Friday, April 19, 2013

Wrong Problem Redux

Let me pull out from yesterday's post several bits of excerpt from Scott Sumner. I'm taking everything Sumner after the topic-phrase "US growth before and after 1980".

There's one little piece I don't need today; I scratched it out.

Sumner, in yesterday's sequence:

Growth has been slower [since 1980], but that’s true almost everywhere. What is important is that the neoliberal reforms in America have helped arrest our relative decline...

...neoliberal reforms lead to faster growth in real income, relative to the unreformed alternative.

The neoliberal revolution occurred precisely because growth was slowing almost everywhere in the 1970s and 1980s, and after 1980 growth slowed the most in those countries that reformed the least.

And his summary:

I am not denying that growth in US living standards slowed after 1973, rather I am arguing that it would have slowed more had we not reformed our economy.

So what is Scott Sumner saying, really? Seems to me he says two things. He says there was a problem: Growth was slowing in the 1970s. And the second thing he says is that the neoliberal reforms "helped arrest our relative decline". I have problems with both of these statements.

First of all, the reforms did not solve nor even partially solve the problem. Making the economy grow faster is not the same thing as eliminating the cause of slow growth. The latter is a solution. The former is a tweak.

The problem was never solved. The neoliberal reforms used several work-around techniques to compensate for the problem of slow growth. Even if the reforms fully compensated for the decline, which Sumner admits they did not, the underlying problem would not have been solved by work-around reforms.

Secondly, what was the underlying problem? "Growth was slowing," Sumner says. I do not agree that slowing growth was the problem. Not in the 1970s. Look at this graph from Marcus Nunes:

Graph #1 Source: Marcus Nunes

Marcus shows inflation-adjusted GDP on a log scale, so that a constant growth rate appears as a straight line. In red, he shows a constant-rate trend line. And he marks up the graph to identify different periods. I wish to focus on the period labeled "G.I." for "Great Inflation" -- the inflationary years from 1965 to 1980.

Marcus's graph shows the blue line at or above trend for the entire inflationary period. By contrast, before 1965, and again after 1980, the blue line is at or below trend. The inflationary period seems to show particularly good economic performance. I find this odd, because Sumner (and everyone) says growth was not good in the 1970s. Sumner says "growth was slowing". Marcus's graph does not agree.

(Yes I know, there was inflation in those years, and it was a problem. But an inflation problem is not the same thing as a slow growth problem. And neither of those is the same as our actual problem, which was that better growth would come only with more inflation. We could no longer separate the two.)

Growth was well above trend in the inflationary years. But perhaps being above trend is not the same as good economic performance? I went to FRED, duplicated Marcus's graph, and added a trend line by eye, matching as best I could Marcus's red line from Graph #1:

Graph #2: Inflation-Adjusted GDP (blue) on a Log Scale with a Trend Line Added by Eye
The FRED graph shows recessions as gray bars, so now we can see that the recession of 1970 brought the blue line down to trend, as did the 1974 and 1980 recessions, and the 1982 recession brought it below trend. But apart from times of recession, in the 1965-1980 period the blue line tends not only to run above trend, but also to pull away from trend. To increase more rapidly than trend. To grow faster than trend. Repeatedly, each time until the Fed restrains growth to combat inflation.

Looks to me like growth was very good in those years. Too good, you might say. Maybe so, but that is not what Sumner says. "Growth was slowing", Sumner says.

You can't have it both ways.

The real problem was not that growth was slowing in the 1970s. We were getting good growth. The problem was, we couldn't get good growth without inflation. Growth could easily have remained vigorous, if we were foolish enough to accept the inflation.

The problem was not that growth was slow. We could have fixed that by the traditional methods. Nor was the problem inflation. We *did* fix that by the traditional methods. The problem was that the range of good options narrowed and then disappeared. The economy changed. There was no longer a golden zone where we could have decent growth and reasonable price stability at the same time. This was the problem.

To put it in terms an economist might understand, the Phillips curve shifted away from the origin.

The problem in those years was not that we couldn't get good growth. And the problem was not that we couldn't keep inflation at bay. The problem was that we could not do both at the same time.

That much remains true today.

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