Thursday, September 2, 2010

Economic Discontent as Noted by Michael Boskin

An op-ed piece in today's Wall Street Journal is of interest about the slowness of the recovery, but I think also fails in an important way. Michael Boskin argues that the recovery promised by the Obama administration has fallen short. It is hard to disagree with that. He then compares the GDP growth rate in the 4 quarters and 12 quarters after the trough of some past recessions--1975 and 1983. The growth rates were much higher in the previous two recessions than in this recession.

My concern is that not all recessions are alike and that the cause of a recession may be important in determining the pace of recovery. Both the 1975 and 1983 recessions were related to supply side issues such as rising oil prices, and a recent past of high inflation. The Fed tried to reduce inflation by raising interest rates. In the case of 1975, the Fed soon quit raising interest rates because of the recession while in the early 80s, the Fed held firm. Once inflation was reduced substantially and people recognized it, the economy was in a good position to grow rapidly.

The current recession has a different source. Fed policy was not tight; in fact it was probably too loose. Debt was the big problem. Consumers were spending beyond their means and running up debt. When housing collapsed and many households realized their wealth was not as great as they had thought, they reduced spending and worked on increasing savings and reducing debt. It takes time to do this and we cannot expect consumers to return to their old spending patterns in a short period of time. Further, as noted in Reinhart and Rogoff's book, This Time is Different, recessions that begin with financial crises tend to last longer. That is, the cause of the recession matters.

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