Saturday, July 05, 2014

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.


  1. Anonymous4:00 AM

    "Basically, Prescott's thesis sounds like politically motivated derp to me."

    Can someone explain to me how Prescott was ever taken seriously by anyone? Is it just because he tells rich people what they want to hear? I've literally never come across any theory of his that sounded reasonable by any definition of the word. "The Great Depression was caused by workers taking vacations and destroying technology!" seems to be the implication of what he goes on about.

    If we lived in another time and place where the rich didn't promote economists who in turn promoted their agenda, it seems like Prescott would be on a Zero Hedge-type website ranting about unmeasurable government policy uncertainties. Sigh...

  2. I think that R&R&You place too little emphasis on insane austerity and demand for housing by people who can get mortgages. The paths of public sector employment and investment have been bizarre and, I think, unprecedented. This does not follow from a financial crisis. Since you are not a fresh water fanatic, you should guess that it is has been important (also look across countries).

    Housing has also been unusual. This is related to finance via tighter underwriting (well actually via underwriting). My guess is that it also has a lot to do with a huge shift in beliefs about long term trends in house prices compared to the CPI. I think that demand for housing has been distorted by the belief that houses are excellent investments (better than they can be in the long run) since the 1970s. I think the demand for housing which was normal at least in my adult life (that is since 1978) was unsustainable. This implies a very large shift in demand which is there in the data and not just due to the financial crisis.

    Below the usual boring stuff on monetary policy at the zero lower bound.
    I think there was one episode of a dramatic response to the FOMC the increase in interest rates when they talked about possible tapering. After that nothing much. Also after QE1 and before that nothing much. The response to the announcement of QEII (which was telegraphed moving from possible to certain over months but with 4 key days) was not statistically signficantly different from normal change (over 4 randome days). The response to QEIII was very modest. The response to the Evans rule (a genuine surprise) was tiny and of the wrong sign. I think it is unclear what the FOMC will do, but I also think it will have little effect on medium term expected real interest rates (the federal funds rate will not go up much and expected inflation is definitely low after massive expansionary monetary efforts).

    I don't favor parsimony for the recession and the recovery. There is a huge difference between asset prices Sept 08 through roughly June 09 and prices since. Risk premiums are basically normal. No one mentions the TED spread. The financial crisis ended. In contrast, public spending shifted from stable (the recovery act balancing cuts in state and local spending) to extraordinarily contractionary.

    1. I think this is part of it, but I also think there is a long run trend towards lower growth. The last recessions have been "jobless" recoveries. Maybe it's just something that happens to economies as they get big?

  3. There are some papers arguing that uncertainty shocks can be understood as a kind of demand shock (Basu & Bundick [1], or Leduc & Liu [2]). But while this is interesting work (and there are a lot of new papers in this area), in most of these models "uncertainty shock" is just a purely exogenous increase in volatility of another purely exogenous process... not entirely satisfying approach, I guess.


  4. Anonymous8:52 AM

    Noah u cuddly teddy bear

  5. Anonymous9:14 AM

    What is the actionable investing strategy that your conclusion implies?

    Slow recovery after a financial crisis suggests two things to me:

    1. Buy financial stocks
    2. Buy companies doing share buybacks

    A portfolio built this way would have outperformed the market by a massive margin since 2009--but I am not sure if it will still work. In any case, investing in low Treasury yields AND an improving macro environment at the same time will probably pay off. That's an odd combination, and something few people are doing or know how to do.

  6. Daniel9:34 AM

    If the problems were supply-side, you'd have inflation. Like in the 1970s.

    The fact that inflation is low while unemployment is (was) high proves it was demand-side. In short, the Fed did it.

    You can't dismiss that without dismissing the whole AS-AD framework.

    And if your explanations rely on dismissing those concepts ... it's pretty safe to say you're a political operative.

    1. You'd be one of the few to argue that fed monetary policy was too tight. To be fair to them though, at the ZLB their goto tools were unavailable, and its not as if they were getting any help from congress on the fiscal end.

  7. Structural issues = 'the poor should be cut off from any support and forced to work at below survival wages". And, if we did that, somehow, the economy would recover. I don't know but it strikes me unlikely that a slave economy would have a high GDP growth.

    Wrt aftermath of financial crisis, I am, like some previous commenters, a bit more dubious than you are. Yes, we had one. OTOH, financial institutions were aggressively recapitalised and generally open-handedly supported by the full might of the state(s) and central banke(rs). I don't think that's a common characteristic.

    They might no longer grant loans just coz they have finally realised that poor people are actually bad borrowers? And that companies don't grow easily in a stagnant economy?

    Again and again, how is this more complicated that "people don't have enough money and/or don't spend the money they have".

    I think it would be very interesting to see patterns in private consumption and corporate investment to understand what's lacking as far as GDP growth is concerned...

    1. I don't know but it strikes me unlikely that a slave economy would have a high GDP growth.

      GDP measures things for an average person. Slavery, absent getting your throat slit in a servile rebellion, is very good for the winners, though.

  8. R&R's 'explanation' that financial crisis recoveries are nearly always slow is not an explanation, it's an observation. Could it not just be that the policy response to a financial crisis is nearly always inadequate, one way or the other, and we haven't figured out properly what to do?

    1. That's what Bernanke said when asked about R&R during Congressional testimony. Policies are usually inadequate.

  9. Compared to the rest of the world, the US. recovery has been pretty brisk as measured by consumer spending, housing, exports, profits & earnings, stock prices and many other metrics. GDP growth is slow and labor force participation is low, but it's that way around the world and there's plenty of good data to counteract this.

  10. "I'd like to see some empirical work on this, but I don't know exactly where to look...." Not exactly what you're asking for, but check out my empirical post on the Taylor Rule: It has a couple graphs showing how the Taylor Rule evolved over the past half century.

  11. Hilarious.

    You know "people" who stayed on UI longer than necessary, we all do, and you know hundreds of people, but not thousands, so you intuitively distrust your poll as anecdotal.

    But there's an EVEN simpler hypo: IF everyone was forced to work, the wage level / price level would be even lower than it now.

    That's exactly what happens with GICYB.

    Noah, the thing driving down prices / wages is technology. Not using the same tech to do Uber for Welfare, is artificially keeping wages TOO HIGH.

    -lion rides a horse.

  12. Zathras3:32 PM

    Anecdote 1: At my employer (A Fortune 50 company) 5,000 lost their jobs 2 years ago because McKinsey convinced our CEO we could do without. We have profit centers which barely have enough to cover existing accounts, let alone get new customers

    Anecdote 2: When I was at a conference on Business Economics, I spoke with several other people whose company had the exact same experience. Amongst the 5 of us, McKinsey had convinced people that 32,000 jobs could be done away with.

    Anecdote 3: Walmart loses billions in sales because they don't have enough staff to keep shelves stocked.

    All of this happened because of claimed automation in I/S made their jobs redundant. This has not been the case; our group did an analysis which showed internally a strong correlation between profit centers which had high job cuts and profit centers which had high drops in sales. And we have increasing job attrition because people are overworked and pissed off. Business leaders would rather pay less for an inferior workforce and then being pissed off rather than paying for the workforce they need. It's a Ryanair economy.

    We are in a suboptimal equilibrium point. It may not make sense financially for an individual company to hire more. However, if all companies hire more, the increased economic activity will benefit everyone. But in the meantime, business leaders still prefer to stay pissed off.

  13. Why doesn't anyone concern troll supply-siders? Say, eliminating welfare programs might cause more fiscal and monetary uncertainty, now prove me wrong.

  14. Anonymous4:16 PM

    Noah, you vile scum sucking piece of sub-human feces. You brain dead fucking POS. Take your pseudo-intellectual drivel and shove it up your ass.

    Please, fuck off and die of AIDs and cancer, and the sooner the better, you lying sack of shit, for the good of the human race.

    1. Oh wow, getting comments like this is a badge of honor. Don't get too proud, Noah :-).

    2. Anonymous2:47 PM

      It could be a joke;-) A bad one, but still, I'm not sure how that can be taken seriously.

  15. Anonymous10:15 PM

    Since Q2 2013, the US economy has not been running slow. I think the government missed the turn and some upward revisions are coming. This recession is basically over. This is the summer of 94 all over again. All the "U's" match to the summer of 94 except for 6 and that really is structural(people working full time but called "part time").

    Why it took awhile to get going? Finances. Finances of financial companies to create "money". The same thing happened in the 90's on a smaller scale. With the inability to create "money" it forced people to deleverage. Financialism has given the lever of demand to the financial companies. They control demand. You also have to seperate this from 'bank lending'. A bank makes a loan, money goes into the economy, now the ability of the consumer or investor to grab money via financial companies puts money into the economy on a hope they will pay it back. In the 90's it worked well as the economy responded and wages surged to repay. Then the loans got out of control in the 00's(with RE), but that is for another post.

  16. Anonymous1:17 PM

    We should continue watching John Cochrane's evolving view, I think. He seems open to criticism of Mulligan's lack of grasp over the important of magnitudes.

    I don't read all of this as anti-Keynesian. Calling demand uncertain doesn't deny that Keynesian stimulus would help.

    The problem of uncertainty over government actions does actually affect quite a few markets, but just not the ones that Cochrane thinks it affects, at least not in a way that can be corrected quickly.

    The markets most affected due to unsureness are those that require very long lead times for investment. This would include many kinds of projects that ONLY governments do, such as huge infrastructure projects. It also includes labor markets where education or long-term experience is required. These markets are enormously affected by government intervention, and especially if that intervention is predictably anti-employee intervention designed to drive down wages or artificially change the number of workers in a field.

    These are the sources of unsureness that matter right now.

  17. Anonymous4:58 PM

    But are slow recoveries after financial crises predicted in a New K model. Is this not what Cochrane is saying large multipliers don't really exist in a New K liquidity trap? How is a slow recovery after a financial crisis not structural?

  18. How does one measure regulatory uncertainty? Do they divide the number of House committee impasses by the number of filibuster hours? If we had a solid anti-trust policy, higher taxes, tightened regulations and vigorous prosecution, would that count as less uncertainty? I'm guessing that in the circles where "uncertainty" is most frequently cited, it would count as more.

  19. Anonymous1:58 AM

    Dean Baker sums it up a simply as possible:

    "The basic story of the Great Recession is about as simple as they come. The economy was being driven by a housing bubble and the bubble burst. The combination of the loss of housing construction, due to the enormous overbuilding of the bubble years, and the loss of the consumption that had been driven by bubble generated housing wealth, created a gap in annual demand of more than $1 trillion. That's all simple and easy.

    And what did economists think would fill that gap in demand, manna from heaven? Did they expect another building boom even when vacancy rates were at record highs? Better go study the basics of supply and demand. Did they expect investment to soar at a time of massive excess capacity? That one would not be supported by any studies of the determinants of investment I have seen. Would consumers just ignore the $8 trillion in housing wealth they saw vanish and spend just as though nothing had changed?"

    Pretty simple.

    1. Daniel5:26 AM

      Dean Baker (along with most macro-economists) is an idiot.

  20. I participate in the economy as a self employed professional and as an investor. The great policy uncertainty that has effected my investment decisions has the repeated efforts by the Republicans to shut down the government. The right wing might be right that policy uncertainty is a drag on the economy but it is the right wing which is most to blame for that uncertainty.

  21. I also agree with R&R, and I think their empirical findings can be explained by the supply-side theory of adjusting from resource misallocation and the demand-side theory of wounded balance sheets, which I see as the real and financial sides of the same coin.

    There is also of course a long-term slowing trend. Which can be explained simply by the rising base, and by relatively large and high-wage (compared to EMs) and thus highly weighted slow-productivity-growth sectors such as restaurants dragging down overall real growth rates.

    But really, nobody thinks there''s a competitiveness problem? I guess these guys haven't yet noticed that the United States is not a closed economy. To be fair, also the vast majority of Keynesian writing ignores everything cross-border. American economists are stupendously insular.

    I think you're way too kind to Tyler. This has been an unprecedented period of monetary policy stability with unprecedented long-term forward guidance. How can anybody with a straight face call that rising uncertainty? Even from the simple mathematical range of possibilities perspective, when rates are near zero you know at least they won't fall much further.

    1. PS There could be a point worth making, though I don't recall Tyler making it, that although the degree of policy uncertainty is low, the magnitude of monetary policy risks is relatively high. That is everyone's loaded up on low-interest, long-term assets which could suffer very heavy capital losses if rates moved significantly higher.