Category Archives: Stimulus

Falling Demand in 2008 May Have caused this Recession, Yet Demand Stimulation Might Not End it Now

Since the start of this recession and slow recovery, there has been an ongoing debate about if their depth and duration are due to lack of demand or some other factors.  I’ve read a number of interesting blog contributions on these questions of late and wanted to share them.  I think they suggest blunt stimulation of aggregate demand may not help the unemployed that much, because at least now lack of demand is not the main problem.

First in The Short Run is Short Eli Durado makes a point on these issue and why monetary stimulus as the fed is pursuing may not be very effective though lack of demand was the initial problem:  it isn’t now.  This would mean the fed’s new stimulus is much too late to be effective:

If we view the recession as a purely nominal shock, then monetary stimulus only does any good during the period in which the economy is adjusting to the shock. At some point during a recession, people’s expectations about nominal flows get updated, and prices, wages, and contracts adjust. After this point, monetary stimulus doesn’t help.

The point being that even  if this recession started out as a response to lack of demand and remained so, prices and wages should have fallen by now to clear the market (PUT WORKERS BACK TO WORK).  Unemployment due to lack of demand is a short-run phenomenon.  Is the short-run over after 4 years?

Obviously, there is no signal that is fired to let everyone know that the short run is over, so reasonable people can disagree about how long the short run lasts. But I think there is good reason to think that the short run is over—it is short, after all…

Around 40 percent of the unemployed have been unemployed for six months or longer. And the mean duration of unemployment is even longer, around 40 weeks, which means that the distribution has a high-duration tail.

Now, do you mean to tell me that four years into the recession, for people who have been unemployed for six months, a year, or even longer, that their wage demands are sticky? This seems implausible…

So what is the evidence that we are still in the short run? I think a lot of people assume that because unemployment remains above 8 percent, we must be in the short run. But this is just assuming the conclusion. There are structural hypotheses for higher unemployment

The Short Run is Short
Tue, 18 Sep 2012 13:54:26 GMT

He goes on to suggest:  that a lack of demand may have been the initial pulse that kicked of the recession and maybe it could have been offset by aggressive monetary actions at that time, but now the adjustment to that impulse has concluded.  The duration of the recession may be due to follow-up effects of the recession that can’t be offset by monetary (or fiscal for that matter) stimulus now.

So what about the duration of this recession?  It is part of a trend that has been evident in the last 3 business cycle as discussed in Countercyclical Restructuring and Jobless Recoveries.  This graphic (found in the paper  here) was really interesting:


That top graph represent the ‘average’ behavior of Total Hours and Employment following the trough of business cycle prior to the 1991 recession.  The colored lines below that line represent the %change at the same number of months from the trough.  That the recovery of both hours worked and employment has so clearly been much slower following the bottom of recession in recent recessions.  This recession isn’t necessarily the most slow in its recovery.

So why the change?  It may be because firms are more able to respond to recovery and demand for their product without expanding their labor force.  This in turn is because the recession caused the layoff of the least productive works, and thus the firms ability to expand is not hindered by fewer workers for a long time.  Or in the authors word:

…firms grow “fat” during booms but then aggressively restructure their workforce during recessions. In the model, fi…rms employ unproductive workers because learning about match quality takes time and because adjustment is costly. In recessions, firms shed [these] unproductive workers…  Firms enter the recovery “lean and mean with a greater ability to meet expanding demand without hiring additional workers.

Why is this effect so important now?  Firms may well be better at distinguishing the productivity of workers the author suggests.

It would seem to me that the problem may also be that changing demands on the employee are simply rendering more workers not able to offer what employment demands any more.  The long recovery time may just be a sign, that workers being left behind in skills are let go during recession and it takes a long time for the economy to generate sufficient demand for labor to make a place for these folks.  This is an increasing problem and thus the long drawn out recoveries.

The large number of long-term unemployed workers is consistent with this idea.

In any case, both of these articles suggest that stimulation of ‘demand’ may not be an appropriate response to the slow recovery EVEN IF DEMAND WAS THE INITIAL PROBLEM.

Econ 101 for the Supercommittee at Steven Landsburg | The Big Questions: Tackling the Problems of Philosophy with Ideas from Mathematics, Economics, and Physics

Econ 101 for the Supercommittee at Steven Landsburg | The Big Questions: Tackling the Problems of Philosophy with Ideas from Mathematics, Economics, and Physics.

Looking at China’s Real Estate Boom Before it Busts

NoOneOfAnyImport shared this.

I’ll just post the video, which was fascinating. I’d heard of China’s real-estate bubble before, but the scope of a booming but overbuilt real-estate sector is amazing.  The video really made that starkly real.  It’s the result of a centralized economy.

A few observations:

1. Clearly allocation of productive workers and resources is still not so good in a communist countries.  Strong conservatives gleefully point this out.

2. If more of Chinese labor was occupied in manufacture for export the competition with US workers might be even more painful for us.  Hooray for communism after all?  Strong conservatives might be less gleefully about this.  Overall though and in the long-run better use of Chinese productive capacity would benefit produce more benefits than costs.  But workers in US manufacturing would be hurt.

3. This is a kind of stimulus on steroids.  Keynesianism can produce full employment of a sort.  People are employed, but not in making anything there’s any voluntary demand for, except for speculation.  A point that isn’t useful to any one ideology.

4. Note though that apparently private investors are buying these empty pieces of real estate.  In the end apparently, this may wipe out much of the new Chinese middle class.  What happens if that happens?

5. China is still remarkably poor.  At least partially a failure of socialism.

More on the subject here:

Marginal Revolution

via Nouriel Roubini on Austro-Chinese business cycle theory.

China is rife with overinvestment in physical capital, infrastructure, and property. To a visitor, this is evident in sleek but empty airports and bullet trains (which will reduce the need for the 45 planned airports), highways to nowhere, thousands of colossal new central and provincial government buildings, ghost towns, and brand-new aluminum smelters kept closed to prevent global prices from plunging.

Commercial and high-end residential investment has been excessive, automobile capacity has outstripped even the recent surge in sales, and overcapacity in steel, cement, and other manufacturing sectors is increasing further. In the short run, the investment boom will fuel inflation, owing to the highly resource-intensive character of growth. But overcapacity will lead inevitably to serious deflationary pressures, starting with the manufacturing and real-estate sectors.

Eventually, most likely after 2013, China will suffer a hard landing. All historical episodes of excessive investment – including East Asia in the 1990’s – have ended with a financial crisis and/or a long period of slow growth.

Is a broad lack of demand our Economy’s problem?: Recalculation vs. the data

The answer suggested in the post below is no.  He argues mostly that those who suggest we have a problem with people being in the wrong economic activity, not a lack of demand can’t explain why construction dropped for several year before the economy really hit the skids.  I think the housing story and people in the wrong jobs may still hold up.  My thinking is that there are transmission mechanisms from the falling construction to the broader economy that take effect with a long and distributed lags.  For example the drop in housing would impact furniture and other houseware sales but only after time.

There’s no question that Arnold Kling’s recalculation view is more intellectually appealing than the messy arguments about wage stickiness used by us ”GDP factory” proponents:

Regular readers know that I am trying to nudge them toward a different paradigm in macroeconomics. I want to get away from thinking of economic activity as spending, and instead move toward thinking of it as patterns of sustainable specialization and trade. Even if there is only a small chance that this alternative paradigm is useful, I think it is a worthwhile exercise.

One reason for wanting to change the paradigm is that I believe that trying to describe economic activity using an aggregate production function is a mistake. When I use the derisive expression GDP factory, I am referring to the aggregate production function.

Yes, macroeconomics should be all about specialization and trade.  Except business cycle theory, which needs a special ad hoc sticky wage/price model.  Why?  Because the evidence simply doesn’t fit any other approach.  Here’s Kling on the construction bust:

I want to suggest that the output that is “lost” is output that people do not want. In 2008 and 2009, Americans do not want 2 million houses to be built. So I do not think that it is right to speak of a shortfall in output. Instead, we should say that the people who were building houses have not found a pattern of trade in which they can produce something that people want.

Yes, housing output was low in 2009 and unemployment was high.  But is there a causal relationship?  I say no.  Housing starts peaked in January 2006, and then fell steadily for years:

January 2006 — housing starts = 2.303 million, unemployment = 4.7%

April 2008 — housing starts = 1.008 million, unemployment = 4.9%

October 2009 — housing starts = 527,000, unemployment = 10.1%

So housing starts fall by 1.3 million over 27 months, and unemployment hardly changes.  Looks like those construction workers found other jobs, which is what is supposed to happen if the Fed keeps NGDP growing at a slow but steady rate.  Then NGDP plummeted, and housing fell another 480,000.  Is this because people didn’t “want” those houses?  No.  They didn’t want 2.2 million new houses a year; that really was a societal screw-up (with many possible villains.)  Kling’s completely right about that.  But they probably do want about a million new houses a year as our population grows by 3 million per year and families average about 3.  The reason housing fell far below normal is because the severe fall in NGDP created a deep recession.  Unemployed factory and service workers aren’t going to buy new houses.

Most importantly, the huge run-up in unemployment did not occur when the big fall in housing construction occurred, but much later, when output in manufacturing and services also plummeted.

Here is Kling on the Great Depression:

I think that technological change can drive the marginal product of many workers close to zero (When I mention ZMP, I always feel I owe Tyler Cowen a footnote.) I suspect that this happened in agriculture in the U.S. in the late 1920’s and early 1930’s, dumping a lot of manual laborers into unemployment.

I don’t agree with this.  There had been a very long term secular decline in farm jobs going back for decades before the Depression.  Those workers gradually moved to the cities and were absorbed by growing manufacturing and service industries.  So what changed between the booming late 1920s when unemployment was about 3%, and the early 1930s when it rose to 25%?  The answer is manufacturing collapsed, as industrial production fell by roughly 50%.  It was factory workers losing jobs that explains the Great Contraction, not farm workers.  Yes, farm workers continued losing jobs, but there was no longer any place in the cities for them to find jobs.  Why not?  Because NGDP fell in half between mid 1929 and early 1933.

Here’s Kling on oil prices:

Could “pumping up demand” help in such a situation? Perhaps. But if the recalculation story is right, the higher demand could end up not doing much for employment. Instead, it might only do a lot to raise oil prices.

Of course more demand could raise nominal oil prices by boosting inflation.  But with CPI inflation running around 1% it’s more likely that Kling is referring to an increase in real, or relative, oil prices.  Could monetary stimulus boost real oil prices?  Absolutely.  But if and only if it raised expected levels of output and employment.  In other words, if and only if it was expected to work.

In my next post I’ll address Tyler Cowen’s ZMP workers argument.

Recalculation vs. the data
Fri, 14 Jan 2011 18:24:16 GMT

The myth of Japan’s "lost decade"?

From Urbaneconomics comes this.   The take away is that Japan’s economic performance is not as bad as represented when per working age productivity is examined, but an aging population slowed aggregate growth.  The issue of aging population will be one for most industrialized nations. 

One additional thing to consider is what does this say for the success of Japan’s stimulus programs.  These programs have generally been dismissed as not very successful, but that may be an unwarranted assumption.

Daniel Gros provides an interesting twist to the conventional wisdom that Japan suffered a "lost decade" in the first decade of the millennium, posting annualized real GDP growth of just 0.6% (to US’s 1.7%) – demography!
He argues that instead of blindly comparing the overall GDP growth rates, a more meaningful standard for comparison will be the growth of income per head of the working-age population (WAP)(which represents an economy’s productive potential). And a comparison reveals,

"When one looks at GDP/WAP (defined as population aged 20-60), one gets a surprising result: Japan has actually done better than the US or most European countries over the last decade. The reason is simple: Japan’s overall growth rates have been quite low, but growth was achieved despite a rapidly shrinking working-age population.
The difference between Japan and the US is instructive here: in terms of overall GDP growth, it was about one percentage point, but larger in terms of the annual WAP growth rates – more than 1.5 percentage points, given that the US working-age population grew by 0.8%, whereas Japan’s has been shrinking at about the same rate.
Another indication that Japan has fully used its potential is that the unemployment rate has been constant over the last decade. By contrast, the US unemployment rate has almost doubled, now approaching 10%. One might thus conclude that the US should take Japan as an example not of stagnation, but of how to squeeze maximum growth from limited potential."

Assuming the working population as the measure of the country’s productive capacity, it can be safely concluded that Japan has been successful in squeezing out the most from its shrinking working population. Since its working age population will continue to shrink by about 1% per year, Japan’s continued relative decline is to be expected. Germany and Italy too are likely to follow in Japan’s footsteps. Prof Gros attributes the current strength of the German economy partly due to the temporary demographic stabilization in the 2005-15 period.
In many respects, Japan’s current problems can be a reliable precursor for many of the other developed economies, including the US. The stand-out performance of the US economy over the past two decades, in comparison to the weakness in Japan and Europe, conceals the demographic advantage enjoyed by the US. In this context, Prof Gros raises concerns about the long-term growth prospects of developed economies, given their unfavorable demographic trends

"Slow growth in Japan over the last decade was due not to insufficiently aggressive macroeconomic policies, but to an unfavorable demographic trend. Second, a further slowdown in rich countries’ growth rates appears inevitable, given that even in the more dynamic countries the growth rates of the working-age population is declining. In the less dynamic ones, like Japan, Germany, and Italy, near-stagnation seems inevitable."

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The myth of Japan’s "lost decade"? (gulzar)
Sun, 09 Jan 2011 00:09:00 GMT