jueves, 12 de junio de 2014

jueves, junio 12, 2014

Can the Great Recession ever be repaired?

Gavyn Davies

Jun 08 16:42 


The US employment report on Friday was notable because it showed that the number of jobs in the American economy now exceeds the high point reached in January 2008 for the first time since the Great Recession. Another important signal that the economy is returning to normal, it might be claimed.

But a period of more than six years with zero growth in jobs in the American economy is anything but normal. According to the Economic Policy Institute in Washington, the US would need to create an extra 6.9 million jobs before the labour market could really be said to be back to normal, in the sense that all those who want employment would be fully satisfied.



The same point can be made about the path for real GDP in almost every developed economy since 2007. While several economies have now returned to their previous peak levels of output, very few have approached the previous long term trendlines which had been established for decades before that. For the developed economies as a whole, output remains about 12 per cent below these trendlines.

Because this level of output has never actually been attained in the real world, there is little sense of tangible loss about this, notably in the political sphere. Nevertheless, the opportunity cost could still be enormous.

The case for believing that the trendlines can indeed be re-attained is that this has always happened after recessions in the past, at least in the US, though it has sometimes taken many years, especially in the wake of financial crashes. The optimists say that none of the growth fundamentals in the system – the state of technological knowledge, the available labour force, and the amount of fixed investment that is profitable to deploy – has been permanently destroyed by the Great Recession. Therefore, they say, it is incumbent upon policy makers to try to re-attain the trendlines, rather than simply accepting the loss. Many central bankers, especially in the US and the UK, strongly believe this.

A more pessimistic view is that the Great Recession has resulted in a permanent (or at least very long lasting) loss of economic capacity, in which case it would be inflationary to attempt to re-attain previous trendlines. On this view, the global economy has now locked on to a different path, with its effective capacity being much lower than previous trends might imply. The latest estimates of capacity published by the IMF and OECD, who should be able to do this sort of work better than most, clearly imply this (see graph above).

An interesting paper released this week by Lawrence Ball at Johns Hopkins University examines the loss of capacity on a country-by-country basis. He does this by extrapolating the IMF/OECD estimates of potential GDP made prior to the Great Recession into the 2008-15 period, and then compares these with the latest published estimates. The difference between these two paths for potential GDP provide an estimate of the lost capacity due to the Great Recession. The results are truly alarming:



As the table shows, most of the decline in output relative to trend in 2013 is attributed to a drop in potential output (7.2 per cent). The US and the core euro area countries perform relatively well in the league table, while the UK and the stressed euro area economies perform badly.

Only about 2.6 per cent of the overall output loss in 2013 is attributed to an “output gap”, or a fall in output relative to potential. This segment is the only part that can rapidly be repaired by expansionary macro-economic policy, which in the current environment means monetary policy, since fiscal policy is still being tightened in most countries. The future growth rate in potential GDP has also dropped by 0.7 per cent a year in the developed economies, so the problem will keep getting worse from now on.

On the latest IMF/OECD forecasts, the output gap will drop to only 1.5 per cent by 2015, which implies that there will be little work left for monetary policy to do by then.

Lawrence Ball’s most interesting result is that there is a very strong association between the actual loss of output since 2007, and the loss in potential output. Those countries which best avoided the recession (eg Switzerland, Germany and Australia) have had the smallest loss of potential GDP, while those which suffered the deepest recession (mainly the stressed group within the euro area) have lost the most in potential GDP.

Ball concludes that “hysteresis effects” have been at work, implying that a demand shortfall in 2008-09 has had permanent effects on potential GDP via reduced labour participation, lower capital spending and reduced innovation and economic dynamism [1].

While Ball clearly believes that the direction of causation runs from the demand side to the supply side, it has to be admitted that these results are observationally equivalent to the opposite conclusion. It is possible that those countries which suffered the largest supply shocks then experienced the largest drop in output, even though there was no prior shortfall in demand. It seems to me far more difficult to make the argument work this way round, but economists should be humble about how much they really know about the causes of recessions [2].

Can anything be now done to reverse these losses in capacity? It is becoming increasingly clear that monetary policy alone will not work. Before too long, financial market bubbles will prevent that.

Some economists believe that the repair can only be accomplished with a much more active role for fiscal policy [3]. Although it is certainly a huge stretch to believe, even in hindsight, that the herculean losses in output since 2007 could all have been prevented by expansionary fiscal policy, the right type of fiscal policy reforms (tax cuts, infrastructure spending, work incentives and capital spending inducements) could now have benefits on both the supply and demand sides.

Those in charge of fiscal and monetary policy are barely, if at all, addressing these problems in their public pronouncements. In fact, a de facto consensus appears to be developing that the losses in potential GDP should be accepted as an unfortunate fact of life. It is a recipe for too easily accepting the second best.

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Footnotes

[1] See also Robert Hall’s highly relevant work on this.

[2] See Noah Smith, Tim Harford and John Cochrane this week for cautionary notes on the pretence of knowledge in this area, with a riposte from Simon Wren Lewis.

[3] See Ball, DeLong and Summers, for example.

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