Thursday, June 5, 2014

Hall on Supply vs. Demand

I'm reading Bob Hall's Macro Annual paper (ungated here). The burning question is, how much of our low GDP relative to the pre-2007 trend and forecasts corresponds to "supply" (really "equilibrium") which monetary and fiscal "stimulus" can't help, and how much is "demand" that they might. (I live in a more model-based and equilibrium tradition, so I don't want to fully endorse these words and the concepts behind them, but they'll have to do for now.) Bob's paper is a really nice quantitative exercise aimed at answering the question, rather than just bloviating as us bloggers tend to do.

Bob starts with
The years since 2007 have been a macroeconomic disaster for the United States of a magnitude unprecedented since the Great Depression. 
He measures our shortfall at 13.3 percent of GDP. Now we add up where it comes from and how much "demand" might help.

From the conclusion
There is no reason to expect that the cumulative shortfall in productivity growth of 3.4 percentage points of output could be reversed by a sudden increase in product demand. That shortfall seems to be the result of a period of reduced innovation, possibly the result of the crisis. ..Whether the return to a normal economy will result in a catchup in productivity growth in the longer term [JC: do inventions proceed on a time trend, and we can quickly implment them] is an unsettled question of growth economics.

...the capital stock is ... responsible for the largest part of the output shortfall, 5.0 percentage points. It can't respond immediately to a boost to product demand, but a boost would probably trigger an accelerator response that would close some part of the shortfall. In the longer run, the strong mean reversion in the historical capital/output ratio should work to close the entire gap. 
... Unemployment dropped slowly to 1.3 percentage points above normal in 2013, contributing 0.9 percentage points to the shortfall in output in that year. The return to normal has been slower than in previous post-recession episodes because the crisis shifted the composition of jobseekers toward those with low job- finding rates and low exit rates from unemployment. An increase in product demand would accelerate the remaining move back to normal....

Labor-force participation fell substantially after the crisis, contributing 2.5 percentage points to the shortfall in output. The decline showed no sign of reverting as of 2013. Part is demographic and will stabilize, and part are effects low job-fi nding rates, which should return to normal slowly. But an important part may be related to the large growth in bene ficiaries of disability and food-stamp programs. Bulges in their enrollments appear to be highly persistent. Both programs place high taxes on earnings and so discourage labor-force participation among benefi ciaries. The bulge in program dependence is a state variable arguably resulting from the crisis that may impede output and employment growth for some years into the future.

I add that up as 3.4+5.0+2.5 = 10.9% / 13% not particularly amenable to "stimulus," and instead reflecting "supply."  Capital stock "mean reversion" means investment which doesn't happen on its own, and I'm dubious of "accelerators." Take your own conclusions.

The paper is good for a detailed search theoretic view of labor markets.

My only big complaint: The title: "Quantifying the lasting harm to the U.S. economy from the financial crisis." I would insist on adding "and policy responses to that crisis." We have had swift recoveries from previous crises.


  1. “My only big complaint: The title: "Quantifying the lasting harm to the U.S. economy from the financial crisis." I would insist on adding "and policy responses to that crisis." We have had swift recoveries from previous crises.” - Dr. C.

    John B. Taylor, lecturing at Duke University, examines recessions caused by a financial crisis and ensuing growth. Taylor examines eight recessions going back to 1882, of which the eight recessions are related to a financial crisis, then examines the first eight quarters of expansion after the recessions ended.

    The current not-so-great-expansion, the policy thereof, the result as it were.…..the policy and abysmal result is blamed on the “financial crisis” being distinctly different than other recessions and hence policy did not create the growth. That is, the failure is blamed on: “Its different this time”.

    Problem is, of the eight financial crisis recessions examined by Taylor, the current growth/policy response is the worst of the bunch. That is, it isn’t different this time as this is the eighth recession related to a financial crisis, a series spanning 125 years.

    See 18:35 - 19:45 of the lecture (link below):

  2. So if incompetent policy responses is the main reason for weak recoveries, does that suggest that in a world of better policy responses, risk premia would be much lower?


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