Robert J. GordonRobert J. Gordon

Northwestern University and NBERNorthwestern University and NBER

CIRET Conference, New York CityCIRET Conference, New York City

October 14, 2010October 14, 2010

Controversial Issues About Controversial Issues About the Recession and the Recession and

RecoveryRecovery

The Plan: From Long-Run to Short-Run to

Policy The reasoning behind my pessimistic long-

term US growth forecast, recently summarized in Business Week

Graphs on dimensions of the weak labor market. The labor market is in worse condition than the product market.

New research on the “Demise of Okun’s Law” and the near-term division of output growth between productivity, hours, and employment growth– Why is the labor market in such bad shape compared

to the product market? The policy debate: what more can monetary

and fiscal policy do?

The Pessimistic Long-run Conclusion

Comparing 2007-2027 forecasts with 1987-2007 actual:

Output growth will slow from 2.9 to 2.4 Output per capita growth will slow

from 1.74 to 1.4 That is the slowest growth of income

per capita “since George Washington” Compare to 2.16 1929-2007 or 2.02

1891-2007

Growth in MFP vs. Ypc by Time Interval, 1891-2027

Growth in MFP and Real GDP per capita, selected intervals, 1891-2027

0

0.5

1

1.5

2

2.5

3

1891-1928 1928-1950 1950-1972 1972-1987 1987-2007 2007-2027

Pe

rce

nt

pe

r Y

ea

r

MFP

GDP/Pop

Components of Growth in Y/H, 1987-2007 vs. 2007-27

Components of Growth of Labor Productivity, Two Intervals

0

0.5

1

1.5

2

2.5

Output/Hour Capital Deepening Labor Quality MFP

Pe

rce

nt

pe

r Y

ea

r

1987-2007

2007-2027

From Y/H to Y/N, the Role of Falling LFPR

Components of Output Growth, Two Intervals

0

0.5

1

1.5

2

2.5

3

3.5

Output Output/Hour Output/Person Hours Population

Pe

rce

nt

pe

r Y

ea

r

1987-2007

2007-2027

Possible Further Room for Pessimism

These projections are based on the historical record of growth between years of “normal” utilization (1987, 2007)

No allowance here for long-run “tainting” effects of the current abysmal economy– Loss of skills and human capital– Years of low investment will increase the age of

the capital stock and reduce the growth of both capital quantity and capital quality

Policy Prescriptions for Long-Run Growth

Problem Slowdown reflects aging of population

and stagnation of educational attainment Solve the first by immigration,

particularly of high-skilled people Work on the second by better

government-run student loan programs and direct measures to address the rising relative price of college education (“higher education cost disease”)

Stimulate demand to avert long-run supply sclerosis

Next We’ll Look at Graphs of Raw Numbers

for Current US Labor Market

Now We’re Looking at– Magnitudes: How Severe Is This Episode?– Timing: Do Labor Market Indicators Change

at the Same Time as Output (Real GDP)?– Which Measures Are the Most Different from

1980-82? We Consider 1980-82 as a Single

Recession and also as two back-to-back recessions– (Jan-July 1980 and Jul 81 to Nov 82)

Output Gap vs. Gap in Output Gap vs. Gap in Aggregate Hours of Aggregate Hours of WorkWork

Conclusion to this point

Comparing the 9.6 level of U rate now to 10.8 in Nov & Dec 1982 is misleading– U rate in July 81 or even Jan 80 started higher– Overall increase in 2007-09 is greater– Much more incidence this time of long-term

unemployment and forced part-time The emergence of long-term unemployment:

is the US becoming more like Europe’s two decades 1985-2005?

Stylized fact: If the empl/pop ratio was the same today as in 2000, there would be 14 million more jobs (9 million from lower unemployment rate, 5 million from higher LFPR) “New Normal” for LFPR? For U Rate?

Documenting and Explaining the Change in

Cyclical Labor-market Behavior

Documenting– A new approach to disentangling trends and

cycles Use of “outside information” from inflation

equation to determine the unemployment rate gap

– A new approach to data Total Economy not NFPB Sector Conventional vs. Unconventional Measures

– Initial finding as reported before: hours gap > output gap in 2008-09, the reverse of 1980-82

The Output Identity: Simple The Output Identity: Simple Version and Conventional Version and Conventional

VersionVersion

NN

L

L

E

E

H

H

YY

NN

L

L

E

E

E

E

H

H

YY

H

H

P

P

P

P

PP

Conventional Compared to Conventional Compared to Unconventional IdentityUnconventional Identity

NN

L

L

E

E

E

E

H

H

YY

H

H

P

P

P

P

PP

NN

L

L

E

E

H

H

YY

H

H

H

H

II

Kalman Trends, Conv vs. Unconv Output

Aggregate Hours

Total Economy Labor Productivity (Y/H)

Output Gap vs. Gap in Output Gap vs. Gap in Aggregate Hours of WorkAggregate Hours of Work

Close-up for Period since 1986

Regression Analysis

Changes in hours gap regressed on– Own lags– Current and lagged changes in output gap– Error-correction term (lagged level of

hours gap)– “End of expansion” dummy variables

(capture overhiring end of expansion, underhiring beginning of recovery)“Early recovery productivity bubble”

Long-run Coefficients: The “Demise of Okun’s Law”

Explanations Offered in My Research

The “Disposable Worker” Hypothesis Similar sources as rising US inequality Increased market power of managers and

highly paid professionals– Increased share of executive incomes coming

from stock options Reduced market power of workers due to:

– Declining unions, declining real minimum wage, low-skilled immigration, and imports

Implications for the Unemployment Rate

Translate forecast growth in hours into the hours gap

Regression coefficients imply roughly 60% of an improvement in hours gap flows into employment rate gap

Optimistic path, output gap shrinks 0.8 points per year (3.3 vs. 2.5)

Pessimistic path, output gap stays where it is forever (2.5 percent growth forever)

Implied Unemployment Paths

Unemployment Rate: Actual and ProjectedOptimistic and Pessimistic Outlooks

0.00%

2.00%

4.00%

6.00%

8.00%

10.00%

12.00%

1986 1992 1998 2004 2010 2016

Year

Optimistic Projection

Pessimistic Projection

Actual

Reasons This May BeToo Optimistic

Why does pessimistic U Rate decline even though output gap is fixed?– Error-correction term implies mean reversion both of

negative hours gap and positive productivity gap Division of predict real GDP growth between

productivity and hours: mean reversion may be delayed– Much publicized “reluctance to hire”– Matched with “reluctance to invest”– Firms are not expecting the 3.3 growth scenario

If the 3.3 growth rate actually happened, short-term outcome would be more productivity growth and less hours and employment growth

But will that output scenario happen?

Reasons To Be Skeptical of Optimistic

Scenario Reinhart-Rogoff. Recoveries after

financial crises are slower than after garden-variety recessions

Ineffectiveness of monetary policy

Political paralysis just as Obama stimulus is about to be withdrawn

The Fed is Out of Ammunition

Textbook IS-LM model still taught in intermediate undergrad macro

Monetary policy is ineffective if:– Horizontal LM curve– Vertical IS curve

The Fed now is plagued by both Why should QE2 work since QE1

didn’t?

The Fed Can’t Control the Cost of Business Borrowing

Fundamental Causes of Weak Recovery (Vertical

IS) Consumption

– Collapse of Household Net Worth– Record-high indebtedness

Residential Construction– Foreclosures and Under-water Mortgages– People walk away from under-water– Their credit is tainted for years– Their houses add to supply but not to demand– My mortgage broker’s story, 3 vs. 80

Consumption Problem:Household Balance

SheetThe Twin Peaks of Household Net Worth

400

450

500

550

600

650

700

750

800

Per

cen

tage

of

Dis

po

sab

le P

erso

nal

Inco

me

Total Assets

Total Liabilities

Net Worth

Sources : Federal Reserve Board Flow of Funds Accounts and Bureau of Economic Analysis NIPA Tables . Details in Appendix C-4.

-150

-100

-50

0

50

100

1970 1975 1980 1985 1990 1995 2000 2005 2010

Housing Starts Used to be a Leading Indicator,

but Not Any MoreQuarterly Housing Starts, 1970-2010

0

500

1000

1500

2000

2500

1970 1975 1980 1985 1990 1995 2000 2005 2010

Qu

arte

rly

Ho

usi

ng

Star

ts (

tho

usa

nd

s)

U.S. Census Bureau Manufacturing, Mining and Construction Statistics

Where is Fiscal Policy?

Krugman NYT Monday: it wasn’t tried.

Look at government employment excluding census workers

The Obama stimulus was too small and too much was wasted on tax cuts and capital-intensive infrastructure spending

What Ended the Great Depression?Chart Extends 1929-41 Quarterly

0

5

10

15

20

25

30

1929 1931 1933 1935 1937 1939 1941

Spen

ding/

GDP R

atio

State and Local Spending/GDP

Transfer Payments/GDP

Federal Spending/GDP

How Does the Obama Stimulus Measure Up?

0

5

10

15

20

25

30

1980 1985 1990 1995 2000 2005 2010

Spen

ding/

GDP R

atio

Federal Spending/GDP

State and Local Spending/GDP

Transfer Payments/GDP

The Current Debate,What About Inside vs.

Outside Govt Debt? Monetary Policy is parralized but still

can support fiscal expansion A fiscal stimulus does not raise outside

debt (“held by the public”) if the Fed buys the bonds

This is the classic Milton Friedman “heliocopter drop” of money

In today’s terminology, QE2 supports a fiscal stimulus

But where is the political will?

Conclusions

A Real GDP path of 3.3 brings the U rate down to 6 percent by early 2014

Reasons this may be too optimistic Pessimistic path leaves U rate at 8 percent in

2016, Europe déjà vu 1985-2005 Model has mean-reversion built in, underhiring

in 2009-10 will be reversed, productivity bubble will be reversed.

Basic problems: Reinhart-Rogoff, ineffective monetary policy, lack of political will on fiscal policy, about to become much worse after the elections