William J. Polley

I worry much more about slipping into a stagnation scenario-- note I said stagnation not stagflation.

A recession is a normal part of the business cycle -- or it least it use to be -- that contains the seeds of the next recovery and it is largely a self correcting mechanism, except for 1929-33.

But quarter after quarter of sub-par growth is another animal -- something we have never really experienced. Even though stagflation was frequently forecast back in the 1970s it never actually happened. We have had two examples of soft-landings, 1967 and the mid-1990s. In the 1967 example guns and butter ended it and set the stage for the inflation of the 1970s. In the mid-1990s it was ended by the capital spending boom triggered by falling cost of high technology
and rapid advances in the personal computer and communication.

So if we slip into another period of sub-par growth-- and we just experienced a year of under 2% real gdp growth -- how do we get out of it?

As I pointed out in a previous post, the volatility of GDP seems to have diminished greatly after the mid-1980s.

http://www.williampolley.com/blog/archives/2005/11/real_gdp_growth.html

Expansions have been longer and without the extremely high peaks. Recessions have been tame to the point of being more of a prolonged slowing as was the case in 2001 (through 2003 if you count the really slow labor market recovery).

I think the safest thing to say is that the next recession, whenever it arrives will look more like the 2001 recession than anything prior. To me, that means we (the profession) needs to figure out a way to communicate what a recession is in the world we live in today. It's not the '60s, and it's not the '70s. It's not even the '80s.

A low and stable inflation environment should contribute to more stable GDP growth as well. The declining volatility of GDP growth seems to coincide with the end of the Great Inflation. That may be more than coincidence.

Would it be better to have a full-blown, old-fashioned, two quarters of negative GDP growth style recession or a couple of years of positive, but less than 2% (or even less than 1%) growth? That may be more than an academic question.

spencer: I think that 1929-1933 might be a unique case - if nothing else for the unique convergence of really bad policies on the part of the Hoover administration combined with extraordinary uncertainty of what his successor FDR would do that really exacerbated the situation.

Bill: I have to agree that the classic definition of a recession might not apply - I'd be somewhat partial to a scale like David Tufte uses ( http://voluntaryxchange.typepad.com/voluntaryxchange/2005/07/grading_gdp.html ) - and to be clear, the version without grade inflation - but modified to use a rolling-average GPA over several different periods.

The Fed also failed us during the Great Depression.

I like the idea of Tufte's scale, but I have one problem with it that perhaps your modification or something like it could address. On his scale, growth at potential GDP (average over time) is a C+/B-. Now suppose we could continue that for 2 or 3 years. That's a long string of C's (or B's). That's not going to make the Dean's list. But it would almost surely be consistent with low inflation, and I, for one, would take it gladly. Unless we get a productivity miracle, I wouldn't want to get straight A's on his scale.

I made this point to David way back when. I think he understands my point, and I agree that it's a minor quibble with an otherwise good scheme.

But ultimately, putting this sort of grading scale on GDP makes for some strange interpretations. How would the Fed respond to a couple of "A" grades on this scale? Raise interest rates to head off any incipient inflation. Implication: The economy is running a little hot. Need to cool it down (and get a lower grade). That's not how my students view grades.

A rolling-average would take care of some of that problem. I'd make one component of the grade essentially Tufte's scale. But there would be another component that would give credit for movement of the growth rate (i.e. the 2nd derivative) back toward potential from either direction. Still another component would penalize for deviations from potential over the last several periods (with more weight given to the recent past).

That might get closer to a grading scale that would be useful at communicating the policymaker's dream of a "Goldilocks" economy--not too hot and not too cold.

Ironman-- are you the individual that does the political calculations blog? If so I want to complement you on the thing you did on the minimum wage and profits.

To anyone who looks at the data it is obvious that a minimum wage is a transfer of income from small business owners to minimum wage workers. Why most economist continue to use the ludicrous argument that a rise in the minimum wage hurts minimum wage workers is beyond me.

Bill: You're points are well taken. Thinking about it further, and picking up on your running hot and cooling down metaphors - it wouldn't be that difficult to set the scale up as a temperature gauge. Something along the lines of what Steve Conover over at the Skeptical Optimist did with his international debt thermometer:

http://www.optimist123.com/optimist/2007/06/international_d.html

spencer: That would be me. Thank you for your kind words!

Economists that focus on the rising minimum wage hurts minimum wage workers are really emphasizing
the unintended consequences of raising the minimum wage. The truth is that there are trade-offs involved - both at the individual business level:

http://politicalcalculations.blogspot.com/2006/10/minimum-wage-and-small-business.html

and nationally:

http://politicalcalculations.blogspot.com/2007/01/presidential-pretensions.html

For public policy, it really comes down to a question of "how much of those consequences are acceptable?"

"Why most economist continue to use the ludicrous argument that a rise in the minimum wage hurts minimum wage workers is beyond me."

Spencer it is because the argument is not fundamentally an economic one at all, still less data based, which is why they never quantify it. Instead it is political jiu-jitsu intended to turn worker solidarity against actual worker interests. In principle workers like to see people work and generally don't like to see people fired, These economists want to freeze the argument right there: "Jobs good, job loss bad". I call it the 'Jimmy the Stockboy argument'. "Sure we would like to give everybody a raise, but we would have to let Jimmy go and everybody knows he is a good kid". By keeping workers focused on effects at the margin they hope and often rightly to get workers to overlook effects at the center, that maybe pay raises for 99 of 100 workers offsets the loss of that last job, particularly since when Jimmy gets a new job it will be at the new higher rate.

The argument fundamentally relies on a combination of guilt and innumeracy among the target audience, as well as some dubious concepts of marginal productivity among the perpetrators. It is telling that when challenged the response among some is simply to take away the vote from those who would object (i.e Caplan and 'Myth of the Rational Voter'). The don't have the economic numbers to back their claim and are vastly outnumbered by workers, and as such have no defence against a democratic challenge.

Consciously or not most arguments along these lines are designed to maintain a power imbalance all the while denying that power is even in operation. Needless to say this breaks down when it encounters the reality of the workplace.

Just to follow up - I've taken a stab at a GDP thermometer gage:

    http://tinyurl.com/3xz7es

I'm open to suggestions for tinkering....

Just to follow up - I've developed that GDP temperature gauge I hinted at earlier here:

http://tinyurl.com/3xz7es

I've incorporated much of what I talked about here, but it may yet benefit from additional tinkering - I'd be happy to consider any suggestions (thanks in advance!)

Just to follow up - I've developed that GDP temperature gauge I hinted at earlier here:

http://tinyurl.com/3xz7es

I've incorporated much of what I talked about here, but it may yet benefit from additional tinkering - I'd be happy to consider any suggestions (thanks in advance!)

Well, interesting - I had believed that my comment from this morning was lost in the Internet aether, and I just double-posted a comment, now making three on the same topic.

Some days, you just can't get enough coffee.... My apologies for cluttering the comments thread.