Earlier this week Paul Krugman was patting himself on the back for predicting years ago that the economy would not bounce back quickly from our slump. After quoting himself from 2008 talking about how this slump was different from the V-shaped ones of the past, Krugman (writing two days ago) says:
That’s from early 2008, before we had any idea just how bad it was going to be, but it was already obvious to me then that V-shaped recovery was not in the cards, precisely because prolonged jobless recoveries had already, pre-2008, become the new normal. I was still too optimistic about the length of the slump, but remember, this was seven months before Lehman fell.
So I didn’t mean to imply that 2008 was completely sui generis; on the contrary, it simply represented a stronger form of a pattern that was already apparent from 2001 and before that in 1990-91.
Why, then, did the White House predict V-shaped recovery? I don’t know. I will say, however, that a lot of business economists were still thinking that a deep recession means a fast recovery, essentially because they weren’t thinking about the changing nature of slumps. And maybe that view infiltrated Treasury, in particular.
Not bad, Dr. Krugman. I seem to recall another guy at the time who was skeptical of the White House’s view of the recovery from the slump. Here’s what he wrote in March 2009:
[W]hen I read the [Council of Economic Advisers’] CEA’s forecast analysis, this sentence jumped out at me:
“a key fact is that recessions are followed by rebounds. Indeed, if periods of lower-than-normal growth were not followed by periods of higher-than-normal growth, the unemployment rate would never return to normal.”
That is, according to the CEA, because we are now experiencing below-average growth, we should raise our growth forecast in the future to put the economy back on trend in the long run. In the language of time-series econometrics, the CEA is premising its forecast on the economy being trend stationary.
In the CEA document, Table 2 shows growth rates immediately after recessions end. It demonstrates that growth is higher than normal in most of the recoveries. Is this evidence against the hypothesis that Campbell and I advanced?
I don’t think so. The problem is that those numbers start at the end of the recessions, and we do not know when the recession will end. In other words, if God came down and told us the exact date the current recession was going to end, my forecast subsequent to that date would be for higher than normal growth. But absent that divine intervention, there is always some chance the recession will linger (remember the Great Depression), and an optimal forecast has to give some positive probability weight to that scenario as well. The forecast should be an unconditional expectation, not an expectation conditional on a particular end date for the recession.
Right now, we are facing a particularly high-variance economy. (Just look at the VIX index.) That means, under the conjecture I just described, that when recovery comes, it will probably be a robust one. But this logic is not necessarily a reason to raise the unconditional expectation of economic growth, because we don’t know when that recovery will begin.
That economist was Greg Mankiw. At the time, when he doubted the Administration’s forecast of a quick rebound from the slump, Krugman replied immediately:
As Brad DeLong says, sigh. Greg Mankiw challenges the administration’s prediction of relatively fast growth a few years from now on the basis that real GDP may have a unit root — that is, there’s no tendency for bad years to be offset by good years later.
I always thought the unit root thing involved a bit of deliberate obtuseness — it involved pretending that you didn’t know the difference between, say, low GDP growth due to a productivity slowdown like the one that happened from 1973 to 1995, on one side, and low GDP growth due to a severe recession. For one thing is very clear: variables that measure the use of resources, like unemployment or capacity utilization, do NOT have unit roots: when unemployment is high, it tends to fall. And together with Okun’s law, this says that yes, it is right to expect high growth in future if the economy is depressed now.
But to invoke the unit root thing to disparage growth forecasts now involves more than a bit of deliberate obtuseness. How can you fail to acknowledge that there’s huge slack capacity in the economy right now? And yes, we can expect fast growth if and when that capacity comes back into use.
I quoted the whole thing because it is simply amazing. It is awful for two separate reasons:
(1) Mankiw wasn’t denying that “we can expect fast growth if and when that capacity comes back into use.” Mankiw was saying that he doubted the Administration’s forecast that capacity would come back into use within a few years.
(2) KRUGMAN HIMSELF in that timeframe was denying that “low GDP growth due to a severe recession” would lead to a sharp rebound; that’s why he’s now patting himself on the back, after all.
I am trying to come up with an analogy for what Krugman did here, but there’s too many levels. It is simply impressive, is all I’ll say.