September 08, 2013
My friends Mike Konczal and Paul Krugman are duking it out over views about a self-correcting economy in blog posts today. It’s actually not much of a fight, but there are a couple of points worth adding.
First, Krugman repeats his often stated view that this time is different, that the downturn in 2007-2009 is not self-correcting because the Fed was up against the zero lower bound. The story is that other central banks also faced the same situation. This meant there was no choice but to turn to fiscal policy to provide the necessary lift to get the economy back to full employment.
There is a small problem with this “this time is different” argument. The Fed didn’t quite lower interest rates to zero in the 2001 downturn, but it got pretty damn close. Because the bounce back from recession was so weak (the economy didn’t start adding jobs again until September of 2003, almost two years after the end of the recession) it lowered the federal funds rate to 1.0 percent in the summer of 2002 and kept it there for two years.
Okay, math geeks everywhere are jumping up and down right now pointing out that 1.0 percent is not zero. This is true, but the ECB had kept its overnight rate at 1.0 percent until well into 2012. This didn’t keep economists from saying that it was up against the zero lower bound. While lowering the rate to its current 0.5 percent undoubtedly gives some positive boost to the euro zone economy, and lowering it further to zero would help even more, no one seriously believes that the drop from 1.0 percent to zero makes all that much difference.
In other words, it is reasonable to say that the Fed was up against the zero lower bound following the 2001 recession. This means that such experiences are not quite as rare as some may believe. It also means that stimulatory fiscal policy might have been an appropriate response to that downturn, even if the Bush tax cuts and the wars in Afghanistan and Iraq may not have been the best routes for boosting the economy.
The other point has to do with the long-run question. The idea is that something changes so that even if we never have any policy response to the downturn we eventually get back to something like full employment. Mike discusses the fact that workers who go unemployed long enough can eventually become unemployable. This suggests one possible route back to full employment. We eventually make enough of our workforce unemployable so that current levels of employment are consistent with full employment. (Mike doesn’t push the argument this far, but it is certainly a plausible story.)
The other route suggested by both Mike and Paul is that something eventually kicks up to boost demand. This one is a bit harder to see.
Contrary to what you read in the papers, business investment is not low as share of output. It didn’t fall off that much in the downturn and has pretty much recovered back to its pre-recession levels. Nor is consumption low. In fact, the share of disposable income that is going to consumption is well above the average in the 1960s, 1970s, and 1980s. It is below the peaks of the stock and housing bubble, but unless we get another bubble, it is difficult to see why it would rise back to those levels. People need to save for retirement. If anything, current savings rates are far too low for people to be able to enjoy comfortable retirements. So there is little reason to think there will be a rebound in consumption.
Residential construction of course plummeted in the downturn following the building boom of the housing bubble years. However it has rebounded strongly in the last two years. It is now pretty much back to its normal share of output. There is no reason to think we will again get a 2002-2006 building boom unless we see another bubble. And those who think there is now a tremendous dearth of housing as a result of the recession slump have not been looking at the vacancy data.
In short, it doesn’t look like the long-term holds out much hope for much of a rebound in these components of private sector spending. Net exports, the one major item that both Konczal and Krugman left out, is more promising. We continue to run a trade deficit of more than 3 percent of GDP, which would likely be over 4 percent of GDP if we were at full employment. This is sustained by developing countries buying up vast amounts of dollars to hold as reserves. This props up the dollar and allows them to keep their export markets in the United States. In effect, they are paying us to buy their stuff.
At some point developing countries will realize that they don’t have to pay us to buy their stuff, they can pay their own people to buy their stuff. When they come to understand this fact, they will stop buying dollars and the dollar will fall against the currencies of our trading partners. This will make U.S. goods more competitive internationally, leading to more exports and fewer imports, and a return to full employment.
Anyway, this is the happy long-run story, but don’t hold your breath on it. If you want to see people get back to work anytime soon the government is going to have to do it. And that’s true no matter how much you like the private sector.
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