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Krugman has a recent post where he cites a SF Fed study regarding the unemployment rate among recent college graduates:

Mark Thoma leads us to new research from the San Francisco Fed showing that recent college graduates have experienced a large rise in unemployment and sharp fall in full-time employment, coupled with a decline in wages. Why is this significant?

The answer is that it’s one more nail in the coffin of the notion that employment is depressed because we have the wrong kind of workers, or maybe workers in the wrong place.

And asks:

The right question to ask, with regard to all such arguments, is, where are the scarcities? If we have the wrong kind of workers, then the right kind of workers must be in high demand, and either be in short supply or have rapidly rising wages. So where are these people?

Now, not to diminish the fact that what most people refer to as “The Recession” was, in fact, the result of a demand deficiency (or more aptly, a large increase in the demand for money not accommodated by the Fed), I’d like to point to some anecdotal evidence that in reality there is a problem a skill mismatch and “recalculation” that is proving difficult to tract. To the extent that this is the problem, rather than a problem, I’m not quite sure. From David Andolfatto:

For the 15 million Americans who can’t find jobs, the labor market is like an awful game of musical chairs. There are many more players than there are available seats.

Yet at Extend Health, a Medicare health insurance exchange firm in Salt Lake City, Utah, the problem is just the opposite—a growing number of chairs to fill and not enough people with the skills to fit the jobs.

“It seems like an oxymoron in this environment that you can somehow be challenged to find great workers,” CEO Bryce Williams admits, almost sheepishly.

Extend Health’s call center workers help retirees navigate the process of signing up for commercial Medicare Advantage and drug coverage plans.

For this fall’s Medicare Enrollment season, the firm will need close to a thousand workers. The ideal candidate is over 40, with a background of financial services in order to qualify for insurance licensing.

“They need to be able to pass the state of Utah exam, which is not easy,” Williams explains. “They need to have a background in comparing the financial metrics of trying to help someone compare and analyze and give great advice.”

Andolfatto has a link to another story along the same lines regarding manufacturing workers (a field which has become highly specialized). There is also the two facts that college degrees are large fixed investments in skills that may be reduced in demand. This is something that I’m largely familiar with, as I was in school for a prized IT career before the tech bubble burst. As I know Mark Thoma has noted (though I can’t find the link), we have a disproportionately high amount of graduates in business and finance, which is probably still true, and a low proportion of graduates in applied sciences. This of course leads into the next issue: the squeezing of efficiency out of a smaller workforce. How does that relate to the degree profile of our college graduates? Because it is comparatively easy to squeeze extra efficiency out of people who work “in business”. Much easier than, say, squeezing extra efficiency out of an existing construction or manufacturing worker. So if more people are specialized in business or finance, areas that took a major hit, and also an area where substitution is comparatively easy, then there is likely a skills mismatch between there.

So yes, I believe that there is more than trivial problem of skills mismatch, which I think was nearly the whole story up until late 2008, when the large fall in expected NGDP caused various financial obligations to be much harder to service (that tends to pin people down, and reduce employment options). That is a demand story. However, as we slog out of this recession, real job growth may remain low even as we return to previous trend NGDP. We should be at least prepared to discuss the supply side when that happens.

P.S. If anyone was wondering, I’m starting to feel better, though I haven’t gotten a diagnosis as to what is wrong with me, still. Been keeping busy with confusing insurance statements, school, and work. I think I’m at the point where I can end my hiatus from blogging, and write a few things. Glad to be back =].

P.P.S. For a long time I’ve been trying to find oddball diagnoses that fit my symptoms. Doctors hate that, by the way…but I do it anyway. In any case, I’ve been stuck on Whipple’s Disease for a while. Symptoms fit like a glove.

Paul Krugman is doubting that financial collapse was a key part of the recession

My take on the US economic crisis has increasingly been that banks were less central than many people think, while the housing bubble and household debt are the key players — which is why financial stabilization by itself wasn’t enough to produce a V-shaped recovery.

I am not sure how central people think the banks were so I am not sure how hard to push back.

My take is that household debt and the banking collapse were symbiotic in their destructive nature. At the center of the story, however, is money and credit.

Highly leveraged households meant that consumers were very sensitive to economic disruption. The danger in having a lot of leverage is that when things go bad they go really bad. The flipside of course is that when things go good they go really good. We have to have some story about how things started to go bad before household debt can be invoked to explain why things went really bad.

Debt is ultimately just a promise.  Lots of debt is precarious when there are many interlocking promises that depend crucially on one another. If one person flakes – as eventually one person will – the whole network could crashing down.

When the banking sector collapsed it created a huge flake. Lending fell dramatically. Projects and production that were dependent on a smooth supply of lending could not go through. This rocked many households who were themselves in locked into sensitive promissory positions.

Now knowing that a flake was possible we might step back and ask either “why did we allow such sensitive networks to develop” or “why were housing prices allowed to climb on top of these tightly wound promises”

However, the more fundamental mistake was thinking that the Fed was prepared to firewall this whole thing if it went bad. It wasn’t that people couldn’t see the debt or the housing bubble building. Its that they thought it didn’t matter. The phrase commonly thrown around was “the Fed doesn’t target asset prices.”

That’s a more convoluted way of saying, this business with housing and mortgages may be a house of cards, but “so what?”

I don’t want to sound like I am pointing fingers here. I was deeply sympathetic to that view. Sufficiently powerful monetary policy I thought, and honestly still believe, could offset virtually any shock.

What we wasn’t appreciated fully enough was the fact that monetary policy would not be powerful enough; that central bankers are only human and that they will be hesitant to take extreme action.

In the light of those limitations it becomes more important to manage precarious situations as they arise. However, from the point of view of understanding the economy we also need to note, as Matt Yglesias reminds us to do, what powerful monetary policy can indeed accomplish. 

I had been urging the Fed to effectively “go negative” by promising inflation. In Sweden, the central bank went literally negative.

For a world first, the announcement came with remarkably little fanfare.

But last month, the Swedish Riksbank entered uncharted territory when it became the world’s first central bank to introduce negative interest rates on bank deposits.

Even at the deepest point of Japan’s financial crisis, the country’s central bank shied away from such a measure, which is designed to encourage commercial banks to boost lending.

The result was a surging Swedish economy. Indeed, as the FT reports, the fastest growth on record. This is coming out of a worldwide economic collapse.

This is also despite a long-run price to income profile that’s not that far off from the United States and peaked around the same time


I don’t think Krugman is doing this, but it is easy to get too caught up in thinking the macroeconomy is an extension personal finance. Having bought a house you couldn’t afford seems like a really bad situation to be in, and if everyone is in that situation then it seems like that ought to be really bad for the economy.

However, keep always in the front of your mind that a recession is not simply a series of unfortunate events.  A recession is when the economy produces less. For example,  the AIDS epidemic in Botswana is a horrible event for millions of people that uprooted lives and destroyed families and promises to leave a generation of orphans.

However, Botswana’s GDP growth didn’t turn negative until Lehman Brothers went under. 


That a Global Financial Crisis could do what rampant death and disease could not, is an important indicator of the nature of recession.

A recession isn’t when bad things happen, whether that’s loosing your house to foreclosure or your parents to AIDS. A recession is when the economy produces less.

Somehow you have to make a link between the bad thing happening and the economy producing less. I maintain that, that link almost always runs through the supply of money and credit.

The Data

Gallup ask small businesses about their hiring practices.


Nearly as many reported hiring fewer than needed as reported hiring as many as needed.

Note the question asked was as needed.  From an economists perspective this is as if the firm is saying that if deliberately did not continue hiring until marginal revenue produce equaled the wage rate. There were workers, there was work, profit could have been made. They decided not to make it.

The question is of course why?

Gallup asks that as well


The top two answers are consistent with standard Aggregate Demand stories.

The first is a New Keynesian story that employers can’t sell all the product that they want at existing prices.

The second is a more monetarist flavored story that real cash balances are two low.

The third is a structural reason. Not the right employee mix. Note that this is a Mismatch story. Not recalculation.

The fourth is harder to interpret. It could be regulatory uncertainty: Is the new health care law going to cost me too much.

It could be a sticky-wages story: I can’t just take away my employee’s health care at the drop of hat. If health care costs are rising that is forcing real wage increases on me.

It could be a Austrian story. The relative demand for health care is rising implying that I should reduce resource use in my area to free up resources for the health sector but the price signals are screwed up health care, making this unclear to business owners.


Lastly Gallup asks a question that reveals why Aggregate Demand might cause the natural churn of the economy to bubble up into recession.



41% of those hiring say they did so to replace an employee who left. Employees quitting is part of the natural economic churn. No problem there The problem is that the employers didn’t all hire up to the point that they needed. Meaning that our natural churn spilled over into excess unemployment.

We really want to to see the crosstabs here but with 41% hiring to replace a lost employee and 42% saying they hired less than they needed, it seems reasonable that many employers did not replace all lost employees even if they needed them.

The Story

The story that makes sense to me is that employees left for some reason – could be fired, dead, quit, laid off when recession hit, whatever. Employers could profitably replace those employees if they were sure they could sell all their merchandise at existing prices.

They are not sure, and so they have hired only a few employees.

Now this could be an entirely real story. It could be that small businesses completely misinterpreted the real economy and so now are readjusting. They have to wait to see if demand is really there or not before committing resources.

The question is why did this happen to so many employers at once.

This is where I think Bob Murphy and his Sushi story have an advantage. He says the Fed confused everyone and that is why so many businessmen are confused at once.

The problem with that story is that it depends on some workers have very low or zero marginal product during the transition. It seems to me that this is akin to saying these workers are needed.

However, the survey here suggests that there were workers who were needed but not hired.

To me this points to an Aggregate Demand story where a sudden drop of in sales leads many owners at once having more inventory than they can sell at current prices and reluctant to hire unless that inventory starts moving again.

I was going to write up a post on my exasperation at the Fed’s recent meeting statement, but Ezra Klein got to it before me and did a good job, so you should go read what he has to say. One point that I want to highlight, because I have made the point that the dual mandate is mostly just an insiders joke:

Paragraph two: We admit everything is terrible. In fact, it’s so terrible that it means we’re failing our mandate. “Measures of underlying inflation are currently at levels somewhat below those the Committee judges most consistent, over the longer run, with its mandate to promote maximum employment and price stability. With substantial resource slack continuing to restrain cost pressures and longer-term inflation expectations stable, inflation is likely to remain subdued for some time before rising to levels the Committee considers consistent with its mandate.”

[Image Courtesy of David Beckworth]

How many of you wish that you had a job where you could consistently fail at the very time when it is clutch that you deliver in a big way? How many of you would like to say, “Well, I have a model of the economy that says we won’t be hitting any of our own targets…but oh well”? The Federal Reserve is in the exact position in the economy where they can act quickly and decisively and actually make a large impact on nominal spending. I would even go as far as to say that they can do so without “long and variable lags”, as markets should price in actions by the Fed nearly immediately, and indeed they have been.

Contrary to the popular narrative, I believe that it is this very passivity by the Fed that brought us to the brink in the fall of 2008, when every indicator of economic activity (industrial output, consumer spending, business confidence, NGDP expectations, etc.) were found to be in sudden free-fall mode. At that time, interest rates were in the 1.5%-2% range, and the Fed’s target was still 2% until October 2008!

And here we are, fully two years later, and we still cannot get the Fed to act…nor can we get the executive branch of government to take the problem seriously! This inaction belies an institution that either is ill-equipped to respond when necessary, or is structured in a way that prevents decisive action. Since I believe that the Fed has all the tools it needs (it being a monetary superpower), I would place the blame on the structure of the network.

There is nothing more important on the Fed’s plate right now than bringing nominal spending back in line with the previous trajectory of NGDP. Not only to assist 50 million people who are currently unemployed, and help numerous others rebuild their balance sheets…but to save our economy from the whims of populist sentiment that will likely take hold if our economic malaise continues for very much longer. That means rounds and rounds of fiscal stimulus. That means the development of an entire class of freeters who never reach full potential. And most importantly, that means the loss of real goods and services that could otherwise be produced in our economy — which translates into a lower real standard of living for everyone.

At this point I would do anything for a little more monetary stimulus.

Another chart to steal from Real Time Economics, this time provided by Justin Lahart.

The classic hydraulic macro story would imply that someone is hoarding cash. It would be really nice then if we could look around and see some cash being hoarded. Indeed, we do.

A point I want to make is that none of these pieces of evidence is in-and-of itself conclusive: The small business survey, the flow of funds, inflation expectations, etc.

There could be explanations for all of them that involve something other than the traditional liquidity demand story: that is that recessions are caused by excess demand in the market for cash/bonds/safety.

However, the liquidity demand story suggests that certain things should all be happening at the same time: a decline in the demand for labor, a decline in the purchase of durables, a decline in consumer prices and business’s pricing power,  a decline in asset prices, a decline in inflation expectations, an increase in cash holdings, an increase in the ease of finding workers, etc.

And, all of those things are happening.

I like to focus on inflation because I think just about all of us have agreed that inflation is primarily controlled by actions at the Fed. Thus close patterns between inflation and other variables should suggest that they are also controlled by the Fed.

Here is fraction of income spent on durables and inflation.


Ed Leamer likes to say that its all durables and housing. I think there is more going on in housing than money creation but lets check the Leamer story versus inflation.


Looking at durables only suggests that inflation might flatten out soon. Looking at durables and new houses suggests that deflation will be upon us for sure. It will be interesting to see what happens.

Note, however, that this is not saying that a reduction in income spent on durables and housing will cause a decline in inflation. Its saying the Fed has already taken certain actions. The immediate result of those actions is a decline the fraction of income spent on durables and new houses. The future impact of those same actions will be a decline in inflation.

In other words the inflation decline is already baked in. What we have to ask ourselves now is whether we want to take actions that would raise inflation expectations for the medium future.

Update: I probably should have put “during the recession” in the title. Unfortunately it’s gone to press.

Chevelle, at Models and Agents, explains why the previous round of “quantitative easing” performed by the Fed did not have a [sufficient] expansionary effect:

By that metric, the Fed’s past LSAPs have probably fallen short. Clearly, measuring the counterfactual is impossible, but there are reasons to believe that the impact on aggregate demand was small. Why? First, because the reduction in mortgage rates boosted refinancings only by people who could refinance—i.e. people with jobs and some positive equity in their home. Not exactly the most cash-strapped ones who would have spent the extra cash.

Second, the portfolio-balance effect of the LSAPs on the prices of assets like corporate bonds or equities is at best weak, if not counterproductive. The reason (which I explained in detail here) has to do with the fact that US Treasuries and MBS are not “similar in nature” to corporate debt and equities. Unlike the latter, Treasuries/MBS have more of a “safe haven” nature—so that removing them from investors’ portfolios create demand for more “safe” assets, rather than boosting the prices of equities, high yield bonds, etc.

Luckily, one Benjamin S. Bernanke explained how to perform private asset purchases that would, in fact, have an expansionary effect:

If the Treasury issued debt to purchase private assets and the Fed then purchased an equal amount of Treasury debt with newly created money, the whole operation would be the economic equivalent of direct open-market operations in private assets.

If you see that guy around, tell him to talk to the Federal Reserve. I remember hearing a podcast with Scott Sumner a while back where he floated the idea of the Fed buying bonds off of the public (i.e. You and I), and paying for them with cash. Lets get to it!

Scott Sumner routinely forgets my name when listing people who thought money was tight, and favored unconventional monetary responses to the recession…but that’s okay. I wasn’t blogging that much in late 2008. In any case, I would like to provide a concise answer to a question Scott raises on his blog today:

The very fact that Congress and the President are ignoring this issue (confirming FRB nominations), pretty much tells me that they are clueless on monetary policy. On the other hand, both groups do favor more AD, so their “heart” is in the right place. And of course I’m a big believer in democracy. So who do I favor making the decisions; the clueless or the heartless? I’m tempted to say “Whoever agrees with me; first tell me the target Congress would set.” But of course that’s cheating. The honest answer is that I don’t know. But it is becoming increasingly clear that we won’t get good policy until this dilemma is resolved.

In my mind, the myth of an independent central bank has pretty much been shattered (Karl’s as well). Every time the theory of why we have an independent central bank has been put to the test in a big way, the Fed has failed miserably.

But maybe the answer is more nuanced than that. Perhaps the Federal Reserve itself is simply a proximate cause. If you take the view that the actions of the Fed represent the consensus of the economics profession, then perhaps it is the economics profession who are the underlying cause.

In either case, it is clear that there should be hard rules in place that the Fed must abide by. At the same time, I think that the Fed should have maximum room to act independent of politics when it really needs to. Our current “dual mandate” provides nothing but an excuse for the Fed to shirk its duties. Thus, I believe that the Federal Reserve Charter should be rewritten to state that it is the Fed’s contractual duty to set an explicit nominal target, level targeting, and do everything in their power to hit that target. If you ask me I favor NGDP, but some people favor price level, and some favor inflation…if you really want to pin the Fed down, write which nominal target the Fed needs to hit into the charter. NGDP will still be here 100 years from now.

However, and this is important, that is the end of Congress’ power. Once they have arbitrated as to what the Fed needs to do, Congress gets out of the way and lets the Fed act. The only point at which Congress should have the authority to intervene is if the Fed is off-target, in which case Congress should have the power to remove the current board (or specific members) and appoint a new one. But, and this should be written into the charter as well, the only circumstances in which Congress can do so is if the Fed is missing its target (or criminal behavior, or other things that don’t have to do with monetary policymaking).

Separating politics from policymaking is definitely a good thing (I even came around on TARP), especially in monetary policymaking. However, having a monetary authority that is gallivanting around, allowing NGDP expectations to plummet 8% with zero recourse is unacceptable.

In a fairly textbook recession (adverse shock to aggregate demand), demand for money increases, while demand for everything else produced in the economy decreases. This raises the real value of money, producing the macroeconomic dislocations resulting from what is popularly known as “price stickiness”. This phenomenon is similarly true (perhaps even more-so) within the labor market. An increase in demand for money reduces the demand for labor, which increases the quantity (and thus average quality) of labor available.

Nick Rowe noticed this phenomenon in the popular small business survey chart that is running around the blogosphere. He then said that if he were more technically capable, he would produce a graph of “poor sales minus labor quality”. I was going to produce one for him, but luckily I found this in the report:

[Click Image to Enlarge]

There is such a stark inverse relationship between the two answers that a separate index is hardly necessary (although I took the liberty of coloring the chart myself). As you will notice, taxes are always a favorite, and since the start of the Great Moderation, interest rates have hardly been of concern — which one would expect from the smoothing of business cycles and increases in foreign exchange.

Karl has a post today arguing that Brian Wesbury is wrong for taking the view that fiscal stimulus is not effective (indeed harmful!) for two reasons: 1) that it pushes up interest rates through government borrowing (crowding out), and 2) people will expect future taxes to pay for the stimulus.

Unfortunately these are annoying arguments that get conservatives in a lot of trouble with smart commentators on the other side, and then tend to discredit their entire enterprise. Paul Krugman has made a cottage industry out of sniping these crude arguments from otherwise distinguished economists (see Robert Barro via flexible-price models).

However, while Googling Mr. Wesbury, I came across an article that I want to dredge up from February 2008. I want to do this not to point out that Wesbury has no credibility (like some commentators *ahem*), but to show how thinking in terms of interest rates screws people up, and how uncertainty is very dangerous to reputations. The title of the article is “Brian Wesbury Sees No Recession Ahead“.

Q: You say we are not in a recession and we are not even headed for one, right?

A (Wesbury): That is correct. Every single recession in the United States for the last 80 years has been preceded by a tight Federal Reserve policy — in other words, excessively high interest rates. And we clearly don’t have that today. Recessions are also preceded frequently by tax hikes or protectionism. So I would say that today we have very low interest rates, we have low tax rates, and we are not moving in a protectionist direction. As a result, those conditions that have led to recessions in the past don’t exist. One last point: I know of no point in history where we have ever scared ourselves into a recession. It just has never happened before and I don’t think it will happen this time, either.

This is a bombshell of a quote. My main point is that given the events that had happened up until then, saying that we won’t experience a terrible-horrible recession was not an unreasonable position to take. The problem is equating the setting of interest rates with the stance of monetary policy. I also know of no correlation between taxes and recession, and I’m sure he had in mind Smoot-Hawley when he was talking about protectionism…but that tariff was a drop in the bucket of what the actual problem was (then and today): falling NGDP.

By late 2008, in hindsight, Wesbury looks like a fool…but how would he have possibly known that the Fed would let NGDP fall at the fastest rate since 1938 later in the year? As a counterfactual, had the Fed kept up expectations that it would hit its 5% NGDP growth target, Wesbury’s statement wouldn’t look so bad today.

Arthur Laffer was (YouTube) famously in the same boat while talking with Peter Schiff, and of course made to look like a moron. My first piece of advice would be to not attempt to make public predictions. Since that is impossible, my second piece of advice would be to err on the side of caution when making predictions based on models (that is also true with NK multiplier models)…especially when facing strong headwinds.

P.S: I’m happy about the “Babble” tag.

There has been a lot of chatter around the blogosphere about Narayana Kocherlakota’s speech in Michigan last week, and seeing as I am trying to catch up on news, I think that is a good a place as any to start. First, here is the whole speech, so that you can read it if you would like.

The big focus, especially among left-leaning commentators, has of course been Kocherlakota’s comments on the unemployment situation. The only troubling thing to me about a monetary policymaking body discussing unemployment is the fact that it is happening at all. I don’t believe that there is anything “special” that monetary policy can do to alleviate unemployment — even in a booming economy. The capacity of monetary policy to act is to keep nominal GDP growing at a constant rate, year over year, and to tighten a little when it overshoots and loosen a little when it undershoots — such that the trend path of NGDP is a constant upward slope. I’m not an expert on the welfare-maximizing trend rate of NGDP…but people who are much smarter than me on average advocate 5% NGDP growth.

In any case, in the speech, Kocherlakota breaks down how Fed meetings operate, and then breaks down his “forecast speech” that he gave to the FOMC. Along those lines, he has three points: GDP (real), inflation, and unemployment. On those three points, he has this to say:

Typically, real GDP per person grows between 1.5 and 2 percent per year. If the economy had actually grown at that rate over the past two and a half years, we would have between 7 and 8.2 percent more output per person than we do right now. My forecast is such that we will not make up that 7-8.2 percent lost output anytime soon.


The Fed’s price stability mandate is generally interpreted as maintaining an inflation rate of 2 percent, and 1 percent inflation is often considered to be too low relative to this stricture. I expect it to remain at about this level during the rest of this year. However, our Minneapolis forecasting model predicts that it will rise back into the more desirable 1.5-2 percent range in 2011.[1]


Monetary stimulus has provided conditions so that manufacturing plants want to hire new workers. But the Fed does not have a means to transform construction workers into manufacturing workers. [...] Given the structural problems in the labor market, I do not expect unemployment to decline rapidly. My own prediction is that unemployment will remain above 8 percent into 2012.

[1]5yr TIPS spread is at 1.43, 10yr @ 1.55.

Now, not making up the lost employment is partially a function of his previous point about per capita GDP remaining under trend for an extended period of time. This is the cyclical component of unemployment. Cyclical unemployment is created due to the relationship of the economy to the cycle of time. As such, the level of cyclical unemployment correlates well with the business cycle, seasonal factors, etc. I believe that most of the unemployment we are currently experiencing is of cyclical nature.

I think the error in Kocherlakota’s thinking stems from this quote:

Monetary stimulus has provided conditions so that manufacturing plants want to hire new workers. But the Fed does not have a means to transform construction workers into manufacturing workers.

This is wildly baffling. Not only does Kocherlakota make the forecast above — i.e. we will not be hitting any of our targets (nominal or otherwise) any time soon — he also states that he believes that money has been easy. That implies that monetary policy has zero effect on the economy, any time. He also identifies that low rates for an extended period of time are a sign of monetary failure, but does so in a future-orientation. While it is true that low rates can (and do) accompany* a deflationary “trap”, the policy prescription that follows is not to raise short-term rates regardless of the composition of employment. The proper policy response in that situation is to set a positive nominal target, level targeting and commit to move heaven and earth to hit that target.

That, rather than his statements about unemployment, is what I view as Kocherlakota’s underlying problem.

*H/T to Andy Harless in the comments. Also, read his post about Kocherlakota’s statements.

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