Matt Yglesias: Wrong Crisis?

Matt Yglesias thinks that my Washington Monthly piece is talking about the crisis that “we should have had,” not the crisis we actually had.

I think sections of Tyler Cowen’s The Great Stagnation are about the crisis we should have had, that Michael Spence’s The Next Convergence is largely about the crisis we should have had, Joe Stiglitz’ recent Vanity Fair article is basically about the crisis we should have had, Michael Mandel’s piece on the myth of American productivity is about the crisis we should have had. I can name others. There’s no particular ideological tendency grouping these people together, since if we were facing a big profound crisis then it would be the case that we need big profound answers that can support a range of different ideological positions. Indeed, I would say that an awful lot of the Obama agenda has been about efforts to address the crisis we should have had. That’s why long-term fiscal austerity is important and why there was no “holy crap the economy’s falling apart, let’s forget about comprehensive reform of the health, energy, and education sectors” moment back in 2009.

But this is not the crisis we’re having. Interest rates are low. Headlines tell us that “U.S. Factories Could Suffer From Dollar’s Appeal”. I’m inclined to think that we will, at some future point, face the crisis we should have had and it will need to be addressed in complicated ways. But the crisis we’re having is, for all its horror and scale, a pretty banal monetary crunch—the natural rate of interest is below zero, nomimal rates can’t go below zero, and the Fed won’t act to push real rates lower.

I don’t understand Matt’s argument. He cites low interest rates as evidence for his side. However, we would expect a slow growth, low-innovation crisis to push interest rates lower, since there would be fewer good opportunities for investment.

The other issue is that the economy is not behaving the way we would expect a high-productivity, high-innovation economy to behave. One example: real wages for new college grads have been falling for a decade, even before the recession. That shouldn’t happen if there were growing innovative industries for them to find jobs in.

Ezra Klein on the policy response to the recession

Ezra Klein has the best piece yet on the policy response to the recession, and why it wasn’t enough.  He  highlights the way that  bad data led to bad policy mistakes.

To understand how the administration got it so wrong, we need to look at the data it was looking at.

The Bureau of Economic Analysis, the agency charged with measuring the size and growth of the U.S. economy, initially projected that the economy shrank at an annual rate of 3.8 percent in the last quarter of 2008. Months later, the bureau almost doubled that estimate, saying the number was 6.2 percent. Then it was revised to 6.3 percent. But it wasn’t until this year that the actual number was revealed: 8.9 percent. That makes it one of the worst quarters in American history. Bernstein and Romer knew in 2008 that the economy had sustained a tough blow; they didn’t know that it had been run over by a truck.

Ezra then goes on to discuss in great detail the choices and constraints of the Obama Administration, and comes to a fascinating conclusion.

Yet the Obama administration did too little. Its team of interventionist Keynesians immersed in the lessons of the Depression and Japan did too little. Everyone does too little, even when they think they’re erring on the side of doing too much. That’s one reason “this time” is almost never different.

The tendency thus far has been to look at these crises in terms of the identifiable economic factors that make them different from typical recessions. But perhaps the better approach is to look at the political factors that make them turn out the same, that stop governments from doing enough even when they have sworn to err on the side of doing too much.

The political crisis–here, in Europe, and in Japan in the 1990s–is not separate from the economic crisis, but lies at its heart.

Five Things to Remember

  1. The stock market is not the same as the economy. When the stock market was rising, it didn’t mean the economy was good. When the stock market is falling, it doesn’t mean the economy is bad (see here)
  2. Much of the growth of the federal deficit went to fund economic growth abroad, not in the U.S.  Yes, I know that the official data shows that real imports are smaller today than when the recession started. It’s not true.
  3. The official data are wrong. Real import growth is stronger than the numbers show, productivity and real GDP growth are much weaker. (see here).
  4. The last thing the U.S. needs is another stimulus to consumption. Consumption leaks right out the door as higher imports.
  5. The U.S. should be a production economy, not a consumption economy.  It’s time to stop chasing low consumer prices and focus on investment in physical, human, and knowledge capital. That’s the only path to sustained prosperity.

Business Investment Drought Worsens

To me, the big news in the first quarter GDP data is that the business investment drought has worsened.  I compare the actual level of real business investment with the long-term trend level (assuming that the ten-year growth rate as of 2007IV had continued). Here’s what we see:

As of the first quarter, real nonresidential investment is 23.1% below its long-term pre-crisis trend, slightly wider than in the fourth quarter of 2010. This is the clearest sign of the weakness of the economy, since no one can argue we had a bubble in nonresidential investment before the crisis started. The longer this investment shortfall last, the harder it will be to recover.

Incidentally, the business investment drought is far bigger than the shortfall in consumer spending. The chart below shows the shortfall in real PCE, relative to long-term pre-crisis trend

The consumption shortfall is only 9.2% relative to the ten-year trend. That’s widening too, as real PCE growth is still below the long-term trend. However, given the fact that the U.S. was supposedly over-consuming before the crisis, a 9.2% shortfall may not be big enough!

Here’s another comparison:



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