Economic Slowdown: Ideology at Work

To the Obama-haters at the Wall Street Journal, the stubborn economic slowdown reflects business’ fear of looming tax hikes. The Administration-friendly folks at the New York Times, by contrast, blame the lackluster economy on political stalemate in Washington. Meantime, over at Bloomberg Businessweek, they tell us it’s all a matter of us having our cake and eating it, too — loving both the Bush-era low taxes and Obama-era high spending and failing to choose between the two.

The inability of our economy to surge back consistently from the Great Recession has become a Rorschach test for pundits. They look at the ugly blot and discern a pattern, one that – not surprisingly – reflects their biases. Love small government and Bush-era tax cuts? Obama’s overreaching is to blame for our woes. Never met a problem that more money from Washington couldn’t solve? It’s the shortfall in such largesse that is making that blot so skinny. And if they can’t make up their minds, they blame both Bush-era “wisdom and folly” – whatever that fence-straddling phrase means.

For my money, the reality is more a matter of the Depression-era notion of pushing on a string. Our policymakers can’t find the levers that will kickstart the economy, that will ignite the animal spirits of our business leaders, and that will drive down the pathologically high unemployment rate. Nothing seems to work, though the folks at the Fed aim to keep pushing whatever buttons they can. Their newest tack, revealed on Aug. 10: buying up more Treasury debt to keep interest rates low.

In the end, the problem may be that the hole we put ourselves into in the Great Recession is just depressingly deep. It took years to dig. And it could take years, sadly, for us to find our way out. To take just one measure, U.S. employment plunged by more than six percent in the recession that began in 2007, the steepest fall of any of the 11 recessions we’ve suffered through since World War II. To take another measure, these downturns lasted from six to 16 months, and our latest slide – believed to have ended in 2009, though the National Bureau of Economic Research has yet to date it – will almost certainly prove to be longer than any of them. (For policy wonks, the Minneapolis Fed puts all these comparisons into perspective here.)

If history proves anything, however, it’s that economies do claw their way back. Sometimes, they do so with the help of Washington. Sometimes, they move on despite government meddling, however well-intentioned. Even today, economists don’t agree on whether D.C. pulled us out of the Depression or prolonged it – making that bout of global misery our first and biggest political and economic Rorschach test.

It’s no comfort to people who have been out of work for months or even years at this point. It’s also small comfort to investors or people considering whether to deploy capital, especially since they are still sussing out Washington’s new regulatory reach. And, if this downturn proves at all similar to earlier ones, whole industries will emerge reshaped as a result of it (think Detroit), not to mention companies (think GM). We will come out of this as a far different economy with areas like Internet-related industries taking a dominant place over the manufacturing icons of the past. (How is it that people still have enough money for iPads?)

Following every twist and turn in this uneven recovery is enough to generate serious palpitations. For players in the capital markets – or anyone, for that matter — it’s healthier to set aside the dire headlines of the moment and keep your eyes on the horizon, however distant it seems. Bet on a long slow ride up, with lots of dips. Keynes famously said that in the long run, we are all dead. But at the moment, the promise of the long run is the only thing we have to hang onto.

Double-dipping?

Gentle reader,

Here is an excerpted take on the question of a double-dip recession, from the people at CalculatedRisk, a blog I dip into now and again. Echoes a post here a couple days ago, but with some more detail. Call us a pair of Pollyannas, but maybe we’re onto something.

Personally, I get nervous when conventional wisdom all moves in one direction — as the sliding markets lately seem to suggest. I’ll stick with the contrarians.

Tuesday, June 29, 2010
2nd Half: Slowdown or Double-Dip?

by CalculatedRisk on 6/29/2010 04:00:00 PM

No one has a crystal ball, but it appears the U.S. economy will slow in the 2nd half of 2010.

For the unemployed and marginally employed, and for many other Americans suffering with too much debt or stagnant real incomes, there is little difference between slower growth and a double-dip recession. What matters to them is jobs and income growth.

In both cases (slowdown or double-dip), the unemployment rate will probably increase and wages will be under pressure. It is just a matter of degrees.

The arguments for a slowdown and double-dip recession are basically the same: less stimulus spending, state and local government cutbacks, more household saving impacting consumption, another downturn in housing, and a slowdown and financial issues in Europe and a slowdown in China. It is only a question of magnitude of the impact.

My general view has been that the recovery would be sluggish and choppy and I think this slowdown is part of the expected “choppiness”. I still think the U.S. will avoid a technical “double-dip” recession.

Usually the deeper the recession, the more robust the recovery. That didn’t happen this time (no “V-shaped” recovery), and it is probably worth reviewing why this period is different than an ordinary recession-recovery cycle.

# First, this recession was preceded by the bursting of the credit bubble (especially housing) leading to a financial crisis. And there is research showing recoveries following financial crisis are typically more sluggish than following other recessions. See Carmen Reinhart and Kenneth Rogoff: “The Aftermath of Financial Crises”

An examination of the aftermath of severe financial crises shows deep and lasting effects on asset prices, output and employment. … Even recessions sparked by financial crises do eventually end, albeit almost invariably accompanied by massive increases in government debt.

# Second, most recessions have followed interest rate increases from the Fed to fight inflation, and after the recession starts, the Fed lowers interest rates. There is research suggesting the Fed would have to push the Fed funds rate negative to achieve the same monetary stimulus as following previous recessions. See San Francisco Fed Letter by Glenn Rudebusch The Fed’s Exit Strategy for Monetary Policy.

The graph from Rudebusch’s shows a modified Taylor rule. According to Rudebusch’s estimate, the Fed Funds rate should be around minus 5% right now if we ignore unconventional policy (obviously there is a lower bound) and probably close to minus 3% if we include unconventional policy. Obviously the Fed can’t lower rates using conventional policy, although it is possible for more unconventional policy.

# Third, usually the engines of recovery are investment in housing (not existing home sales) and consumer spending. Both are still under severe pressure with the large overhang of housing inventory, and the need for households to repair their balance sheet (the saving rate will probably rise – slowing consumption growth).

On this third point, I put together a table of housing supply metrics last weekend to help track the housing market. It is hard to have a robust economic recovery without a recovery in residential investment – and there will be no strong recovery in residential investment until the excess housing supply is reduced substantially.

During previous recoveries, housing played a critical role in job creation and consumer spending. But not this time. Residential investment is mostly moving sideways.

It isn’t the size of the sector (currently only about 2.5% of GDP), but the contribution during the recovery that matters – and housing is usually the largest contributor to economic growth and employment early in a recovery.

Two somewhat positive points: 1) builders will deliver a record low number of housing units in 2010, and that will help reduce the excess supply (see: Housing Stock and Flow), and 2) usually a recession (or double-dip) is preceded by a sharp decline in Residential Investment (housing is the best leading indicator for the business cycle), and it hard for RI to fall much further!

So I’m sticking with a slowdown in growth.