Unemployment and Depression--Posner

I am not bold enough to make forecasts about economic recovery, given the unusual economic situation that the country is in. The recovery may be fast or slow, shallow or steep, continuous or interrupted--and if fast and steep may set the stage for inflation and other economic troubles. So I am neither an optimist nor a pessimist. I am uncomfortable with the way in which modern economists discuss economic downturns. Before the 1930s depression, economic busts were called--"depressions." As far as one can judge from the incomplete nineteenth-century economic statistics, that depression was of unprecedented severity, and hence came to be called the "Great Depression." Which is fine. But thereafter, for reasons I can't fathom, economic busts, instead of being called "depressions" (though of course not "Great Depressions," because they were much less severe), came to be called "recessions." The current downturn, because it is the worst since the Great Depression, is now being called the "Great Recession." I find this lexical nitpicking distracting and unhelpful. Why not just say, we're in a depression, severe by postwar standards but mild compared to the Great Depression? I also question the convention that says that a depression (or recession, if one insists on retaining that word) ends when GDP growth resumes. Actually, that is not the official (National Bureau of Economic Research) position; its business-cycle committee looks at other factors as well, such as employment. It would be a nonsensical convention applied to the Great Depression; it would imply that the Great Depression ended in March 1933, when output and employment began to rise from their respective one-third and one-quarter decline from 1929. I would prefer to say that a depression ends either when economic output returns to its pre-depression level or, better, when it returns to the GDP trendline of average annual growth, which is about 3 percent in real terms. So this depression has not ended. This depression was never likely to be as severe as the Great Depression. One reason is the automatic stabilizers, such as unemployment benefits and other social-welfare programs, and progressive income tax. Another reason is changes in the composition of the workforce. Manufacturing and construction, two of the industries most likely to respond to a fall in demand by laying off workers, account for a much lower percentage of the U.S. workforce today than in the 1930s; and services (which had a low unemployment rate even in the Great Depression) account for a much higher percentage. In addition, there is federal deposit insurance, and a clearer understanding that in a depression the government should try to increase the money supply, and indeed should try to create at least a mild inflation. The Roosevelt Administration did both things as soon as it took office and they probably were responsible for the rapid improvement in the economy that began soon after his inauguration, though it was later interrupted by the economic dive in 1937 and 1938--what has been called the "second depression." Nevertheless this depression resembles the Great Depression in one respect that makes forecasting particularly chancy--it has been accompanied and made worse by a financial crisis. The normal depression comes about either from something that happens in the nonfinancial economy, such as a big increase in productivity which causes unemployment, or by the action of a nation's central bank in raising interest rates to stop or head off inflation. In both cases, as shown in research by Christina Romer and others, the depression can be effetively treated by the central bank's reducing interest rates, which stimulates economic activity by increasing lending. But we are in a depression in which interest rates are very low. Indeed, the Federal Reserve is maintaining the federal funds rate at just a shade over zero percent and has been for many months. There are other interest rates, and the effect of the federal funds rates on them is complex, but nevertheless there is nothing further the Fed can do, or at least that it wants to do (because it's beginning to worry about a future inflation), to lower interest rates, though credit remains very tight because the banks remain undercapitalized and demand for loans is weak because people and many businesses are overindebted. It's because monetary policy, though in combination with bailouts it has saved the banking industry from bankruptcy, cannot do anything to stimulate economic activity that we have the $787 billion stimulus program and other programs, such as the federal subsidies that are keeping GM and Chrysler in business. These programs may be responsible for the recent improvement in the economy, at least in part, though there is no good evidence. The consumer price index is lower than it was a year ago, which means we're in a deflation. It's a mild deflation, but any deflation increases the burden of debt, which in turn reduces personal consumption expenditures and investment. The unemployment rate is high and rising, and the underemployment rate, 16.8 percent in August, is very high. Housing prices remain very low, which increases indebtedness because a house is the principal asset of most people, and mortgage debt obviously does not fall when the value of the mortgaged property falls. The fall in housing prices, by wiping out the housing equity of milliions of people, exacerbates unemployment by making it more difficult for the unemployed to seek jobs in different parts of the country--they can't afford the down payment on a house if their existing house is worth less than the unpaid balance of their mortgage. Another factor retarding recovery is the reluctance of older workers to retire, because their retirement savings are impaired. Employers are reluctant to lay them off for fear of being accused of age discrimination, which is illegal. With fewer workers exiting the work force, there is less room for the thousands of people who each day are looking for a job. There are factors pushing in the opposite direction--toward a rapid recovery. As manufacturers work off their inventories, production restarts; as people's incomes fall, they divert more income to consumption and less to savings; when their incomes fall really far, they start spending their existing savings; and as durables wear out, the demand for durables increases. (It's the fact that the purchase of durable goods is postponable that leads to such drastic falls in manufacturing in a depression, compared to services.) And as economic conditions improve in other countries, U.S. exports will rise, which will stimulate U.S. output. I don't know how these factors balance out, and I suspect no one knows. After the economists and the businessmen alike were caught by surprise by the housing and credit bubbles and ensuing financial crisis, all macroeconomic forecasts should be treated with a measure of skepticism.

Comments

[Anonymous]

Judge Posner, I think you have the better take here. This was never a manufacturing-driven bust, hence the reason applying output/productivity analysis is unhelpful. It is, as you stated, a bust cycle, caused by a speculative bubble spurred on by what Greenspan termed "financial innovations" back in 2002. Bubbles cause misallocations of resources and so distort the economic landscape.

Illusory wealth measured in the trillions of USD vaporized almost literally in an instant last fall. Out of control leveraging, notably in the hundreds of trillions in notional value circulated by the large banks, has left a giant crater that global GDP growth will not fill in a true sense in the near term. A major culprit -- still unaddressed, and perhaps owing to a powerful oligarchical hold over government -- is the "too big to fail" dynamic. The ability of financial institutions to generate bubbles has to be reined in.

[Anonymous]

I agree with you. In fact, I think that Prof. Becker agrees with us about QE. It seems to me that your views are a version of the Chicago Plan of 1933, which is what I supported and still do. QE with a reinforcing stimulus.

I thought, following Fisher and Simons, that a Debt-Deflationary Spiral causes massive financial downturns. After reading them, you wouldn't want such an event under any circumstances. In fact, I think that Hayek and Robbins came to later acknowledge the destructive power of deflation.

Having avoided it, barely, we're too busy patting ourselves on the back. Chairman Bernanke gave a talk on deflation in 2002. Anyone who follows Fisher and Simons would do anything to avoid a spiral. And yet we almost had one. Now people are already making light of it. The real question is: How did we come so close? Yikes!

I know that a lot of people now have theories about how we could have avoided this nightmare, and that's fine. A few of them might even prove useful. But the fact that we've had QE with a Stimulus seems to have worked, whatever the mix. I'm not sure what would count for evidence of this if our current economic history doesn't. It reminds me of this quote from Wittgenstein:

"At the end of reasons comes persuasion."

[Anonymous]

The above post was from Don the libertarian Democrat

[Anonymous]

Judge, I believe it's reasonable to posit that the behavior of people who largely perform responsibly as individuals will be mirrored when they don their corporate suits. Individuals are keeping the purse strings tied. There's an abundance, even a surplus, of critical commodities like food grains, ores, plastics, lumber, and finished products. Ergo underutilized capacity and price competition among producers and distributors. But it's horrible for the income prospects of the unemployed and underemployed. Companies are doing the same thing at the plant, shop, or office that company managers who still have a job do when they get home. They take on more work themselves. They improve efficiencies. They get fewer haircuts and hire less yard work. They defer projects that would cost money. Nobody wants to get caught holding the bag again. In 1933 or '34 FDR famously proclaimed, "All we have to fear is fear itself." But the Depression dragged on until WW II broke out in Europe and the U.S. cranked up to prepare for what lay ahead. We're a much different society and economy now than then, but severely wounded public confidence still heals at a glacial pace. We'll see occasional fits and starts but we'd better get used to practicing patience.

Brian Davis
Austin, TX

[Anonymous]

Judge Posner:

You have many interesting things to say about this economic contraction. Like many, I look forward to your comments for balance, clarity, and perspective.

But, with all due respect, I think you are running the insistence upon "depression," rather than "recession," as the only appropriate description of our condition, into the ground. Yes, you are right that "recession" represents a triumph of euphemism over clarity. But public confidence is an important part of what is required to recover from an economic contraction, whatever it is called. And "depression," for perfectly understandable reasons, is a scary term. Economists and journalists who avoid it are merely exercising elementary prudence.

So cut them some slack.

[Anonymous]

Also possibly hindering the recovery I'd say is the massive state budget crisis, as their tax revenues are WAY off, and likely to stay that way for quite some time. Also the whole health care social security medicare medicaid mess, which one hopes the current reform will fix, but it seems increasingly improbable that anything currently "on the table" will even meaningfully address it. The government's being able to eventually square expenditures with revenue and prevent the national debt from going into a positive feedback loop until something breaks is what I'm questioning. Ya, ok, the government spent billions and promised trillions, and that solved the liquidity crisis mostly for now. That's great, but if I may compare the economy to an engine, and the financial system as the oil system, with cash as engine oil lubricating exchanges, then the liquidity crisis was a loss in oil pressure threatening to cause catastrophic failure in fairly short order. The government solved the issue by dumping in a bunch more oil, we got minimal pressure back but unless it addresses the fact that it appears the system is hemorrhaging oil, which is what caused the loss of pressure in the first place, it's committed to a path that seems to me CLEARLY unsustainable.
Do you have any idea what happens if the government borrows too much money? Can it? Where is that point? I don't know, but we seem on course to find out.

[Anonymous]

A very good read. Thank you...!

So much talk about the FED's exit plan. What is the KEYNESIAN's exit plan...? You guessed it... higher taxes...!

The FED will battle the KEYNESIANS (Democrats...) to see who gets to exit first. The problem is that both MUST exit once recovery takes hold, and that will be very tricky.

I agree with Pos, we are all guessing and nobody knows the future here. I just have a hard time believing policy makers pull this magic trick off without serious bumps. It is either stagflation (higher taxes and loose monetary) or double dip depression.

[Anonymous]

...And stagflation is better than a double-dip depression and further deflation. HIgher taxes are definitely coming. The FED will not be able to exit, and they'll accommodate too much and for too long to overcompensate for higher taxation on top of all the other problems, mainly credit.

Loose monetary policy and higher taxes will produce stagflation.

[Anonymous]

I'm a bit confused by the second-to-the last paragraph in Posner's post. He seems to imply that people spending the last of their savings is a good thing and will help spur economic recovery. The fly in the ointment is that the unemployed will be accepting much lower paying positions and will not be able to rebuild a comfortable savings cushion before the next bubble bursts, similar to what happened to tech workers after the circa 2000 dot-com bust. At some point, I figure a critical mass of people will run out of savings, which will delay recovery for a much longer period of time.

[Anonymous]

There are factors pushing in the opposite direction--toward a rapid recovery. As manufacturers work off their inventories, production restarts; as people's incomes fall, they divert more income to consumption and less to savings; when their incomes fall really far, they start spending their existing savings; and as durables wear out, the demand for durables increases.

Agree with the previous comment that this paragraph misses the mark. Judge, what you're missing is the already over-leveraged condition of U.S. households. The easy-money credit market is not something to be continued, but something to be dismantled. Liberal lending standards were a major contributor to the mess in the first place. Much of consumption was financed by plastic or by HELOC. Thus the credit bubble.

Secondly, inventory management is far more sophisticated today than in decades past. Government subsidies through cash 4 clunkers and the home-buyer tax credit have been rather successful helping to move auto and home inventory. But in most kinds of manufacturing today we no longer see major inventory stockpiling.

This was emphatically NOT a classic manufacturing/excess capacity-driven recession/depression and inventory is not going to pull us out. We're in for a prolonged period of low -- and very possibly occasional negative -- growth as deleveraging continues for years to come.

[Anonymous]

Dear Judge Posner:

Thank you for this well-written and thoughtful article.

You have made the subject comprehensible even to those of us who do not have advanced degrees in economics. And I certainly agree that today's semantics (the "Great Recession")obscure more than they clarify.

Sincerely,

Philip J. Loree Jr.

[Anonymous]

Affordable housing is good. No?

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