“Just one of those things”

John Fernald, Robert Hall, James Stock and Mark Watson (JF, RH, JS, MW) write “The Disappointing Recovery in U.S. Output after 2009”.

The summary:

U.S. output has expanded only slowly since the recession trough in 2009, counter to normal expectations of a rapid cyclical recovery. Removing cyclical effects reveals that the deep recession was superimposed on a sharply slowing trend in underlying growth. The slowing trend reflects two factors: slow growth of innovation and declining labor force participation. Both of these powerful adverse forces were in place before the recession and, thus, were not the result of the financial crisis or policy changes since 2009.

The conclusion:

Some commentators have viewed the generally sluggish recovery from the deep U.S. recession of 2007–09 as a lingering consequence of financial and economic disruptions, perhaps reinforced by post-2008 regulatory changes. In this Letter, we find that neither of these are the main story of a slowing trend that, to an important extent, predated the recession. The seeds of the disappointing growth in output were sown before the recession in the form of slow productivity growth and a declining labor force participation rate.

Quantitatively, relative to the recoveries of the 1980s, 1990s, and early 2000s, cyclically adjusted output per person has grown about 1¾ percentage points per year more slowly since 2009. According to our analysis, about a percentage point of this is explained by the shortfall in productivity growth and about ¾ percentage point is explained by the shortfall in labor force participation. Other factors are small and offsetting.

Although the magnitude of the trend slowdown has surprised forecasters, the underlying forces were recognized before the recession. For example, Aaronson et al. (2006) forecasted declines in participation as the baby-boom generation retired and the 1960s to 1980s surge of women into the paid labor force plateaued. Similarly, Fernald, Thipphavong, and Trehan (2007) discussed the post-2004 slowdown in productivity.

Finally, it is important to recognize that our findings do not imply that the recession was not enormously costly. Indeed, the collapse in demand during the recession and financial crisis contributed to the slow return of output to a trend rate that was already slowing sharply.

Interestingly, two of the authors, Stock & Watson, were the ones who in 2002 coined the “Great Moderation” moniker to describe the behavior of output and inflation from the mid-1980s to the mid-2000s.

In Has the business cycle changed, and why? they conclude:

To the extent that improved policy gets some of the credit, then one can expect at least some of the moderation to continue as long as the policy regime is maintained. But because most of the reduction seems to be due to good luck in the form of smaller economic disturbances, we are left with the unsettling conclusion that the quiescence of the past fifteen years could well be a hiatus before a return to more turbulent economic times.

Soon after, it appears, the Fed “ran out of luck”!

The chart shows a lengthy span for real output (RGDP) and its trend, beginning in 1954.

Note that while during the “Great Inflation” RGDP stays persistently above trend, after the deep 1981-82 recession output rebounds back to trend (“rapid cyclical recovery”), and during the “Great Moderation” hugs closely to trend.

Note also that following the 1990-91 recession, which was shallow and brief, output converges back to trend slowly. The same happens following the 2001 recession. That is one implication of “Great Moderation”. No “busts & booms”.

In 2003, as output was converging to trend, the economy was buffeted by a strong back-to-back oil shock. Did those shocks herald the end of the “good-luck” period? Or did the policy regime fail?

What was the essence of the “Great Moderation” policy regime? It stabilized aggregate spending (NGDP) growth along a stable level path. The NGDP & Trend chart for the 1990s illustrates.

To do so, the policy regime “ignores” or “looks through” supply (oil) shocks. Otherwise, it will impart additional and unwanted instability. Although Bernanke was well aware of that fact (see his 1997 paper Systematic Monetary Policy and the Effects of Oil Price Shocks), he was “tricked”, by his “inflation obsession” to tighten monetary policy (i.e. let NGDP growth fall fast below trend).

The charts illustrate the outcome of not maintaining the policy.

While in his last months at the helm Greenspan “looked through” the impact of the first leg of the oil shock and kept NGDP growth on the stable path, Bernanke did not.

An oil shock has a negative impact on RGDP growth. However, as Bernanke was cognizant:

Substantively, our results suggest that an important part of the effect of oil price shocks on the economy results not from the change in oil prices, per se, but from the resulting tightening of monetary policy.

As he should have expected, the tightening of monetary policy, gauged by the steep fall in NGDP growth, led to a strong drop in real output growth.

It strains credulity, therefore, that according to JF, RH, JS, MW, “the deep recession was superimposed on a sharply slowing trend in underlying growth”, in which case, most, if not all, of the steep drop in labor force participation was the direct consequence of the Federal Reserve´s enormous policy error.

The coincidence in time is simply amazing!

As the first chart above shows, there has been no “cyclical recovery”, with the economy remaining trapped in a “depressed recovery”. The also “depressed” level of the labor force participation is maybe just a reflection.

As a final note, once I wrote a piece called Bernanke, the man in the “irony” mask. I just discovered a new irony.

In February 2004, Bernanke gave a speech that helped popularize the “Great Moderation”. In the conclusion, he states:

The Great Moderation, the substantial decline in macroeconomic volatility over the past twenty years, is a striking economic development.

Whether the dominant cause of the Great Moderation is structural change, improved monetary policy, or simply good luck is an important question about which no consensus has yet formed.

I have argued today that improved monetary policy has likely made an important contribution not only to the reduced volatility of inflation (which is not particularly controversial) but to the reduced volatility of output as well.

Moreover, because a change in the monetary policy regime has pervasive effects, I have suggested that some of the effects of improved monetary policies may have been misidentified as exogenous changes in economic structure or in the distribution of economic shocks.

This conclusion on my part makes me optimistic for the future, because I am confident that monetary policymakers will not forget the lessons of the 1970s.

Exactly two years later, he took over the Fed…and failed massively. That happened because it was not the lessons of the 1970s that should not be forgotten, but the more recent one of the Fed striving for nominal stability!

Just one of those things






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