IS RECESSION NECESSARY?
THE FOLLOWING WAS DELIVERED AS A COMMENTARY OVER WAMC RADIO IN EARLY JANUARY OF 2008 BY MICHAEL MEEROPOL
Two days after my last commentary, the New York Times asked six economists about the upcoming recession. One of them, James Grant, asserted that recessions serve a useful purpose:
"They allow the sorting out of boom time error. They permit - indeed, force - the repricing of inflated assets. In a downturn, previously overpriced businesses, houses and buildings are made affordable again." 1
In other words, a recession "corrects" for mistakes made during the previous boom. Grant argued that policy-makers have gotten so good at responding vigorously to recessions, that the correction process gets aborted. Recessions are too short and too shallow.
The result, he laments, is that when, "… a new upcycle does begin, … it's slow off the mark. The world's top economy seems curiously sluggish. And the economists and politicians ask, 'What happened to America's dynamic economy?'"
In Grant's view, the failure to have a real rip-roaring recession such as our economy last experienced in 1981 and 1982, sets the stage for sluggish growth, reduced competitiveness and, in the long run, harm to the economy.
This is an inconvenient view. When students learn Principles of Economics, they are usually taught that the two problems our economy must confront are inflation and unemployment. There is a law on the books called the Employment Act which dates back to 1946 with a significant amendment in 1978. The amended law enjoins the government keep the unemployment rate at 4% or lower while making sure inflation never gets above 3%. 2
The Federal Reserve (our Central Bank) has mostly ignored that unemployment goal in its effort to achieve price stability while stating they also have a goal that the economy will grow "fast enough." In its publications, the FED concedes that pursuit of price stability may require short term slowdowns in growth which justifies them ignoring that 4% goal. 3
So here is the contradiction: while the official goal of US policymakers is to maximize employment and growth, the desire to contain inflation means that that goal has been honored in the breach. To put it bluntly, policy-makers implicitly agree with Grant that recessions are necessary every so often to contain inflation - while refusing to admit it.
This contradiction is not the result of stupidity or dishonesty - it is our economic system - American style free-market mixed capitalism -- with all its successes since the 19th century in terms of economic growth, technological change, economic opportunity, that is a system of contradictions..
To have the good (economic growth) some people must suffer the bad (periodic recessions - where they lose their jobs, businesses, homes, etc.). Since World War II, policies that reduced the length and severity of recessions have also reduced the chances for explosive growth. Between 1945 and the early 1970s, we in the United States thought we could have both explosive growth and short shallow recessions. Since then, even though we've had a couple of rather nasty recessions, the rate of growth has significantly slowed (with a short exception between 1996 and 2000). 4 Worse, the growth in income has been seriously skewed to a very small percentage of the population so that the vast majority of the people have benefited very little from it.
This is very significant. From 1973 to 2005 the 80 per cent of US workers in non-supervisory jobs saw a real hourly wage increase of 2% -- that's over 32 years. Meanwhile, productivity went up 75%. The benefits from that went to the richest Americans. 5
If you don't like this set of alternative choices, -- either periodic depressions as bad as 1981-82 or the sluggish growth since 1975 - and those ARE the two choices --- then you probably don't like US style capitalism - even if you think you do. 6
Footnotes:
1 For Grant's complete op-ed, see http://www.nytimes.com/2007/12/16/opinion/16grant.html?_r=1&oref=slogin. That entire OP-ED page set of articles is quite interesting. It is from the December 16, 2007 edition and available on line at http://www.nytimes.com/2007/12/16/opinion/16recession.html?ref=opinion. The other articles are: You Can Almost Hear It Pop, by Stephen S. Roach, The Facts Say No, by Marcelle Chauvet and Kevin Hassett, Bet the House on It, by Laura Tyson, Not if Exports Save Us, by Jason Furman, and Wait Till Next Year, by Martin Feldstein
2The Full Employment and Balanced Growth Act is Pub.L. 95-523. It was signed into law on October 27, 1978. The relevant passages specifying the goals to be achieved between 1978 and 1983 are as follows:
(b) Interim numerical goals for initial Economic Reports The medium-term goals in the first three Economic Reports and, subject to the provisions of subsection (d) of this section, in each Economic Report thereafter shall include (as part of the five-year goals in each Economic Report) interim numerical goals for- (1) reducing the rate of unemployment, as set forth pursuant to section 1022 (d) of this title, to not more than 3 per centum among individuals aged twenty and over and 4 per centum among individuals aged sixteen and over within a period not extending beyond the fifth calendar year after the first such Economic Report;
(2) reducing the rate of inflation, as set forth pursuant to section 1022 (e) of this title, to not more than 3 per centum within a period not extending beyond the fifth calendar year after the first such Economic Report: Provided, That policies and programs for reducing the rate of inflation shall be designed so as not to impede achievement of the goals and timetables specified in clause (1) of this subsection for the reduction of unemployment; See http://www4.law.cornell.edu/uscode/uscode15/usc_sec_15_00001022---a000-.html
To find these sections, you will need to go to the THIRD screen once you click on this link.
3 See, for example a staff report for the Federal Reserve Bank of New York which attempts to measure the so-called "sacrifice ratio" - the output lost due to constraining the economy with monetary policy aimed at reducing inflation. The authors note: "It is generally agreed that permanently low levels of inflation create long run benefits for society, increasing the level and possibly the trend growth rate of real output. There is also a strong belief that engineering inflation reductions involve short-term costs associated with a corresponding loss in output." "Structural Estimates of the US Sacrifice Ratio," Stephen Cecchetti and Robert Rich, Federal Reserve Bank of New York, March 15, 1999 (http://www.newyorkfed.org/research/staff_reports/sr71.pdf): 1
4 The National Bureau of Economic Research identifies the "turning points" of business cycles - the peaks tell us when an expansion ends and a recession begins - the troughs tell us when an expansion ends and a recession begins. See http://www.nber.org/cycles/cyclesmain.html. For rates of growth of GDP (in nominal and in real terms) see http://www.bea.gov/national/index.htm#gdp (on the first screen click on "percent change from preceding period." From 1945 to 1973, real GDP growth averaged 3.33% per year. From 1973 to 2006 that average fell to 2.8% per year. (The average for 1946 to 1973 is much higher because the year 1946 saw so much inflation that real GDP actually fell 11%. The 1946 to 73 average is 3.49% per year.) 5 These numbers all come from the Bureau of Labor Statistics. I found them on an article entitled Our Subprime Economy by Richard D. Wolff of the University of Massachusetts Economics Department. If anyone wants an electronic copy, just write me at mameerop@wnec.edu.
6 I am not trying to be flip here. One of the major aspects of growth in a market economy (a capitalist economy) is that it happens over a boom and bust cycle. The late David M. Gordon penned an article in the New York Times Magazine entitled, "Recession is Capitalism as Usual" on April 27, 1975 which spells out the argument completely. The argument being made in my commentary, following the Grant piece in the New York Times is that the suppression of the role of recessions has a potentially negative feedback onto the rate of growth of the economy as a whole. This point is developed quite forcefully in Michael Perelman's book The Pathology of the US Economy Revisited which was published in paperback in 2002.
Two days after my last commentary, the New York Times asked six economists about the upcoming recession. One of them, James Grant, asserted that recessions serve a useful purpose:
"They allow the sorting out of boom time error. They permit - indeed, force - the repricing of inflated assets. In a downturn, previously overpriced businesses, houses and buildings are made affordable again." 1
In other words, a recession "corrects" for mistakes made during the previous boom. Grant argued that policy-makers have gotten so good at responding vigorously to recessions, that the correction process gets aborted. Recessions are too short and too shallow.
The result, he laments, is that when, "… a new upcycle does begin, … it's slow off the mark. The world's top economy seems curiously sluggish. And the economists and politicians ask, 'What happened to America's dynamic economy?'"
In Grant's view, the failure to have a real rip-roaring recession such as our economy last experienced in 1981 and 1982, sets the stage for sluggish growth, reduced competitiveness and, in the long run, harm to the economy.
This is an inconvenient view. When students learn Principles of Economics, they are usually taught that the two problems our economy must confront are inflation and unemployment. There is a law on the books called the Employment Act which dates back to 1946 with a significant amendment in 1978. The amended law enjoins the government keep the unemployment rate at 4% or lower while making sure inflation never gets above 3%. 2
The Federal Reserve (our Central Bank) has mostly ignored that unemployment goal in its effort to achieve price stability while stating they also have a goal that the economy will grow "fast enough." In its publications, the FED concedes that pursuit of price stability may require short term slowdowns in growth which justifies them ignoring that 4% goal. 3
So here is the contradiction: while the official goal of US policymakers is to maximize employment and growth, the desire to contain inflation means that that goal has been honored in the breach. To put it bluntly, policy-makers implicitly agree with Grant that recessions are necessary every so often to contain inflation - while refusing to admit it.
This contradiction is not the result of stupidity or dishonesty - it is our economic system - American style free-market mixed capitalism -- with all its successes since the 19th century in terms of economic growth, technological change, economic opportunity, that is a system of contradictions..
To have the good (economic growth) some people must suffer the bad (periodic recessions - where they lose their jobs, businesses, homes, etc.). Since World War II, policies that reduced the length and severity of recessions have also reduced the chances for explosive growth. Between 1945 and the early 1970s, we in the United States thought we could have both explosive growth and short shallow recessions. Since then, even though we've had a couple of rather nasty recessions, the rate of growth has significantly slowed (with a short exception between 1996 and 2000). 4 Worse, the growth in income has been seriously skewed to a very small percentage of the population so that the vast majority of the people have benefited very little from it.
This is very significant. From 1973 to 2005 the 80 per cent of US workers in non-supervisory jobs saw a real hourly wage increase of 2% -- that's over 32 years. Meanwhile, productivity went up 75%. The benefits from that went to the richest Americans. 5
If you don't like this set of alternative choices, -- either periodic depressions as bad as 1981-82 or the sluggish growth since 1975 - and those ARE the two choices --- then you probably don't like US style capitalism - even if you think you do. 6
Footnotes:
1 For Grant's complete op-ed, see http://www.nytimes.com/2007/12/16/opinion/16grant.html?_r=1&oref=slogin. That entire OP-ED page set of articles is quite interesting. It is from the December 16, 2007 edition and available on line at http://www.nytimes.com/2007/12/16/opinion/16recession.html?ref=opinion. The other articles are: You Can Almost Hear It Pop, by Stephen S. Roach, The Facts Say No, by Marcelle Chauvet and Kevin Hassett, Bet the House on It, by Laura Tyson, Not if Exports Save Us, by Jason Furman, and Wait Till Next Year, by Martin Feldstein
2The Full Employment and Balanced Growth Act is Pub.L. 95-523. It was signed into law on October 27, 1978. The relevant passages specifying the goals to be achieved between 1978 and 1983 are as follows:
(b) Interim numerical goals for initial Economic Reports The medium-term goals in the first three Economic Reports and, subject to the provisions of subsection (d) of this section, in each Economic Report thereafter shall include (as part of the five-year goals in each Economic Report) interim numerical goals for- (1) reducing the rate of unemployment, as set forth pursuant to section 1022 (d) of this title, to not more than 3 per centum among individuals aged twenty and over and 4 per centum among individuals aged sixteen and over within a period not extending beyond the fifth calendar year after the first such Economic Report;
(2) reducing the rate of inflation, as set forth pursuant to section 1022 (e) of this title, to not more than 3 per centum within a period not extending beyond the fifth calendar year after the first such Economic Report: Provided, That policies and programs for reducing the rate of inflation shall be designed so as not to impede achievement of the goals and timetables specified in clause (1) of this subsection for the reduction of unemployment; See http://www4.law.cornell.edu/uscode/uscode15/usc_sec_15_00001022---a000-.html
To find these sections, you will need to go to the THIRD screen once you click on this link.
3 See, for example a staff report for the Federal Reserve Bank of New York which attempts to measure the so-called "sacrifice ratio" - the output lost due to constraining the economy with monetary policy aimed at reducing inflation. The authors note: "It is generally agreed that permanently low levels of inflation create long run benefits for society, increasing the level and possibly the trend growth rate of real output. There is also a strong belief that engineering inflation reductions involve short-term costs associated with a corresponding loss in output." "Structural Estimates of the US Sacrifice Ratio," Stephen Cecchetti and Robert Rich, Federal Reserve Bank of New York, March 15, 1999 (http://www.newyorkfed.org/research/staff_reports/sr71.pdf): 1
4 The National Bureau of Economic Research identifies the "turning points" of business cycles - the peaks tell us when an expansion ends and a recession begins - the troughs tell us when an expansion ends and a recession begins. See http://www.nber.org/cycles/cyclesmain.html. For rates of growth of GDP (in nominal and in real terms) see http://www.bea.gov/national/index.htm#gdp (on the first screen click on "percent change from preceding period." From 1945 to 1973, real GDP growth averaged 3.33% per year. From 1973 to 2006 that average fell to 2.8% per year. (The average for 1946 to 1973 is much higher because the year 1946 saw so much inflation that real GDP actually fell 11%. The 1946 to 73 average is 3.49% per year.) 5 These numbers all come from the Bureau of Labor Statistics. I found them on an article entitled Our Subprime Economy by Richard D. Wolff of the University of Massachusetts Economics Department. If anyone wants an electronic copy, just write me at mameerop@wnec.edu.
6 I am not trying to be flip here. One of the major aspects of growth in a market economy (a capitalist economy) is that it happens over a boom and bust cycle. The late David M. Gordon penned an article in the New York Times Magazine entitled, "Recession is Capitalism as Usual" on April 27, 1975 which spells out the argument completely. The argument being made in my commentary, following the Grant piece in the New York Times is that the suppression of the role of recessions has a potentially negative feedback onto the rate of growth of the economy as a whole. This point is developed quite forcefully in Michael Perelman's book The Pathology of the US Economy Revisited which was published in paperback in 2002.
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