The Great Growth Recession?

According to the BEA's advance estimate, the US economy continued to grow in the April-June quarter, but at a not-very-fast 2.4% annual rate. That's not fast enough to bring the unemployment rate down. Since output growth has been positive for a year now, we can't really say we're in a "recession," but with growth too slow to reduce unemployment, the word "expansion" doesn't really feel right. An informal term for this positive-but-slow growth state is "growth recession." While we shouldn't read too much into one quarter's (preliminary) data, it does raise the question of whether or not the "great recession" will be followed by the "great growth recession."

On a more optimistic note, nonresidential fixed investment growth (i.e., the part of investment that is not houses or inventories) accelerated to a 17% rate. So businesses are adding equipment and software again... if only we could get them to hire workers, too!

Consumption was sluggish - growing at a 1.6% rate as households continued to increase savings.

Net exports made a big negative contribution to the overall total - export growth of 10.3% was swamped by imports rising at a 28.8% rate. After decreasing sharply during the recession, the US trade deficit is headed back up:It remains to be seen how much of a "rebalancing" effect we'll ultimately get out of this slump. This suggests that the US hasn't entirely relinquished the "demander of last resort" role in the global economy, especially with Europe hobbling (ahem, Germany). The flight-to-safety spike in the dollar in 2008 did not help (in general, the effect of exchange rate movements on trade tends to occur with a significant lag).

The BEA release also included revisions of past data which were downward for 2007, 2008 and 2009 (Calculated Risk has a useful picture). In that light, the horrific job numbers make more sense. First quarter 2010 growth was revised upward from 2.7% to 3.7%.

See also Catherine Rampell's Times story and reaction to the report from: James Hamilton, Free Exchange, Mark Thoma and RTE's Wall Street round up.

Update (8/3): New inventory data give reason to expect a downward revision when the second estimate comes out Aug. 27.

The Postulates of the Classical Economics

At Project Syndicate, Keynes biographer Robert Skidelsky writes:

The chief task that John Maynard Keynes set himself in writing his General Theory of Employment, Interest, and Money was to uncover the deep axioms underlying the economic orthodoxy of his day, which assumed away the possibility of persistent mass unemployment. The question he asked of his opponents was: “What must they believe in order to claim that persistent mass unemployment is impossible, so that government ‘stimulus’ to raise the employment level could do no good?” In answering this question, Keynes reconstructed the orthodox theory – and then proceeded to demolish it.

He goes on to provide a nice quick sketch of Keynes' critique of "classical" economic assumptions; the original argument, which is well worth reading today, is found in chapter 2 and chapter 12 of the General Theory.

Effective Protectionism

One of the lessons in international trade class is that tariffs on input goods harm upstream domestic industries - e.g, a tariff on steel would put domestic automakers at a disadvantage by raising their costs relative to foreign competitors. To account for this, economists use a measure known as the "effective rate of protection" which calculates the net effect from the tariffs on the final product that protect an industry and the input tariffs that harm it.

Economists have a strong reflex to sigh when we see a headline like "House Passes Tariff Bill to Help Manufacturers," so it was a relief to read beneath it:

The House of Representatives approved a bill on Wednesday to help U.S. manufacturers by suspending import duties on hundreds of raw materials they use to make finished goods.

That is, the House is increasing the effective rate of protection by lowering tariffs. Perhaps they're more clever than I thought...

Is 'It' Happening Here?

Inflation is very low, as the Consumer Price Index (Blue) and GDP Deflator (Red) indicate:
According to the BLS, the CPI fell in April and May (the "core" CPI, which excludes food and energy prices was flat in March and April and slightly positive in May). Moreover, the Atlanta Fed's Macroblog reminds us that the CPI tends to overstate inflation:

[I]n an article (available to all in its working paper version) appearing in the latest issue of the American Economic Review, Christian Broda and David Weinstein say the earlier estimates of the new goods/quality bias may be a bit understated. The authors examine prices from the AC Nielsen Homescan database and conclude that between 1996 and 2003, new and improved goods biased the CPI, on average, by about 0.8 percentage points per year. If this estimate is accurate, consumer price increases since last October would actually be around zero, or even slightly negative, once we account for the mismeasurement of the CPI caused by new and improved goods.

But (oh, you just knew there was going to be a "but" in here, right?) the authors also point out that, because new goods are introduced procyclically, this bias tends to be larger during expansions and smaller during recessions. In other words, given the severity of the recession and the modest pace of the recovery, there may not be a whole lot of innovation going on right now in consumer goods. This is a bad thing for consumers, of course, but it would be a good thing for the accuracy of the CPI.

Why is deflation a problem? One eminent scholar of monetary theory and history explained it thus:

Although deflation and the zero bound on nominal interest rates create a significant problem for those seeking to borrow, they impose an even greater burden on households and firms that had accumulated substantial debt before the onset of the deflation. This burden arises because, even if debtors are able to refinance their existing obligations at low nominal interest rates, with prices falling they must still repay the principal in dollars of increasing (perhaps rapidly increasing) real value. When William Jennings Bryan made his famous "cross of gold" speech in his 1896 presidential campaign, he was speaking on behalf of heavily mortgaged farmers whose debt burdens were growing ever larger in real terms, the result of a sustained deflation that followed America's post-Civil-War return to the gold standard. The financial distress of debtors can, in turn, increase the fragility of the nation's financial system--for example, by leading to a rapid increase in the share of bank loans that are delinquent or in default. Japan in recent years has certainly faced the problem of "debt-deflation"--the deflation-induced, ever-increasing real value of debts. Closer to home, massive financial problems, including defaults, bankruptcies, and bank failures, were endemic in America's worst encounter with deflation, in the years 1930-33--a period in which (as I mentioned) the U.S. price level fell about 10 percent per year.

That's Ben Bernanke, in a speech titled "Deflation: Making Sure 'It' Doesn't Happen Here" given during our last deflation scare, in 2002. This one is far more serious because we have indeed reached the zero lower bound and are in recovering slowly from a severe recession.

Bernanke went on to explain that he believed monetary policy was far from powerless, even even after nominal interest rates had been driven down to zero:

U.S. dollars have value only to the extent that they are strictly limited in supply. But the U.S. government has a technology, called a printing press (or, today, its electronic equivalent), that allows it to produce as many U.S. dollars as it wishes at essentially no cost. By increasing the number of U.S. dollars in circulation, or even by credibly threatening to do so, the U.S. government can also reduce the value of a dollar in terms of goods and services, which is equivalent to raising the prices in dollars of those goods and services. We conclude that, under a paper-money system, a determined government can always generate higher spending and hence positive inflation.

Two Questions:

1. Do we have a "determined government"?

Its hard to tell, sometimes, but this Washington Post report was moderately encouraging:

Federal Reserve officials, increasingly concerned over signs the economic recovery is faltering, are considering new steps to bolster growth.

With Congress tied in political knots over whether to take further action to boost the economy, Fed leaders are weighing modest steps that could offer more support for economic activity at a time when their target for short-term interest rates is already near zero. They are still resistant to calls to pull out their big guns -- massive infusions of cash, such as those undertaken during the depths of the financial crisis -- but would reconsider if conditions worsen.

Top Fed officials still say that the economic recovery is likely to continue into next year and that the policy moves being discussed are not imminent. But weak economic reports, the debt crisis in Europe and faltering financial markets have led them to conclude that the risks of the recovery losing steam have increased. After months of focusing on how to exit from extreme efforts to support the economy, they are looking at tools that might strengthen growth.

"If the economic situation changes, policy should react," James Bullard, president of the Federal Reserve Bank of St. Louis, said in an interview Wednesday. "You shouldn't sit on your hands. . . . I think there's plenty more we could do if we had to."

2. Would more aggressive Fed action really work?

Perhaps, but the worry is that, while the Fed can create money, it can't force people to spend it. Mark Thoma says "Don't Expect Miracles from Monetary Policy" and Bruce Bartlett reminds us that any increase in money supply can be offset by a decline in money velocity.

Update (7/11): From Paul Krugman, evidence on a trend toward deflation; see also his Times column.

Reinhart and Rogoff

In today's Times, an amusing profile of the authors of "This Time is Different."

June Employment Report

Ugh...
The good news isn't so good - according to the BLS, the unemployment rate ticked down to 9.5% (from 9.7 in May), but that is an artifact of 652,000 people leaving the labor force. According to the household survey (from which the unemployment rate is calculated), the number of people employed fell by 301,000, and the labor force participation rate declined to 64.7%. That suggests that people may be so discouraged about their employment prospects that they are giving up (to be counted in the labor force, people must either be working or looking for work).

The bad news isn't so bad - the decline in payroll employment of 125,000 (calculated from the separate establishment survey) was driven by a 208,000 decrease in government jobs, mostly due to the end of temporary census jobs. Private-sector payrolls increased by 83,000. But that's still not very good - its way far short of the pace needed to keep up with population growth and productivity increases, not to mention getting the massive number of unemployed people back to work.

One would hope this would put an end to all the new austerity talk (discussed here by Paul Krugman) and create a sense of urgency about extending unemployment benefits and increasing aid to state and local governments. As David Leonhardt explained in his column last week, we are in danger of repeating the mistakes of 1937 - I doubt anybody understands this better than Ben Bernanke and Christina Romer.

And yet, the White House appears to be putting a positive spin on things. The Times' Jackie Calmes reports that while the administration's economists want more stimulus, the political advisors are fretting about public deficit anxiety. Meanwhile, down the street, congressional Democrats have created a procedural obstacle to doing anything more next year, as Ezra Klein explains.

More takes on the June report from David Leonhardt, Mark Thoma, Free Exchange and RTE's round-up from Wall Street "economists."

Government Spending and the Slump

In assessing the impact of the stimulus on the economy, one trap that many people seem to be falling into is confusing "federal spending" with "government spending." In fact, over 60% of the government purchases contribution to output (i.e., the G component of GDP), comes from state and local government. While federal component of fiscal policy has been expansionary, the state and local part has been pushing in the opposite direction, a problem that may get worse, according to Ezra Klein:

Some 46 states are facing budget gaps that will require them to cut spending or raise taxes. The Center on Budget and Policy Priorities estimates that in 2011, the states will have to come up with a total of $180 billion.

These budget shortfalls are the equivalent of a massive anti-stimulus, which some experts believe has overwhelmed the $787 billion stimulus passed by the federal government in 2009.

On this, see also Bruce Bartlett and Stephen Gordon (and this previous post).

Super-Asinine Propensities

As Economix notes, Mark Thoma has coined the term "austerians" for those who are calling for budget cutting in the face of continued high unemployment. That's pretty good, but I think Keynes said it even better, as his biographer Robert Skidelsky writes in the FT:

When the Conservative-Liberal coalition that had succeeded the Labour government introduced an emergency budget in September 1931, Keynes again stood out against the chorus of approval. The budget was, he wrote, “replete with folly and injustice”. He explained to an American correspondent that “every person in this country of super-asinine propensities, everyone who hates social progress and loves deflation, feels that his hour has come and triumphantly announces how, by refraining from every form of economic activity, we can all become prosperous again.”

Speaking of Alan Greenspan... Paul Krugman, Andrew Leonard and Calculated Risk respond to his super-asinine WSJ op-ed. See also Andrew Leonard on Skidelsky's piece.

Update (6/23): Paul Krugman says: [A]nti-stimulus appeals to a fundamental meanness of spirit that is always present in the political world. The super-asinine we shall always have with us.

What Happens to a Global Rebalancing Deferred?

Tim Duy notes that the shifts in relative global demand that would lead to a 'rebalancing' of current account deficits and surpluses seem to be on hold. With the crisis in Europe leading to a decline in the euro, which, in turn appears to have given China cold feet about letting the yuan rise, it looks like we may be back to the status quo ante where the US is the world's "consumer of last resort". He concludes:

Where does this all leave us? The rest of the world is intent on pursuing a begger thy neighbor strategy, with the US being the neighbor. I suspect US policymakers will eventually relent; it will be the only choice left. All we can do now is sit back and wait for the inevitable explosion in the US trade deficit, waiting idly by for the next crisis and the "chance" to bring some sanity to the global financial architecture.

Michael Pettis believes that the European crisis makes the yuan revaluation more urgent, but he is not optimistic that the powers-that-be see it that way. He worries the end result will be trade tension and protectionism:

Most policymakers around the world – while publicly excoriating the US for its spendthrift habits – are intentionally or unintentionally putting into place polices that require even greater US trade deficits.

This cannot be expected to happen without a great deal of anger and resistance in the US. The idea that suffering countries should regain growth by exporting more to the world, and that rapidly growing surplus countries should not absorb much of this burden, will only force the US into even greater deficits as US unemployment rises to reduce unemployment pressure in Europe, China, Japan and elsewhere.

I would be surprised if the US accepted this with equanimity. On the contrary, I expect it will only exacerbate trade tensions and ensure that next year the dispute will become nastier than ever.

Of course, real exchange rates can adjust due to price changes as well as exchange rate movements. Some of the recent wage gains by Chinese workers give some reason for optimism. In a story about rising prices of Chinese exports, the Times' David Barboza writes:

Last week the Japanese automaker Honda said it had agreed to give about 1,900 workers at one of its plants in southern China raises of 24 to 32 percent, in hopes of ending a two-week strike, according to people briefed on the agreement. The new monthly average would be about $300, not counting overtime.

And last Thursday, Beijing announced that it would raise the city’s minimum monthly wage by 20 percent, to 960 renminbi, or about $140. Many other cities are expected to follow suit.

Analysts say the changes result from the growing clout of workers in China’s economy, and are also a response to the soaring food and housing prices that have eroded the spending power of workers from rural provinces. These workers, without factoring in the recent wage increases by some employers, typically earn $200 a month, working six or seven days a week.

But there are other reasons. Analysts say Beijing is supporting wage increases as a way to stimulate domestic consumption and make the country less dependent on low-priced exports. The government hopes the move will force some export-oriented companies to invest in more innovative or higher-value goods.

Also, other emerging market countries are providing another engine of demand. At project syndicate, Mohammed El-Arian and Michael Spence write:

Over the past two years, industrial countries have experienced bouts of severe financial instability. Currently, they are wrestling with widening sovereign-debt problems and high unemployment. Yet emerging economies, once considered much more vulnerable, have been remarkably resilient. With growth returning to pre-2008 breakout levels, the performance of China, India, and Brazil is an important engine of expansion for today’s global economy.

High growth and financial stability in emerging economies are helping to facilitate the massive adjustment facing industrial countries. But that growth has significant longer-term implications. If the current pattern is sustained, the global economy will be permanently transformed. Specifically, not much more than a decade is needed for the share of global GDP generated by developing economies to pass the 50% mark when measured in market prices.

(see also Mark Thoma's comments).

DeLong Answers Kocherlakota

Brad DeLong responds to the claim made in Minneapolis Fed President Narayana Kocherlakota's essay on the state of macro (see earlier post) that:

I believe that during the last financial crisis, macroeconomists (and I include myself among them) failed the country, and indeed the world. In September 2008, central bankers were in desperate need of a playbook that offered a systematic plan of attack to deal with fast-evolving circumstances. Macroeconomics should have been able to provide that playbook. It could not.

DeLong argues that a better understanding of how to respond to economic crises exists, even if it is outside of Kocherlakota's realm of "modern macroeconomics." He goes back to John Stuart Mill:

Let me briefly set out what the macro playbook is, and how it has been developed by economists and policymakers over the past 185 years. Start with Say's or Walras's Law: the circular flow principle that everybody's expenditure is someone else's income--ands everyone's income is somebody else's expenditure. It has to be that way: for every buyer there is a seller: and for every seller who is disappointed because they sell for less than their cost plus normal profit because of excess supply there must be another who is exuberant from selling at more than cost plus normal profit.

How, then, can you have a depression--a "general glut," a situation in which there is excess supply of not one or a few but all commodity goods and services? How can you have a situation in which workers laid off from shrinking industries where demand is less than was expected and thus less than supply are not rapidly hired into industries where demand is more than was expected and hence more than supply?

Moral philosopher, libertarian, colonial bureaucrat, feminist, public intellectual, and economist John Stuart Mill put his finger on the answer in a piece he published in 1844:

[T]hose who have... affirmed that there was an excess of all commodities, never pretended that money was one of these commodities.... [P]ersons in general, at that particular time, from a general expectation of being called upon to meet sudden demands, liked better to possess money than any other commodity. Money, consequently, was in request, and all other commodities were in comparative disrepute. In extreme cases, money is collected in masses, and hoarded; in the milder cases, people merely defer parting with their money, or coming under any new engagements to part with it. But the result is, that all commodities fall in price, or become unsaleable...

DeLong puts the problem in terms of a shortage of "safe" assets. The policy response of creating more of them - issuing more government bonds - is the flip side of the traditional Keynesian remedy of deficit spending (or deficit financed tax cuts), as well as of an aggressive "lender of last resort" central bank policy. See also DeLong's related project syndicate column, and this Vox piece by Ricardo Caballero.

So, is this further evidence that we are living in what Krugman called the "dark age of macroeconomics"? Yes and no. As DeLong notes, policymakers have largely been following his playbook (though there are ominous signs they are pulling back too soon). However, academic models employing the reigning methodology of "dynamic stochastic general equilibrium" (DSGE) have generally not been very helpful. That paradigm is still relatively young - it remains to be seen if it will develop in a direction that makes it more useful for policy, or whether it will be supplanted in a more fundamental shift.