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.

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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.

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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.

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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.

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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?