Monday, October 8, 2012

Could the Recovery from the Great Recession Been Faster?

ABC’s This Week invited Nobel Prize winning economist Mary Matalin to debate known liar Paul Krugman. OK, I think I got this backwards even though Matalin did say:
I don’t make up numbers ... you have lied about every position and every particular of the Ryan plan on Medicare from the efficiency of Medicare administration to calling it a voucher plan ... You are hardly credible on calling somebody else a liar.
Actually - it was established a long time ago that Mary Matalin is a partisan hack but what about this claim:
Has there ever been this not be true in history that the deeper — the deeper the recession, the steeper and stronger the recovery. There is no such thing as a deep recession with a moderate recovery.
Poor Mary had not read this:
Fact-checking financial recessions is a salient issue, especially in a US election year. On the one hand, the incumbent faces criticism that the recovery is slow. In August the Mitt Romney campaign invoked US history to argue that performance has been poor: “The 2007-2009 financial crisis produced a severe recession ... But GDP growth has been anaemic since then, averaging just 2.2% per year since the trough. This pattern is unusual. The past ten recessions have been followed by faster recoveries, and GDP has fairly swiftly recovered to the previous trendline.” On the other hand, none of the last ten US downturns coincided with a financial crisis. In his convention speech nominating Barack Obama a month later, Bill Clinton intimated that the usual pattern in normal recessions was not relevant in this instance: “The difference this time is purely in the circumstances… no president, not me, not any of my predecessors, no one could have fully repaired all the damage that he found in just four years.” ... We reach back into the historical record over 140 years, examining the experiences of 14 advanced countries, to document the pervasive cyclical influence of credit in the economic fortunes of nations … The more excess credit in the preceding expansion, the worse the recession and subsequent recovery appear to be ... By this reckoning the US has done quite well, steering out of the to-be-expected financial recession range based on the inherited level of excess credit, especially if the shadow system is considered. Most importantly a deep financial recession was avoided at the outset, and this level effect remained intact ... To assume that this US recovery would resemble previous “normal recession” is to use the wrong benchmark.
There is a very simple way to think about this using standard IS-LM thinking. The 10 recessions from the late 1940’s to 2001 (see this for the dating of US business cycles) differed from the Great Recession as well as the Great Depression in terms of the ability of conventional monetary policy to quickly reverse these milder recessions. In those 10 situations, we could have and actually did reverse these recessions by allowing interest rates to fall. Some of these recessions (notably the ones from 1969 to 1982) were started by deliberate monetary contractions to “Whip Inflation Now” as President Ford once quipped. The ability to rely on monetary expansion had lead many economists including myself to wonder if we ever really needed fiscal stimulus to manage downturns in the modern business cycle. Yes – more fiscal stimulus would have been called for during the Great Depression but not in the modern US economy – unless we fell victim once again to the liquidity trap. The financial crisis in other nations such as Japan should have warned us that falling into a liquidity trap was a real possibility but I guess we had to relearn the lessons of history on our own. When Barack Obama prevailed in November 2008, he seemed to realize the need for a massive and effective stimulus package but alas didn’t push hard enough for what Christina Romer recommended. And alas, US fiscal policy has recently drifted towards austerity. So while I agree with those who argue that policy responses to severe financial crisis are different than policy responses to garden variety recessions, all this really means is that we may have to look beyond conventional monetary policies to have quick and effective remedies to downturns in aggregate demand. Alas the Republican Party and Team Romney to date has been opposed to fiscal stimulus unless it is of the military Keynesian brand.

1 comment:

Jason Norin said...

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