Saturday, July 30, 2011

The Worst Day in Years

It got overshadowed (as everything has) with the unnecessary debt ceiling debacle, but yesterday was a sad day in the realm of macro. The BEA released revised economic data for the last 3 years along with our advanced estimate for this quarter and told us that the economy has been in much worse shape than we had thought. We have yet to return to our pre-recession level of output.

The gap on the graph above may not look like much, but it makes a big difference. It's quite depressing that we're getting downward revisions in the hundreds of billions of dollars a few years after the fact, and is testimony to how difficult our economy is to measure.

Scott Sumner (emphases mine):
NGDP fell nearly 4% from 2008:2 to 2009:2, and has risen at a tad over 4% a year for the next two years. We are up by only 4.1% in 3 years, that’s a little over 1% per year. In other words, per capita NGDP has barely risen in 3 years! To maintain full employment everyone would have had to go nearly three years without a pay rise. But with soaring minimum wage rates, that wasn’t too likely. I’m sure lots of people in government, health care, education, etc, got raises. I did (even with one year of no raise), as did my wife (a scientist.) So with almost no extra NGDP to go around (per capita), we essentially have a game of musical chairs. The lucky ones get pay increases, the other 9.2% are sitting on the floor.

We already knew that the Fed was behind the curve. There is no way we should have seen unemployment above 9% and inflation expectations falling way below the Fed's implicit target last year, it's the Fed's job to prevent that. Now we know Bernanke's FOMC has allowed NGDP even further below trend since 2007. Reappointing Bernanke now looks to be one of the biggest mistakes of the Obama administration. If he had gone with Larry Summers instead, who would have cracked skulls to get what he wanted, we might be living in a different world.

The data does sorta solve one mystery that I've had to explain in class for the last 2 years: why Okun's Law seems to no longer hold in the U.S. It was a mystery why the "jobless recovery" was so bad, why unemployment had departed so far from the rate of economic growth we were seeing. Now we know that economic growth was not as good as we thought. Claims about a vast increase structural unemployment, rather than cyclical, were therefore misplaced.

There is currently a myth that gets repeated on the political Right-- that the government is currently standing in the way of recovery. That growth today is slow because the increase in government spending is crowding out private spending. But what do the data say? State and local government spending and federal government employment are decreasing. The ARRA stimulus is phasing out, meaning that discretionary spending is already on the downturn. Ryan Avent (The Economist) reminds us that such austerity is contractionary:

Government represented a significant drag in the first quarter, chopping 1.23 percentage points off of growth, 0.41 precentage points of which were due to state and local cuts, and 0.74 percentage points of which can be chalked up to declining defence spending. Indeed, the new report reveals the extent to which government has been an obstacle to recovery. In five of the last seven quarters, government has contributed negatively to growth, again thanks mostly to large state- and local-government cuts that offset the federal government's modest attempts at stimulus.
Private-sector investment has been positive, private sectors of the economy are growing, but the growth in GDP is offset by government retrenchment. This may all be well and good in the long-run (especially if you want to drown the government in the bathtub), but contractionary fiscal policy unaccompanied by expansionary monetary policy creates slower economic growth. This is what makes Congress' current wrangling over the debt ceiling problematic-- the focus is all on discretionary spending and not on entitlements-- where almost 100% of our future deficits will come from. The Tea Party wants to cut minor programs now, thinking that this will boost employment and GDP growth now, tossing 400 years of economic data out the window. (If, as part of their austerity package, Congress wanted to mandate an NGDP level target for the Federal Reserve, I'd be an austerity evangelist).

While Economics21 and others want to claim that it's all government regulation and crowding-out, accompanied by "uncertainty" over government policy, the data don't give them much to stand on. David Beckworth points us to WSJ and NFIB surveys indicating that the main problem is aggregate demand, and not regulation. While I've read articles with CEOs complaining that excess regulation is keeping them from expanding, they never point out a single new regulation that is the culprit. Beckworth notes that problems like regulation seem worse when you're not seeing the sales you're used to. Neil Irwin wrote an article in the Washington Post this week about why companies aren't hiring. While it highlighted frustration with uncertainty over fiscal policy, there was no mention of regulation. I asked Neil via Twitter if any of the CEOs he interviewed mentioned regulation. He said they did in general terms-- they named nothing specific. CEOs seem more fed up with the debt ceiling debate than anything:

The groups that represent businesses in Washington, including the U.S. Chamber of Commerce and the Business Roundtable, have been urging Congress to raise the debt ceiling to avoid the risk of a default or downgrade of the U.S. credit rating, even as many newly elected Republican members of the House — who received support from business interests when running — are reluctant to vote for such a measure. A group of major business groups sent a letter to the president and every member of Congress two weeks ago, imploring them to raise the debt ceiling.

Also on Friday, we saw the biggest 1-day increase in the price of 10-year U.S. Treasury bonds since 2009. Corporations are taking advantage by issuing their own debt as quickly as they can before August 2nd, this is a boon for junk bonds. This is an indication that the bond market--investors--now expect lower inflation and slower economic growth in the next ten years than they did around this time last year.



So, yesterday was a bad day even without the debt ceiling fiasco and the Eurozone implosion. Also, political problems in Turkey mean the markets there could do some interesting things on Monday. (But they have much better monetary policy than we do right now, so I'm not too concerned. )

No comments: