Slow recovery explanations - the "structural" alternatives

In his recent Wall Street Journal piece, John Cochrane proposes a number of "structural" explanations:

Where, instead, are the problems? John Taylor, Stanford's Nick Bloom and Chicago Booth's Steve Davis see the uncertainty induced by seat-of-the-pants policy at fault. Who wants to hire, lend or invest when the next stroke of the presidential pen or Justice Department witch hunt can undo all the hard work? Ed Prescott emphasizes large distorting taxes and intrusive regulations. The University of Chicago's Casey Mulligan deconstructs the unintended disincentives of social programs. And so forth. These problems did not cause the recession. But they are worse now, and they can impede recovery and retard growth.

Let's evaluate these hypotheses a little bit.

John Taylor's hypothesis, as I understand it, is a bit different from the Baker/Bloom/Davis explanation. Taylor talks about discretionary monetary policy, while Baker/Bloom/Davis construct an index of policy uncertainty that is not specific about the kind of policy.

If you're a monetarist (in the general sense), you believe that monetary policy matters a lot at all times. In that case, monetary policy uncertainty should be very important - a lot of monetarist models, including New Keynesian models, depend crucially on expectations about the Fed's future behavior. Also, it makes perfect sense that monetary policy uncertainty would have increased, since the question of what exactly to do at the Zero Lower Bound is obviously not something that the Fed has conclusively answered. And I've seen evidence that a large percent of asset returns, since the crisis, have been explained by surprised Fed behavior. So the Taylor thesis is plausible.

Note that this is sort of a demand-based explanation, but not the typical one. The Taylor thesis is that it's not low demand, but uncertain demand (due to uncertain Fed policy) that's causing the slow recovery. But if you believe in any sort of New Keynesian or other monetarist model, then this could definitely make sense. I'd like to see some empirical work on this, but I don't know exactly where to look....

As for Baker/Bloom/Davis, they have evidence, but no model of government policy-making. It could be that government starts becoming less reliable for reasons unrelated to the economy, and then this affects the economy. Or it could be that something bad happens to the economy, and then people become uncertain about the government's response. Or there could be a feedback cycle between the two. Without knowing how the government makes its decisions, it's very hard to tell if Baker/Bloom/Davis is describing a cause of the slow recovery, or an effect.

Ed Prescott's thesis might be backed up by some sort of data or theory, but I haven't seen any. Top marginal income tax rates have gone up a little, but not to historically high levels. Meanwhile, federal tax revenue as a percentage of GDP was historically low during the first four years of the recovery:



As for regulation, I don't even know how to measure that. Basically, Prescott's thesis doesn't sound serious to me. I'm not alone: writing about this thesis in 2010, Steve Williamson said "I doubt that there were any people in the room yesterday who took Ed seriously." Though we always want to be on the lookout for too-high tax burdens, inefficient taxation, and burdensone regulation, there's no evidence so far that this is the reason for the slow recovery.

(Update: There is this paper by Prescott and McGrattan. I had forgotten about that one. I think I'll do a blog post about it at some point...)

Finally, there's Casey Mulligan's thesis of "the redistribution recession" (Mulligan has a book by this name). Intuitively, this thesis makes sense. I've met a couple people who said they were waiting longer to look for work because of extended unemployment benefits, and another couple who had recently gone on Social Security Disability for "bipolar disorder". In 2013, Jordan Weissmann of the Atlantic reported that SSD had become a huge "secret welfare program" that was paying people not to work. Meanwhile, Kurt Mitman and co-authors have a paper claiming that unemployment insurance has been the main factor in the persistently high unemployment in the last 5 years.

However, there are at least two problems with this thesis, right off the bat. The first is wages. Real wages have been basically flat during the recovery:



One would think that if the recession were mainly due to the government paying people not to work, companies at the margin would have to pay higher wages to lure the marginal worker off of his or her living room couch. Instead, the opposite has happened.

Second, in places like North Carolina where extended unemployment benefits have been ended, people have simply stopped saying that they're looking for work; this has understandably resulted in their reclassification from "unemployed" to "not in the labor force", leading to a fall in the official unemployment rate, but the fact is, these people don't have jobs, so they're not contributing much to GDP. The U.S. has canceled extended unemployment benefits as of the beginning of this year (though they might renew them at some point), so I guess we'll see what happens at the national level. I'm not optimistic, given the experiences of other countries in this kind of long stagnating pseudo-recovery.

So some of these "structuralist" explanations have some intuitive, theoretical, or empirical support. But each also has some major problems with it. In cases like this, people often let their political beliefs tip the scale in one direction or another, which I think is a temptation we should resist to whatever degree we can.

So what do I personally think? I think that Reinhardt and Rogoff have this one right - across countries, across time periods, across policy regimes, recoveries after major financial crises are very slow. The academic macro establishment seems to agree with this explanation, since the main area of work seems to be focusing on how finance affects the economy.