A Permanent Slump?
Well, that's the neo-Keynesian approach. In today's NYT, Greg Mankiw has a somewhat different take:hysteresis.Spend any time around monetary officials and one word you’ll hear a lot is “normalization.” Most though not all such officials accept that now is no time to be tightfisted, that for the time being credit must be easy and interest rates low. Still, the men in dark suits look forward eagerly to the day when they can go back to their usual job, snatching away the punch bowl whenever the party gets going.
But what if the world we’ve been living in for the past five years is the new normal? What if depression-like conditions are on track to persist, not for another year or two, but for decades?
Mr. Summers began with a point that should be obvious but is often missed: The financial crisis that started the Great Recession is now far behind us. Indeed, by most measures it ended more than four years ago. Yet our economy remains depressed.
He then made a related point: Before the crisis we had a huge housing and debt bubble. Yet even with this huge bubble boosting spending, the overall economy was only so-so — the job market was O.K. but not great, and the boom was never powerful enough to produce significant inflationary pressure.
Mr. Summers went on to draw a remarkable moral: We have, he suggested, an economy whose normal condition is one of inadequate demand — of at least mild depression — and which only gets anywhere close to full employment when it is being buoyed by bubbles.
The unemployment rate is about three percentage points higher than it was seven years ago, before we got the first whiffs of the economy’s financial problems. The employment-to-population ratio is about five percentage points lower, and it has not recovered much at all since the trough of the recession.
Some of the decline is attributable to an aging population. As more members of the huge generation of baby boomers retire, the employment-to-population ratio naturally declines.
But that is only a small part of the story. A relevant measure is the employment-to-population ratio for those in the prime working age group —25 to 54. This statistic also shows the recession’s lingering effects: the ratio declined to about 75 percent from 80 percent over the course of the recession, and has recovered to only about 76 percent today. So we have recovered only about a fifth of what we lost during the downturn.
The most arresting piece of economic data is in the number of weeks the average unemployed person has been looking for work — statistics that have been compiled since 1948. Until recently, the largest such figure was 22 weeks, in the aftermath of the deep recession of 1981-82. In the most recent recession, however, the average reached about 41 weeks, and it still stands at more than 36 weeks. In other words, after more than four years of recovery, the economy still has an unprecedented number of long-term unemployed.
Some economists believe that long-term unemployment leaves permanent scars on the economy — a theory called hysteresis. One possible reason for hysteresis is that the long-term unemployed lose valuable job skills and, over time, become less committed to the labor market. In some ways, perhaps, they should be thought of as effectively out of the labor force. If this theory is right, the labor market today may have less slack than the unemployment rate and the employment-to-population ratio suggest. Policy makers at the Fed may have to accept that lower employment is the new normal.
To bracket this -- lack of (consumer) demand on the one hand, lack of (labour) supply on the other, there's this: When Wealth Disappears.
Arguably, post-1980s prosperity (or at least the appearance of it) was bought through a credit boom, encouraged by the taming of inflation, that boosted consumer confidence in borrowing at the same time as it shifted them to looking at equities -- or worse, real estate -- aided by banks seeking to bolster their bottom line by departing from the previous norm of tight credit. I think this is what people mean by "financialization."From the end of World War II to the brief interlude of prosperity after the cold war, politicians could console themselves with the thought that rapid economic growth would eventually rescue them from short-term fiscal transgressions. The miracle of rising living standards encouraged rich countries increasingly to live beyond their means, happy in the belief that healthy returns on their real estate and investment portfolios would let them pay off debts, educate their children and pay for their medical care and retirement. This was, it seemed, the postwar generations’ collective destiny.
But the numbers no longer add up. Even before the Great Recession, rich countries were seeing their tax revenues weaken, social expenditures rise, government debts accumulate and creditors fret thanks to lower economic growth rates.
We are reaching end times for Western affluence. Between 2000 and 2007, ahead of the Great Recession, the United States economy grew at a meager average of about 2.4 percent a year — a full percentage point below the 3.4 percent average of the 1980s and 1990s. From 2007 to 2012, annual growth amounted to just 0.8 percent. In Europe, as is well known, the situation is even worse. Both sides of the North Atlantic have already succumbed to a Japan-style “lost decade.”
One can take this any number of ways, according to the four schools of financial throught. For the neo-Keynesians, it is a lack of effective demand, whereby credit makes up for the wage increases workers enjoyed under the post-war Fordist system (remembering that Ford paid its workers enough so that they could actually buy the products they made).
For the Chicago theorists of monetarism, there is no problem. There are no inflationary pressures; money is easy. In some sense, the economy is at equilibrium, and the appetite for risk assets has accordingly adjusted itself.
For the Austrians, we still have to work through the long, long cycle of speculation that resulted in overproduction without adequate reward, defying the iron law of the time-preference of money -- in other words, profit. In a way, this too is an equilibrium argument, in the sense that there will be no capital expansion until there are ready profits to be made.
Strangely enough, some Marxists would agree. Other Marxists would fall into the neo-Keynesian underconsumption camp and call for greater wage equality. But these particular Marxists would say that, unable to make an adequate rate of profit, capital frequently destroys value, till it's worthwhile get out of bed again ... not dissimilar from the Austrian argument.
These are highly stylized positions on my part (call them caricatures if you want), but there is something very different from the period 1945 to 1975 (one might see WWII as an episode of deliberate value destruction, however, as opposed to the Depression being a period of passive capital destruction) and the period 1975 to the present. I would characterize the period 1975 to 1995 as a period of stagnation. Something changed briefly during that time, but it ended around 2000 and so more of the same.
For many of us, the late 1970s, the early 1980s, the early 1990s, were pretty miserable. Then there were brief bouts of euphoria. I'm inclined to think the periods of general disenchantment are more the norm, and that, in line with Rogoff and Reinhart, it will take a long time to work off -- though not necessarily for the reasons they specify.