Monday, February 6, 2012

Postmodern Krugman Cycles


Krugman, Postmodern Business Cycles, January 27, 2012.

Krugman writes:

As I said then, there’s a definite change in the character of recessions after the mid-1980s. Before then, recessions were basically brought on by the Fed, which raised interest rates sharply to curb inflation, causing a slump in housing. When the Fed decided that we had suffered enough, it let rates fall again, and there was a surge from pent-up housing demand. Morning in America!

Since then, however, inflation has been well under control, and booms have died of old age — or more precisely, they have died because of overbuilding and an excessive level of debt. The Fed is then in the position of trying to goose housing (which is the principal channel for monetary policy) even though housing may already be overbuilt (which was the point I was making, sarcastically, when I said long ago that the Fed has to create a housing bubble), and it is cutting rates from an initial level which isn’t that high. So the odds of running up against the zero lower bound are high, and recovery can be a long time in coming.

The early-80s slump was brought on by a huge rise in the Fed funds rate, which left lots of room for cuts, and was driven by a deep slump in housing, which meant that there was lots of pent-up demand when rates fell again. The 2007-? slump was brought on by the bursting of a housing and debt bubble, and left the Fed largely pushing on a string.

It's an analysis I need to have in my head.

A change after the mid-1980s. In other words, between the 1982 recession and the 1990 recession.

Before the mid-80s, recessions were brought on by the Fed fighting inflation.

Since the mid-80s, there's not enough inflation to fight, so the economy grows until it chokes on its own excessive housing and debt. And the recovery is awkward, because to achieve recovery the Fed wants to stimulate the housing sector, which remains overbuilt for some time.

It's an interesting, tidy analysis. I like it. But I don't know if I buy it. Have to think about that for a while.

//

This may be silly, but the thing that bothers me most about Krugman's analysis is that he offers two causes for recent recessions: "overbuilding and an excessive level of debt". Could be. But come to think of it, Krugman's analysis is not so tidy after all.

//

Next morning, Char Weise at Creative Destruction quotes Valetta and Kuang of the San Francisco Fed:

The weak recovery of employment is similar to the jobless recoveries that followed the 1990–91 and 2001 recessions. This suggests that the labor market has changed in ways that prevent the cyclical bounceback in the labor market that followed past recessions. The shift towards jobless recoveries probably reflects a reduction in temporary layoffs during cyclical downturns.

Alternatives to Krugman's explanation #1: The labor market has changed.

Nah. That's a result.

//

Couple days later, a thought on Krugman's analysis:

Before the mid-1980s, the progress of the business cycle would lead to inflation, and the Fed had to raise interest rates to slow the growth of spending in order to slow inflation.

Since the mid-1980s, the progress of the business cycle has *not* led to inflation (on Krugman's analysis), and the booms "have died of old age", of "overbuilding and an excessive level of debt."

If we consider total growth as the combination of real growth and inflation, Krugman's analysis says that there was relatively more inflation (and relatively less real growth) in the before-time; and that there was relatively more real-growth in the recent time.

Q: Does that implication exist in Krugman's analysis?

The Fed used to have to fight inflation; these days it doesn't. The implication is that less "economic energy" now fizzles away as inflation and more remains in real growth.

To the extent that Krugman's analysis implies growth is better since the mid-1980s, Krugman's analysis must be incorrect. It's an interesting puzzle, I think.

//

The first objection I have to my critique of Friedman's Krugman's analysis:

Krugman's analysis does not say that growth was better in recent years than it was before.

Oh, but he does: he speaks of "overbuilding". Too much growth, in housing apparently. In the before-time there was so much demand for housing that it caused inflation. In the since-time, there was so much supply of housing that growth eventually choked itself off. In the before-time, too much demand (relative to supply) caused inflation. In the since-time, too much supply (relative to demand) *IS* an indication that supply is better in the since-time, and thus that growth is better. In other words, Reaganomics worked.

Is this the conclusion we are to draw from Krugman's analysis?

11 comments:

Jazzbumpa said...

Here is the JzB Krugman rule: Whenever you find yourself disagreeing with Krugman, go back and reconsider everything from your implicit assumptions to the algorithm that drives your conclusions.

If you find yourself still disagreeing with Krugman, do it all again, and this time, get serious.

but the thing that bothers me most about Krugman's analysis is that he offers two causes for recent recessions: "overbuilding and an excessive level of debt".

Why does it bother you? They are two different things, but they are not independent, and will necessarily travel together.

Alternatives to Krugman's explanation #1: The labor market has changed.

Nah. That's a result.


I would not reject this so blithely. What is it a result of? Does that make it something to be ignored?

Krugman's analysis says that there was relatively more inflation (and relatively less real growth) in the before-time; and that there was relatively more real-growth in the recent time.

OK - but be careful . . . relative to what?

Krugman's analysis does not say that growth was better in recent years than it was before.

Exactly so.

In the since-time, too much supply (relative to demand) *IS* an indication that supply is better in the since-time, and thus that growth is better. In other words, Reaganomics worked.

Is this the conclusion we are to draw from Krugman's analysis?


Not only NO, but HELL NO!

You've fallen into a fallacy of composition. The housing market is a segment. The proper measure of the whole is GDP growth, which under Reaganomics is much less than it was in the golden age. And, if you believe Tyler Cowan, GDP is overstated, so it's even worse now than we think.

What Reaganomics has given us is depressed GDP growth, the destruction of the middles class, extreme wealth disparity, a sequence of jobless pseudo-recoveries, significant reductions in capacity utilization and workforce participation, and a systematic increase in poverty.

Actually, Reaganomics did work - if the above list corresponds to your goals.

Sadly,
JzB

The Arthurian said...

(you changed the subject.)

Greg said...

Want to know what ails us? Look up the term "Balance Sheet Recession"

That will explain the whole thing. Heres a short version:

Politicians and influential economists think we have "run out of money"

Jazzbumpa said...

(you changed the subject.)

Really?

I though responding directly to statements from you post, and then answering your final question in explicit detail was rather on point.

Where did I go wrong?

Cheers!
JzB

The Arthurian said...

Jazz, I used the word "Reaganomics" once. You used it three times.

I used the phrase "Krugman's analysis" eleven times. You quoted four of them, but used the phrase yourself not at all.

I thought my summary of Krugman's analysis was quite clever: "In the before-time, too much demand (relative to supply) caused inflation. In the since-time, too much supply (relative to demand) *IS* an indication that supply is better".

You ignored my summary, and attacked my punch line.

I attempt to evaluate Krugman's analysis: "To the extent that Krugman's analysis implies growth is better since the mid-1980s, Krugman's analysis must be incorrect."

You think you are disagreeing with me when you say but growth was much less under Reaganomics than in the golden age.

Not only are you *not* disagreeing. You are also not evaluating Krugman. You evaluate Reaganomics. You evaluate my post. And you evaluate Krugman's pedestal. But you do not evaluate Krugman's analysis.

Gene Hayward said...

Art, Jazzbumpa---I have a couple of former students who visit this blog and often read your comments.

They are fellow strugglers like me trying to understand policy and they ask me questions about your content and comments (I do not exaggerate this!).

I admire their grit and determination. One of them asked me about the "Golden Age" both of you mention often. I am 51 so my frame of reference is the late 60's into the 80's.

If you are interested, could you just bullet point (at the minimum) some of the SPECIFIC characteristics of the Golden Age as both of you see it.

Thank you for in advance for any imput.

Jazzbumpa said...

Gene -

I'm flattered.

At age 65, I have a slightly longer perspective. I also want to give you a good answer. I need to hit the road now, but in the next couple of days, I'll put up a post at my blog that addresses your question.

http://jazzbumpa.blogspot.com/

Art -

Here is the Krugman pedestal: Of the current crop of economists, there is a subset who has demonstrated a clear understanding of the current situation and what needs to be done - PK, Thoma, andDelong spring readily to mind. Their predictions have consistently been spot on. Of these Krugman is the most vocal, or at least the one I'm most familiar with.

If saying, "check your work," before, during and after your disagreement with him is putting him on a pedestal, then so be it.

Contrast the hyper-inflation cum bond vigilante guys who have been consistently wrong: Sumner Cowan, ZeroHedge. It's no accident they suffer from severe Krugman derangement syndrome.

As for my comment being off topic, you have seriously strained the concept of off-topic to mean that I didn't write the comment you wanted me to write.

Cheers!
JzB

The Arthurian said...

Jazz, I take it back, half of it any way... Thought about your interp of "overbuilding" and your suggestion "be careful... relative to what" and yes, those are
1. relevant to analysisof Krugman's idea and
2. better than my first prods and pokes into his meaning.

Other than that...

Jazzbumpa said...

Other than that...

Geez, man - it's a comment on a blog . . .

Cheers!
JzB

The Arthurian said...

Gene,

• Productivity. Left and right seem to agree on that. See "The Real Economic Crisis (if this link works):

http://www.cepr.net/index.php/op-eds-&-columns/op-eds-&-columns/the-real-economic-crisis/

I reviewed it here: Productivity is good when total debt is relatively low and is therefore able to increase rapidly.

Also

• Growth was good, and
• Inflation was low

These things are subject to an awful lot of interpretation. It does seems they ought to be very clear before one buys the "golden age" label. Too much politics involved.

Still Krugman rejects claims that growth was better after 1980 than before. And in the February 1995 issue of Readers Digest (page 49) Jude Wanniski said, "You have to have lived in the 1950s and 1960s to have experienced a good economy." (Wish I had a link for that one!!)

In addition to the "golden age" of 1947-1973 (or perhaps 1947-1965 or so, ending when the Great Inflation began), Robert Gordon identifies a "macroeconomic miracle" of productivity, 1995-2000. These dates are more or less confirmed at the "Real Economic Crisis" link above.

Find those dates on Noah Smith's graph of the Phillips Curve, which I have here. The curve is always low-and-left when times are good.

Find those dates on my Debt-per-Dollar graph, in my "slack" post linked above.

I had another bullet point, but I forgot it now :)

Anyway, when times were simpler, economists had two goals: economic growth, and price stability. So any time we're achieving those goals, that's golden.

Egads! I'm late to work!! My productivity is at risk!!!

The Arthurian said...

Gene, a follow-up.

I always expected to see a great difference in growth between the golden age and later years. But the golden growth doesn't really stand out, in my opinion.

Two references come to mind. First, at Early Warning a year or so back, Stuart Staniford rejected the notion that "growth has not been any slower in the past thirty years than the previous thirty years." What stuck in my mind was Staniford's observation: "it's hard to read changes in small growth rates on a log graph."

For me, that helps explain why the golden age is so difficult to see in the graphs.

My second reference is Newt Gingrich, from his 1995 book To Renew America, dedicated to Marianne (second wife?). From chapter five:

The power of economic growth was driven home to me by a study that suggested that a 1 percent increase in our economic growth rate would shrink the federal deficit by $640 billion over the next seven years...

In this world of merely 1 percent higher growth, the Social Security Trust Fund never runs out of money for as far as the current model can look into the future.


One percent higher growth can do that. Just a little extra growth can make the difference between golden times and hard times.