Melissa and I spent the past few days reading all the discussion papers that were presented at the 60th Economic Conference hosted by the FRB-Boston on October 14 and 15. The conference’s theme was “The Elusive ‘Great’ Recovery: Causes and Implications for Future Business Cycle Dynamics.” We think the papers provide a very interesting insight into the sorry state of the macroeconomic thinking and modeling that the Fed relies on to conduct monetary policy. The good news is that Fed officials finally seem to be conceding that maybe something isn’t quite right with their theories and models.
That’s actually a refreshing change. Since the financial crisis of 2008, the consensus view of Fed officials was that their easy monetary policies weren’t working to boost economic growth and inflation as predicted by their models because they hadn’t done enough in the previous round. So they provided another round of more of the same, based on the guidance of their misguided models. Now at least they--and some of the academic macroeconomists they respect (who presented all of the conference papers)--are starting to ask the right questions. Indeed, the title of all six papers ended with question marks.
While Fed Chair Janet Yellen’s keynote address didn’t do the same, the text of her prepared remarks had 19 question marks related to her topic, which was “Macroeconomic Research After the Crisis.”
Let’s start with a brief review of the six papers that are posted on the conference agenda page and pose lots of good questions:
(1) “Why Has GDP Growth Been So Slow to Recover?” This paper concludes that the slow pace of the current economic expansion is mostly attributable to long-term demographic trends, the slowdown in overseas economies, and bad fiscal policy management. These are problems that monetary policy can’t fix. Here is the concluding paragraph:
“Stepping back, our main finding is that the recovery has not been as slow as is often asserted. This is not to say that the pace of recovery was desirable: it was not, and faster growth of incomes and employment would have benefited American workers. But more than half the slow growth, compared to the previous three recoveries, derives from slower long-term trend growth, which in turn is mainly a consequence of changing demographic features of the labor force that have nothing to do with the Great Recession. Compared to what would have been expected in Q4-2009 using cyclical correlations from 1984-2007, there remains a shortfall. That shortfall seems largely associated with the one-off factors of weak international demand and slower than expected growth of government expenditures.”
(2) “Why Has the Unemployment Rate Fared Better than GDP Growth?” Arthur Okun was the first to observe, in 1962, that there was a normal relationship between unemployment and real GDP. The current economic expansion seems to have violated Okun’s Law, as real GDP growth has been weaker than the drop in the jobless rate would suggest. This paper seeks to estimate the impact of various causes of the deviation in what might be better called “Okun’s Rule of Thumb.”
The conclusion is that there have been three big negative components of the breakdown. They are productivity, capital input, and labor-force participation, “each contributing about four percentage points to the shortfall of real GDP [from 2007 to 2014]. The decline in the working-age population contributed another two percent. The favorable components, coming in here with negative signs, are hours per worker, the ratio of private to total hours of work, and labor quality. These saved the big decline in real GDP relative to trend from being 2.4 percentage points worse.”
(3) “Where Have All the Workers Gone?” The author of this paper admits that he has come up with the same answer as others who have studied this issue: “Along with several other studies, this study finds that declining labor force participation since 2007 is mainly a result of an aging population and ongoing trends that preceded the Great Recession, such as increased school enrollment.” The startling insight is that lots of middle-aged men who have dropped out of the labor force are in pain: “Participation in the labor force has been declining for prime age men for decades, and about half of prime age men who are not in the labor force (NLF) may have a serious health condition that is a barrier to work. Nearly half of prime age NLF men take pain medication on a daily basis, and in nearly two-thirds of cases they take prescription pain medication.”
(4) “Why Has Consumer Spending Remained Moderate and the Saving Rate Increased?” This is yet another paper suggesting that the economic slowdown (in this case in consumer spending) since the financial crisis may be structural rather than cyclical. Again, this implies that ultra-easy monetary policy can’t do much about the problem, though policy is likely to remain ultra-easy given that the causes of weak economic growth may be here to stay for a while.
More specifically, some evidence is provided “that for a good fraction of the population (individuals at the bottom of the distribution of skills, with typically high marginal propensities to consume) the slowdown in wages has structural, not cyclical causes, and an enlarged measure of permanent income (which includes the value of assets, i.e., housing wealth as well) has been severely hit by the crisis and there is severe uncertainty about it getting back to pre-recession levels and providing relief from binding borrowing constraints. In this sense, the slow growth of consumption may just be the ‘new normal’, not an episodic deviation from long-term trends.”
(5) “Why Has Inflation Remained Low for So Long?” This paper doesn’t answer the question. Instead, it is full of mumbo-jumbo. One of the discussants responds to the question posed by this paper with the observation that “actually, inflation appeared to be too high for a while.”
(6) “Did Macroeconomic Policy Play a Different Role During This Recovery?” This paper reads like the author’s stream of consciousness. He opines: “It would be very rash to say that we have confidence that the economy is near full employment right now. But it would also be very rash to have confidence that the missing prime-age workers will appear in the labor force without a very high-pressure economy indeed.” Here’s another gem: “If independent central banks are going to retain primary responsibility for macroeconomic stabilization, they need more and better tools in order to do the job.”
And what about fiscal policy? The answer according to this thought piece is that “fiscal institutions really need to step up their technocratic game, or some fiscal authority needs to be transferred to organizations that can play the technocratic game.”
The final piece of advice provided to macroeconomic policymakers is actually the one that makes the most sense to us: Don’t meddle so much! In the tradition of Hyman Minsky, in this paper, J. Bradford DeLong, the widely respected professor from U.C. Berkley, warned: “And the very large current gap between the earnings yields of equities and the returns to safe debt would seem to argue very strongly against policies that seek to avoid macroeconomic risk by reducing market risk tolerance.”
It all reminds us of the absurdist Luigi Pirandello play Six Characters in Search of an Author, in which the characters have free minds and get caught in a tangle of existential questioning about their reason for being and relationship to their author.
Dr. Ed Yardeni is the President of Yardeni Research, Inc., a provider of independent global investment strategy research. To read more of his blogs, CLICK HERE NOW.
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