Sunday, May 28, 2017

Skipping a stone across recent years

Early 2008, not long before the 2009 recession: Real GDP (blue) is right on track, and the track itself (Potential GDP, gray) is predicted to continue rising, undisturbed, for a decade:

Splash #1

Early 2010: In the past two years there was a recession (vertical gray bar). Real GDP (blue) dropped significantly, then turned upward again. In addition, Real GDP has been revised and now uses "2005 Dollars" rather than "2000 Dollars". 2005 Dollars are worth somewhat less than 2000 Dollars. It takes more of them to buy a given amount of Real GDP. That makes the blue line higher:

Splash #2a
For purposes of comparison, the above graph shows the "track" (Potential GDP, gray) as it was in early 2008. In point of fact, Potential GDP was also revised to use 2005 Dollars and, like Real GDP, is higher than it was before the revision:

Splash #2b
With blue and gray both revised, blue still appears to follow gray about as closely as it did before the revision, except since the 2009 recession. Also, for the future, gray appears to fall slightly below the path predicted in the previous graph, then return to it.

Late 2010: Ezra Klein examines the gap created by the 2009 recession. He looks at ways to to bring output back up to trend: Real GDP could accelerate quickly, or slowly, or not at all.

Splash #3

Early 2012: Pursuing Ezra Klein's third option, Real GDP (blue) continues on its new, lower path. Meanwhile, expectations have been somewhat reduced: The old 2010 trend (gray) has been lowered for 2012 (red):

Splash #4
In February John Taylor shows two graphs of recession and aftermath. One graph considers the 1982 recession, after which the recovery was like Ezra Klein's "rapid acceleration" model. The other considers the 2009 recession, after which the recovery is like the "no acceleration" model. But Taylor's graphs are not models. They are actuals.

That same month, James Bullard (PDF, 6 pages) offers a story to explain why we have a "no acceleration" recovery. In the years before 2008 our economy was in a bubble, he says. And the path predicted for our economy (gray, on Graph #1 here) was based on the bubble.

Imagine our economy without that bubble, Bullard says: predict a future path based on that lesser economic performance, and you will have a better prediction. In other words: Forget the Ezra Klein graph. We're not going to bring Real GDP up to trend. We're going to bring the trend down to meet Real GDP.

As I write this today (2017) Bullard's story seems reasonable, even to me. Bullard's is now the accepted story. How did we get here?

Late 2012: Scott Sumner says if the new (lower) trend continues he will "throw in the towel" and accept it:

In 2009 I advocated going all the way back to the old trend line. I currently favor going about 1/3 of the way back. If we keep on the same track for a few more years I’ll through in the towel and advocate starting a new 5% trend line from where we are.

Sumner, struggling to accept the lower trend.

2014: Marcus Nunes shows a graph of Real GDP since the 1980s, including the 2009 recession and the slower growth since that time. The graph also shows the old and new trends of Real GDP growth:

Splash #5
"For RGDP the trend growth rate is 3.3%," Nunes says. But "There´s no doubt that the economy was 'shifted down' during what has become known as the 'Great Recession', and it looks as if this shift is 'permanent'."

Yes, when the economy falls below trend, it is reasonable to assume that it will rebound back to it. The only thing is that the trend it will rebound to is the new much lower one. And that´s something that makes me think that there´s a wide acceptance of the new trend.

What this implies is that over time the “old trend” will, for all sorts of economic reasons, “cease to exist”, in fact coming down all the way to become one with the new trend level, in which the real economy grows at 2.2%...

Nunes worries that people will, like Sumner, forget about the old trend and accept the new one. There is wisdom in his words.

2016: “Is current output really 18% below potential output?” Menzie Chinn puts the question in quotes, suggesting he does not accept the 18% number. He explains:

One thing that should be remembered is that the trend line extrapolated from 1984-2007 implies that the output gap as of 2015Q4 is … -18%.

In other words, he says the 1984-2007 trend must be wrong. This graph, he says, "highlights the implausibility of the -18% output gap":

Splash #6
Menzie Chinn has turned a corner from Marcus Nunes. The old trend is unreasonable, Chinn says; therefore the new trend must be right.

His evidence? The long duration of the new, lower trend. Chinn enhances that duration by showing the new, lower prediction of Potential GDP, which conveniently aligns with the reported data. In fact, though, the new measure of Potential GDP is not better or more accurate than old measures of Potential GDP. Not better, only different. Lower.

And the duration of slower reported growth is not evidence that the old high trend was wrong. It may only be evidence that economists have not yet found the problem, and policy has not yet fixed it.

Marcus Nunes was right: The old trend has ceased to exist. People like Scott Sumner and Menzie Chinn no longer expect good growth to return. With their minds at last made up, economists can now go back to explaining the world making up their stories.

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