Reassessing the recovery". He made two graphs, reproduced here. On the top you see the current recession and recovery. On the bottom you see the typical pattern, exemplified by the biggest previous postwar recession in 1982.
We usually bounce back to the trend line. Now, we're not.
The difference betwen "levels" and "growth rates" accounts for a lot of confusion in popular discussions. "Recessions" are pretty much defined as times in which GDP is declining -- negative growth rates, the level is going down. GDP stopped going down in early 2009.
Yet, as many commentators point out, if the recession is over, why does it feel so glum out there? Answer: because prosperity is measured in levels. Employment responsds to levels.
The big macroeconoimc question for our time is this: Just why are we stuck at a much lower level? What do we need to do to get back to the trend line? Or is that trend line illusory?
There are two stories -- and I use that word advisedly.
1) "Demand." We're about a trillion dollars below trend, so the government needs to borrow an additional $750 billion a year (I'm usuing the Keynesian 1.5 multiplier) and blow it on whatever is handy; Solyndras, high speed rail, windmills, any old rathole will do so long as it's "spent." (Sorry, I'm not doing a very good job of expounding this position. Not my job.) Or just let it be stolen, as thieves have high marginal propensities to consume. The problem is the intractable thriftiness of American consumers, so the government just needs to spend more, or borrow or tax money and give it to people who will.
Monetary policy is close to powerless now, but promising zero percent interest rates for a decade helps; those 3.5% mortgages that are strangling credit could be brought down to 3.4%.
2) "Supply." Companies are skittish about using incredibly low rates to build new houses or factories. Over-regulation, uncertainty, fear of political interference, labor-market mismatches are holding us back. (Steve Davis, Scott Barker and Nick Bloom have a nice paper that tries to quantify this story.) Boeing's efforts to start a factory in South Carolia writ large. As a little recent example, the collected attorneys general of several states have got the banks to cave and send foreclosed homeonwers big checks. The banks are certainly going to learn to be much more careful about who they lend to in the future, which has something to do with 3.5% mortgages that nobody seems to qualify for. There are also stories about housing problems spilling over to the real economy, which I don't agree with, but are still basically "supply" stories.
The uniting features of "supply" stories is that, even if you think fiscal/monetary stimulus works in general, they won't work now.
In short, is our problem "micro" or "macro," "supply" or "demand," a mysteriously lingering business cycle, or the outbreak of a long-term growth slowdown? I lean to "supply," but the stories are not really quantified let alone easy to distinguish. Hence the repeated "micro vs. macro" thoughts on this blog.
This matters for all sorts of reasons. All of the projections that show our fiscal problems getting better in the near term before the entitlement bomb hits rely on our quickly closing the gap. If we don't close the gap, we never make progress on the deficit, and our future looks like Greece a lot sooner.
Monetary policy might help "gaps" but it can't fight "trends" or "supply." Jim Bullard, President of the St. Louis Fed, gave an interesting speech in Chicago yesterday pointing this out. Though I disagree with his analysis of why we might never get back to trend (housing prices as a "wealth shock"), his basic point is deeper: If the "trend" is illusory, if it represents "supply" that the Fed can do nothing about, then we are in danger of repeating the mistakes of the 1970s, in which the Fed kept chasing optimistic "potential" calculations that were in fact unrealizable by monetary policy.
And of course it matters for people. 5 percent of everybody's income is a lot of prospertity; 10 more years of slow growth adds up to a lot of lost prosperity.