Tuesday, September 26, 2017

"... a burst of renewed growth" -- Steven Kopits

The great unwind begins by James_Hamilton at EconBrowser, 20 Sept 2017:

The Federal Reserve announced today that it will begin reducing the size of its balance sheet next month in very modest and deliberate steps.

Hamilton takes a graph of the Fed's balance sheet since 2002, and uses details from the Fed's announcements to calculate what the balance sheet might look like over the next few years.

First he shows the asset side. Then he shows the liabilities side. The latter graph helps explain some of the assumptions Hamilton uses in his asset-side prediction.

Fascinating stuff. Recommended reading.

And something else. The comments on Hamilton's post include one from Steven Kopits. Following is the body of that comment:
Depressions show markedly different economic and social dynamics than ordinary recessions. For example, we see persistent low interest rates, low population growth, low productivity growth, and sluggish GDP recovery, for example.

On the social front, we see a rejection of the established political system, eg, Brexit, Trump and Macron, an exaggerated ideological polarization (fascists v communists fighting in the street), and active steps to deport illegals (also occurred in the 1930s).

One has to speculate as to what could cause such a prolonged malaise. Gavin Davies takes a crack at the issue:

“The graphs above show a simple version of the Taylor Rule, comparing the appropriate rate (red line) with the actual policy rate set by the central banks (black line). The graphs contain a simple but clear message: because of the constraint imposed by the zero lower bound, policy [rates] were much higher than the appropriate rate for the ECB from 2009-16, and for the Federal Reserve from 2009-14. Now, the rise in the appropriate rates has taken policy into slightly expansionary territory in both the ECB and the Fed, despite the rate rises introduced in the US.”

This interpretation suggests that real interests were too high in the aftermath of the Great Recession, and therefore investment, and perhaps productivity growth, were too low. With Taylor Rule interest rates now above target, the economy may begin to operate well again, with productivity growth rebounding and GDP growing nearer (or above) its historical range. Oil consumption growth — above 2 mbpd / year for the last two quarters — and strength in oil prices suggest this might be true.

We know from the Great Depression (for which I have not seen Taylor Rule analysis) that the US struggled through the 1930s, but doubled its GDP from 1941 to 1947, and did not fall back materially with the end of WWII (although there was a stiff post-war recession). We are now at a similar turning point, which would seem to either end in war or in a burst of renewed growth.

I would welcome your thoughts in a post.


I like the opening paragraphs. They describe the world as I see it. The state of the economy affects "social dynamics". Most people look at the world, complain about politics and the decline of society, and toss in a few complaints about the economy as an afterthought.

The economy is not the afterthought. The economy is the driver of the system. And now I lost almost everybody. 99% of six readers gone, anybody still here? No matter: I don't have to be right about this, but you have to think about it. Because if I'm right and you don't think about it, our problem will never be solved. Or you could say it this way: The problem will be solved by a dark age.

Or this way: "Civilization dies by suicide."

Anyhow, look at the Gavin Davies quote and Steven Kopits's evaluation of it. Good stuff. Based on the Taylor rule, the policy rate was too high until recently, they say. But recently the Taylor rate has gone up, so that the policy rate is relatively low and is therefore expansionary.

They say With Taylor Rule interest rates now above target, the economy may begin to operate well again, with productivity growth rebounding and GDP growing nearer (or above) its historical range. In other words, growth and productivity will be improving. Gavin Davies and Steven Kopits are predicting vigor.

Vigor. Sound familiar? See mine of March 3, 2016, April 7, 2016, August 7, 2016, and August 22, 2016.


Philip said...

The severe post-World War II recession mentioned by Steven Kopits was only technically a recession, meaning that there was a sharp drop in income but hardly any drop in consumption. This was mainly because of the savings piled up during the war which compensated for the fall in income (caused by demobilisation, shutting down of wartime industries etc).

On the other hand, depressions or severe recessions following a big asset bubble burst are caused by people sharply cutting their consumption levels over many years to compensate for the drop in their accumulated savings (net worth) caused by the asset market crash.

Keynes was right in saying that recessions are caused by a fall in aggregate demand. But he was wrong in thinking they were set off by a fall in investment. They are caused by a drop in consumption (or worse, a fall in the rate of consumption as a proportion of income).

The Arthurian said...

Hey, Philip. When I took macro in the 1970s (my 3 and only credits in econ) they said investment was the most volatile of C+I+G+NX and iirc the one responsible for causing recessions. Never thought about that till now. I would want to agree with you, recessions are generally caused by a drop in consumption.

Odd, though. Consumption has been increasing as a portion of GDP since maybe 1970. You'd think our economy should be on the world's greatest economic boom by now.

Cutbacks in government growth? Cutbacks in investment? Smaller trade deficit?

Where's the aspirin

Philip said...

I've written a whole ebook on this called "Macroeconomics Redefined".

As I've also pointed out in an unpublished paper, in Y = C + I + G + NX, time does not enter into the equation at all. So if it was only C or I which fell, an increase in G should compensate quickly. And yet recoveries following asset market crashes tend to be very long-drawn-out.

The reason is that the loss in net worth (usually of the poorest part of the population) is very large. One estimate is that following the 2007-08 crash the median household lost 18 years of net worth. So a rough and ready rule of thumb would be that, all other things being equal, the median household would have to double its saving rate for 18 years to recoup its lost net worth. So far it's been only 10 years. And of course when consumption falls so does Y.