The whole post is good. The best follows and looks at the idea that this recession has been so long because of bad policy inhibiting investment and such. He concludes this isn’t the case, because policy has varied across nations but the recession has been pretty severe everywhere.
He also say the behavior of inflation does fit with that idea.
Finally he starts with a neat graphic
I think that title really reaches out of the screen and grabs the reader, don’t you? 🙂
Anyway, Cochrane prefers a different explanation for the long post-crisis stagnation: an iatrogenic one. “Iatrogenic” is a medical term for when an attempt at treating a person causes even greater harm (such as when a routine operation paralyzes a patient). Cochrane supports the idea that government policies that arose in response to what would otherwise have been a short, sharp crash in 2009 ended up making things far worse by causing a long drawn-out stagnation.
…Actually, I think there are two other big problems with the “iatrogenic” explanation of our stagnation.
First, and most importantly, there’s the international aspect of the economy. Here’s Cochrane’s picture of how American consumption has “downshifted” since 2008:
A graph of GDP will look the same. But look at any rich country, and chances are that it experienced the same kind of “permanent downshift” in its consumption after 2008! European countries. Japan. Or look at the graphs for other countries that experienced financial crises – Japan and Sweden after 1990. Korea after 1997. And so on. They all look pretty much the same – a long trend, followed by an abrupt fall, followed by a resumption of growth at the previous trend but at a lower level. Here are two from Sweden and Korea:
Looks familiar, right?
How plausible is it that expectations of future government policy (and government policy itself) would react in exactly the same way all around the world? It does not seem very plausible to me, given the huge heterogeneity of governments and policies.
My second problem with the “iatrogenic” model is prices. Although (as Cochrane points out) the lack of deflation since 2009 is a problem for some New Keynesian models, the lack of inflation seems to me to be a problem for the kind of “permanent income” model that Cochrane prefers. In a simple Econ 102-type AD-AS model, if you have a negative shock to long-run supply (permanent income), prices have to rise rapidly at some point. The logic is simple: An impairment in productive capacity should cause shortages. But since the financial crisis, U.S. inflation has been very subdued:
Now, I realize that AD-AS logic is pretty simple. But I also know that it’s very tricky and difficult to get macro models to tell you that a permanent supply shock has an impulse response on prices that never pokes its head above zero. You can do it, but it’s my understanding that you need to use things like “news shocks” and other such assumptions about the timing of information arrival. It ends up looking pretty weird.
So I think that while there are definitely problems with the New Keynesian interpretation of the world, there are even more problems with the idea that government policy (and far-sighted citizens who guessed government policy years in advance) caused our long post-crisis stagnation. My intuition says the most likely explanation – unfortunately – is that there are some very deep things about how economies work that no macro model yet encompasses.
On the iatrogenic explanation of post-recession stagnations
Wed, 06 Feb 2013 06:02:00 GMT