Wall Street Broke the Mirror: 7 more years of bad timesPosted: September 20, 2010
One week ago, I highlighted a study by Reinhart & Reinhart on VOXEU that’s getting some play among the macroeconomics crowd. I think it’s especially significant to talk about that study and the Robert J Shiller piece about it on Project Syndicate in light of NBER’s dating the end of the last recession. It doesn’t feel like the recession ended about 15-16 months ago [June, 2009] for the unemployed and most Americans and this recovery is not going to feel like most recoveries we’ve had recently because of the exogenous shocked that caused it. That would be a financial crisis. As I said before, the Reinhart & Reinhart study shows that recessions that follow a financial crisis take about 7 -10 years to work themselves to an end. The last few recessions that we’ve had were caused by tight monetary policy. This basically means that the minute the FED loosened rates, the economy improved.
Additionally, let me add that unemployment is a lagging indicator. This means that you’ll see the trough (bottom) of a recessions as indicated by a composite of indicators including leading indicators before you’ll see any improvement in unemployment. That is given that Okun’s law--the traditional relationship between GDP and unemployment–is even operating on the same terms any more. Because of our incredible propensity to buy imports, and the shifting of incomes from spenders (poor-to-middle class households) to savers (the rich) the expenditures multiplier isn’t what it used to be either. The last thirty years has taken its toll on macroeconomic empirics, but not the theory itself. Yes, we’re still all Keynesians now. The models, the variables and the equations are pretty much the same. What’s changed is the parameters. We don’t see the widespread impact of things that we used to be able to count on because the last thirty years have created a lopsided economy based on imports and oligopolistic markets ruled by megacorporations. It’s sort’ve like we’re building up an immunity to antibiotics because the germs have had the time to change their systemic molecular structures to their advantage.
So, yes, the NBER dated the end of the last recession as officially being June, 2009. Again, it was based on a composite of economic measurements with corresponding trough dates.
Macroeconomic Advisers’ monthly GDP (June)
The Stock-Watson index of monthly GDP (June)
Their index of monthly GDI (July)
An average of their two indexes of monthly GDP and GDI (June)
Real manufacturing and trade sales (June)
Index of Industrial Production (June)
Real personal income less transfers (October)
Aggregate hours of work in the total economy (October)
Payroll survey employment (December)
Household survey employment (December)
Just because you see the bottom, doesn’t mean the recovery will be straight up, however. According to the Reinhart & Reinhart (2010) study, we’ll scuttle along the bottom and slowly inch our way up for another 7 years. Rather than repeat what I told you last week, I’ll focus on the Shiller article. He does a pretty good job of covering some of the basic ideas without resorting to using the mathematics of how we study shocks (just like physics studies shock waves.) How I describe this to students is to think of the economy as a tire swing that normal goes back and forth gently with the wind–a some what predictable but random motion in that it always will come to rest at a certain place and the back and forth will happen with in a normal range of variation. Suddenly, something comes along–like a neighborhood kid–and gives it a huge push. Its variation will become much broader but it will eventually settle down to its normal behavior assuming nothing else happens. Well, a financial crisis is like the kid coming under the tire swing and pushing it as high as he can. When it swings to the opposite side it will go far in the other direction and because of that momentum and volatility, it’s going to take a lot longer for the tire settle down then say it would if it was just blowing about due to a very windy day. That’s also given that the rope won’t be change, the tire swing repositioned, or a replacement tire of different size is stuck on the same rope. Wall Street shoved our tire swing.
So, the financial crisis was a huge, violent push and as the Reinharts studied similar huge, violent pushes, and compared them to windy days, they found it takes a about a decade for the swing to settle down. In terms of the NBER date, that means about 7 more years of bad economic performance. Better news, however, is that this might influence how we look at the business cycles which has been somewhat ignored since the post war years.
There seems to be the germ of a new economic theory in the work of the Reinharts and Rogoff, but it remains ill defined. It seems to have a behavioral-economics component, since the “this time is different syndrome” seems psychological rather than rational. But it is still not so sharp a theory that we can really rely on it for making confident forecasts.
Moreover, there are reasons to suggest that this time really might be different. I hate to say so, not wanting to commit the sin defined by their “syndrome,” but this time might be different because all of the modern examples of past crises came during a time when many economists worldwide were extolling the virtues of the “rational expectations” model of the economy. This model suggested that a market economy should be left alone as much as possible, so that is what governments tended to do.
I’m pleased about this having been educated in finance and economics while the stupidity of “rational expectations” has been rampant. If, in fact, we can call an end to this nonsense, this does anything but kill off Keynesian economics–with its explanation of animistic spirits in the investments market-– and Ron Paul (bless his little heart) is delusional as ever. It brings further grounding to behavior economics and finance. Shiller concludes:
According to “rational expectations,” bubbles simply did not exist – which meant that actual bubbles were allowed to grow. But that mindset is waning, and government and business leaders now routinely warn of bubbles and adopt policies to counter them. So, this time really is at least a little different.
In that case perhaps all of those crisis-induced bad decades are no longer relevant. But any such hopes that the aftermath of the current crisis will turn out better are still in the category of thoughts, theories, and dreams, not science.
It is not true that if you break a mirror, you will have seven years’ bad luck. That is a superstition. But if you allow a financial market to spin wildly until it breaks down, it really does seem that you run the risk of years of economic malaise. That is a historical pattern.
So, there are a combination of things working against us seeing a good economy for some time. Excuse me for trying to supplant Dr. Doom, but honestly, there are a lot of things at play here that are different. Here’s my top ten list of why things are different this time.
First different thing: the de-industrialization of America and Walmart inventory techniques. We don’t have inventories, we don’t make anything, nobody wants what we have to sell except what comes out of the sports and entertainment arenas. Not every one can be Drew Brees or Lady Gaga. Second thing, we import stuff like addicts and still do it with credit. Third, huge corporations have spent the last 30 years returning us to the Gilded Age. There are way too many monopoly and oligopoly markets. This ain’t capitalism folks. Fourth, because of point three, our financial markets are riddled with systemic risk and that hasn’t been solved putting us at great risk for repeats. Fifth, very few folks know shit about economics and fall prey to stupid politicians. The fact that we still can’t kill that trickle down myth with facts just appalls me. Republican economists don’t even buy it for Pete’s sake! Sixth, it’s all about which party wins at all costs. Seventh, the folks that are unemployed and are now in their 50s will most likely stay there. Eighth, the kids in their 20s now will likely never catch up. If you don’t have a trust fund or a lot of luck, you’ll live worse off than your parents. Ninth, our media is worse than our elected officials. Do I have to even qualify this if CNN considers Rick Sanchez anchor worthy? And the number 10 reason is that we’ve managed to demonize folks that do work on things that really have value: car mechanics, plumbers, electricians, carpenters, nurses, teachers, doctors, firefighters, and police and the unions that used to work to advance their lives.
Pick a number, and discuss!