Wednesday, October 17, 2012

Weak Recovery Denial

Paul Krugman disagrees with my recent post that the recovery is weak compared to recoveries from past serious U.S. recessions including those associated with financial crises. I’ve been writing about the reasons for weak recovery for two years, but the issue has heated up because of its relevance to the elections this fall.

In making his critique, Krugman appeals to a recent oped in Bloomberg View by Carmen Reinhart and Ken Rogoff who criticize the research of economic historian Michael Bordo and his coauthor Joseph Haubrich of the Cleveland Fed, which I have referred to. Bordo and Haubrich demonstrate that the recovery from the recent recession and financial crisis has been unusually weak compared to recoveries from past recessions with financial crises in the United States. In separate research, Jerry Dwyer and Jim Lothian report the same finding. Neither Reinhart-Rogoff nor Krugman disprove this finding.

To see this, consider the points made by Reinhart and Rogoff, and also by Krugman.

First, they argue for a narrower definition of a financial crisis. Reinhart and Rogoff say that one should “distinguish systemic financial crises from more minor ones and from regular business cycles.” Thus they exclude some cases studied by Bordo and Haubrich. But narrowing the focus to systemic crises in this way does not change the Bordo-Haubrich findings because the recovery from the recent recession is weaker than the average of past recessions cum financial crises even with these exclusions.

Second, Reinhart and Rogoff argue that one should look at recessions together with recoveries when looking at severity. In fact, in their work they explicitly “don’t delineate between the ‘recession’ period and the ‘recovery’ period.” But there is no disagreement that recessions associated with financial crises have tended to be deeper than those without financial crises. I certainly don’t deny that there was a serious financial crisis. In fact I wrote one of the first books on the crisis and found that government policy prior to 2009 was to blame, just as government policy was to blame for the even more serious Great Depression.

The issue that I and others have focused on is whether the recovery is unusually weak. By mixing recessions with recoveries Reinhart and Rogoff blur the classic distinction, which has long been at the heart of macroeconomic analysis. Because they do not examine recoveries per se, their empirical analysis does not disprove the fact that the current recovery is very weak as Bordo and Haubrich and others have shown.

Third, there is the complaint that in a simple chart I used to show how weak the recovery has been, I only looked at the first four quarters of recovery. But I also mentioned that Bordo and Haubrich use a different measure, which goes well beyond 4 quarters, and come to the same conclusion, and also that the current recovery has weakened further since the first four quarters. In any case, the focus on four quarters has nothing to do with it. Here is a chart that looks at growth during the first eight quarters. The story is the same.

Since most of the Reinhart, Rogoff and Krugman criticism is implicitly aimed at the historical work of Bordo and Haubrich, it is appropriate to conclude with what Bordo wrote in response to a press inquiry which he shared with me. Bordo puts it this way:

Aside from the unnecessary political rhetoric and ad hominems, the basic difference between my research with Joseph Haubrich on U.S. recoveries and that of Carmen Reinhart and Ken Rogoff is over the methodology of defining a recovery. Reinhart and Rogoff focus on the behavior of the level of real per capita GDP from the peak preceding the financial crisis to the point in the succeeding recovery at which the earlier peak level of real per capita GDP is reached. We look at what is called the bounce back, the pace of recovery from the trough of the business cycle.

We find that deep recessions accompanied by financial crises bounce back faster than recessions which do not have financial crises. These results are even stronger when we focus on what Reinhart and Rogoff call systemic crises, like 1893 and 1907. The recent recession and financial crisis is a major exception to this pattern. The recovery remains tepid after three years.

Reinhart and Rogoff s methodology combines the downturn with the recovery. Using our data but following their approach one would get the same results as they do, that recessions with financial crises have slow recoveries as I show in my Wall Street Journal op ed. Their use of real per capita GDP rather than just real GDP would not make any difference to our results. Thus comparing their methodology with ours is like comparing apples with oranges. Our approach focuses directly on the question-- are recoveries after recessions with financial crises associated with slower or faster than average recoveries. Their approach answers a different question than we ask.

In sum, the weak recovery deniers have not made their case.

Monday, October 15, 2012



More on the Unusually Weak Recovery

The weak recovery continues to be a major topic. Over the weekend, Russ Roberts issued the second episode of his three part “chartcast” series on the topic, which is based on interviews with me and builds on his highly-regarded podcast series, but with helpful charts and illustrations. (Here is the first episode). Among other things we discuss the work of Mike Bordo and Joe Haubrich on the unusual nature of this recovery, and their views of the work by Carmen Reinhart and Ken Rogoff.

Also, as Jon Hilsenrath and Ezra Klein report, over the weekend Carmen Reinhart and Ken Rogoff released a short rebuttal to Bordo and Haubrich as well as to several opeds. Reinhart and Rogoff argue in favor of a narrower definition of a financial crisis, and they thus focus on a subset of the eight Bordo-Haubrich recessions with financial crises (for example, they exclude 1913 and 1982). This alone does not change the Bordo-Haubrich results as the figure in my post of last week makes clear. But Reinhart and Rogoff argue that one should look at the downturn as well as the recovery when looking at severity. There is no disagreement that recessions associated with financial crises have tended to be deeper than those without financial crises. The disagreement is over the recoveries. By mixing downturns with recoveries Reinhart and Rogoff get different results from Bordo and Haubrich.

But the question for policy now is whether the recovery has been unusually slow compared to earlier recoveries from recessions with financial crises, and the evidence is still clear that it has been. Papers in the book Government Policies and the Delayed Economic Recovery edited by Lee Ohanian, Ian Wright, and me show that policy is the reason.

Saturday, October 13, 2012

Getting Tax Reform History Right

"For the past 75 years or so, tax reform has been defined by a tradeoff: broaden the tax base and lower rates,” as tax historian Joseph Thorndike explained in a recent article. That’s the framework behind the Romney tax reform proposal, as well as the last major federal tax reform in 1986. History tells us that such a strategy will work if the tradeoff and its pro-growth purpose are explained to the American people, and the mechanics of base expansion are then worked out in bipartisan negotiations with Congress. That’s the lesson from the 1986 tax reform in which Ronald Reagan put forth the general framework and the details were then negotiated with Democrats and Republicans in Congress. That history lesson is very important now, but it will be lost if Americans don’t get the history right.

That is why my colleague and tax expert Charlie McLure was so concerned when he heard Vice-President Biden describe President Reagan’s approach to the 1986 tax reform in the vice-presidential debate this week. Charlie served in the U.S. Treasury in the 1980s and was responsible for preparing the tax proposals for President Reagan. As Charlie explained in an email yesterday, the history told in the debate wasn’t right:

"During the Vice-Presidential debate, Vice-President Joe Biden asserted that President Ronald Reagan made his tax reform proposals public. The implication – and the only context in which the assertion would be relevant – is that he did so during the 1984 Presidential campaign. This is not true. As Deputy Assistant Secretary of the Treasury, I was responsible for preparation of the Treasury Department’s proposals to President Reagan. In his 1984 State of the Union address, President Reagan gave Treasury Secretary Don Regan the mandate to send him the proposals by a date in November that fell after the election. That is what we did. The President did not endorse the Department’s proposals and did not send his proposals to the Congress until May 1985, six months after the election. Had he done that before the election, the resulting demagoguery would have forced him to take so many options off the table that the Tax Reform Act of 1986 would not have happened – or at least would not have been the landmark legislation that it was."

Thursday, October 11, 2012

Simple Proof That Strong Growth Has Typically Followed Financial Crises

People are looking for answers to why the economy is growing so slowly. Is the answer that economic growth is normally weak following deep recessions and financial crises, as, for example, Kenneth Arrow argued in the presidential election event with me this week at Stanford? Or is poor economic policy the answer, as I argued?

In my view the facts contradict the “deep recession cum financial crisis” answer, so I have focused my research on economic policy and have found that the answer lies there. The chart below illustrates these facts. It is derived from historical data reported in a paper by economic historians Michael Bordo of Rutgers and Joe Haubrich at the Cleveland Fed.

The bars show the growth rate in the first four quarters following all previous American recessions that are associated with financial crises, as identified by Bordo and Haubrich. The upper line shows the average growth rate in all those recoveries. The lower line shows the growth rate in the four quarters following the 2007-2009 recession. It is very clear that recessions with financial crises are normally followed by much more rapid recoveries than this current recovery. The current recovery not only started out weak, averaging 2.5% in the first year, it got weaker over time, declining to only 1.3% in the second quarter of this year.

Growth was nearly 4 times stronger on average in the past recoveries. The only recovery in this list in which growth was as weak as this one followed the 1990-91 recession, but that was from a very shallow recession with output declining only 1.1%, so growth did not need to get very high to catch up. (The chart would look very similar if instead of 4 quarters you use the length of the recession from peak to trough as Bordo and Haubrich also do).

With such obvious evidence, how can people come to different views? Usually they mix in experiences in other countries with different economies at different points in time, as for example Carmen Reinhart and Kenneth Rogoff have done in an often cited book. But this approach can lead to mistaken conclusions, as Bordo explained recently in the Wall Street Journal. As he put it, “The mistaken view comes largely from the 2009 book "This Time Is Different," by economists Carmen Reinhart and Kenneth Rogoff, and other studies based on the experience of several countries in recent decades. The problem with these studies is that they lump together countries with diverse institutions, financial structures and economic policies.”

Monday, October 8, 2012

Recent Part-time Job Increase Is Not a Good Sign

Many have noted the large September increase in “part-time employment for economic reasons” reported in the BLS household survey. The 582,000 increase in these part time jobs caused total employment to rise by 873,000—a major reason for the decrease of the overall unemployment rate, and the broader U-6 measure of labor underutilization—which adds in this part-time employment—did not decline at all.

This increase in part time jobs is not a good sign for the economy.

Joe LaVorgna, chief US economist at Deutsche Bank, argues that the part-time increase is likely due to the election. He offers two pieces of evidence. First, there was an unusually large gain in non-private employment, defined as total employment less “private industries” employment, which thus includes campaign workers who organize grass roots efforts, make phone calls, knock on doors, or help at political conventions. Second, there was an unusually large increase in employment in the 20 to 24 year age group—a typical age for campaign workers. The explanation is appealing because both Democrats and Republicans are increasing such grass roots campaigns. State data—especially from the swing states—is needed to confirm LaVorgna’s hypothesis. But if true the increase in part time employment is not a sign of an improving economy: it implies that the jobs gain in September is largely temporary.

Another view is that the increase in part-time employment is directly due to the weak recovery, and a sign that it is getting weaker. Surges in part time employment frequently occur in times of economic stress. Consider, for example, all the months in which part time employment rose by 500,000 or more. There are 13 such monthly increases in the BLS data base—Jan 1958, Mar 1958, Jan 1975, May 1980, Oct 1981, Feb 1982, Feb 1991, Sep 2001, Nov 2008, Dec 2008, Feb 2009, Sep 2010, Sep 2012. With two exceptions, every one of these occurred during recessions when the economy was sharply contracting. The two exceptions are in the current recovery, which ia another measure of its weakness.

Even more troublesome is that in the past 6 months of the recovery, the entire employment increase was more than accounted for by part time jobs: Total employment rose by 940,000 from March to September and part time employment rose by 941,000. This deterioration in the labor market is consistent with the dip in economic growth to 1.3 percent in the 2nd quarter. It too is not a sign that the economy is improving.

Sunday, October 7, 2012

From Economic Scare Stories to the Other Side of Reality

Twenty years ago this month my colleague Bob Hall and I wrote an op-ed for the New York Times about how “in recent months press reporting about the economy has become so pessimistic that it has completely lost touch with reality.” (October 16, 1992). The Times editors headlined our article “Economic Scare Stories,” which captured our point perfectly and fit the Halloween season. In October 1992, economic growth was improving following the 1990-91 recession, but most reporting looked beyond good economic news and said that the economy was doing poorly. Amazingly, the frequently-reported view that the economy in October 1992 was like the Great Depression went unchallenged. So we challenged it, hoping that our article would in some small way result in improved reporting.

Today press reporting seems to have switched to the other side of reality. Compared to October 1992, economic growth is now slower, unemployment is higher, and tragically the long-term unemployment rate is twice has high. And reported economic growth has been declining rather than improving as it was in 1992. Yet, in recent months much reporting about the economy has turned so upbeat that it has again lost touch with reality. Many look beyond the tragic growth or employment news and say that the economy is improving, or that things could have been worse, emphasizing that it is fortunately nothing like the Great Depression.

When asked what caused the switch, I answer, facetiously, that people must have read our article, remembered it, tried to make a correction, but unintentionally overcorrected. That answer, of course, is out of touch with the reality that both October 1992 and October 2012 constitute the final days of a presidential election where the main issue is the economy, and, as Bob Hall and I wrote, “people’s perceptions about the economy affect elections.”