying the fact that Friedman’s cure proved to be an inadequate response to the Great Recession – strongly suggesting that it would have fallen similarly short had it been tried during the Great Depression.

The dominance of Friedman’s ideas at the beginning of the Great Recession has less to do with the evidence supporting them than with the fact that the science of economics is all too often tainted by politics. In this case, the contamination was so bad that policymakers were unwilling to go beyond Friedman and apply Keynesian and Minskyite policies on a large enough scale to address the problems that the Great Recession presented.

Admitting that the monetarist cure was inadequate would have required mainstream economists to swim against the neoliberal currents of our age. It would have required acknowledging that the causes of the Great Depression ran much deeper than a technocratic failure to manage the money supply properly. And doing that would have been tantamount to admitting the merits of social democracy and recognizing that the failure of markets can sometimes be a greater danger than the inefficiency of governments.

I find those arguments untenable. The Great Depression only ended when FDR intervened by delinking from gold. Nominal spending (NGDP) immediately turned around (the follow-up government intervention – NIRA – only retarded the process).

The “Great Recession” only bottomed-out when the Fed adopted QE1, and subsequent doses of QE have managed only to keep the economy humming along a depressed path. A target level for spending (or even prices) would have been a better monetary solution.

The spending target level path is ancient. In the Backhouse paper I found out that Evsey Domar, before Clark Warburton, Leland Yeager, James Meade, Bennett McCallum, Mankiw & Hall, among others, had already “been there”:

“Capital expansion, rate of growth and employment” (Domar 1946). This focused on the relationship between productive capacity and national income. Investment was related to both of these, for it generated aggregate demand, which determined income, and it added to productive capacity. Because investment was linked to the growth rate of productive capacity and the level of income, Domar could show that there was an equilibrium rate of growth, at which income would grow at the same rate as productive capacity. Secular stagnation was what happened when investment grew more slowly than this, for in that case there would be an increase in unused capacity and unemployment. However, if, somehow, the growth rate of income could be guaranteed, the result would be sufficient investment to achieve growth without resorting to a government deficit.

JB, the “populist”

In his “I´m a candidate” speech, JB said:

“There is not a reason in the world why we cannot grow at a rate of 4 percent a year,” Bush said as he formally announced his presidential bid in Miami. “And that will be my goal as president — 4 percent growth, and the 19 million new jobs that come with it.”

To do that, he would first have to “recruit” the Fed. Unfortunately, if the Fed acquiesced bad things would happen.

But we see from the chart below that the Fed could help any President if it decided to undo the monetary f-up it perpetrated earlier. But almost everyone has bought the “house bubble-burst – financial crisis – demographic – great stagnation story! Plus, the Fed is “unaware” that it messed-up and is on the verge of doing an encore!
Monetary F-up


The lack of imagination is pervasive!

Gavyn Davies summarizes:

The great financial crash of 2008 was expected to lead to a fundamental re-thinking of macro-economics, perhaps leading to a profound shift in the mainstream approach to fiscal, monetary and international policy. That is what happened after the 1929 crash and the Great Depression, though it was not until 1936 that the outline of the new orthodoxy appeared in the shape of Keynes’ General Theory. It was another decade or more before a simplified version of Keynes was routinely taught in American university economics classes. The wheels of intellectual change, though profound in retrospect, can grind fairly slowly.

Seven years after 2008 crash, there is relatively little sign of a major transformation in the mainstream macro-economic theory that is used, for example, by most central banks. The “DSGE” (mainly New Keynesian) framework remains the basic workhorse, even though it singularly failed to predict the crash. Economists have been busy adding a more realistic financial sector to the structure of the model [1], but labour and product markets, the heart of the productive economy, remain largely untouched.

What about macro-economic policy? Here major changes have already been implemented, notably in banking regulation, macro-prudential policy and most importantly the use of the central bank balance sheet as an independent instrument of monetary policy. In these areas, policy-makers have acted well in advance of macro-economic researchers, who have been struggling to catch up.

The IMF has tracked this process well, and it has just held its third post-2008 conference on Rethinking Macro Policy under the leadership of chief economist Olivier Blanchard. Olivier has summarised the conference (here and here) but so far it has it not been much discussed by macro investors.

I have therefore taken the liberty of organising Olivier’s summary and the conference material into the three tables below. Although highly simplified, the tables represent a snapshot of the current “state of the art” in macro policy, at least as seen by today’s mainstream luminaries of the subject.

And concludes:

In conclusion, what should we expect from macro-policy makers in future, assuming the economic back-drop remains relatively benign? Probably, more of the same: broadly stable central bank balance sheets, very slow declines in public debt ratios and a gradual return to using interest rates as the main weapon of monetary policy. A more rapid return to pre-2008 norms for fiscal and central bank balance sheets is somewhat unlikely.

To call the economic back-drop benign is a stretch; but while that remains the conventional thinking, Summer´s “Great Stagnation” thesis will continue to be ‘celebrated’!

Why can´t they see that the “GS” is the exact opposite of the “Great Inflation”? Interestingly, while the “GI” was going on, the prevalent thought was also that monetary policy couldn´t do much to abate it!