David Wessel at Wall Street Journal:
Christina Romer, chair of the president’s Council of Economic Advisers, says the reason unemployment remains so painfully high is clear: It’s not the inadequacy or laziness of the workers or the long-standing mismatch between workers’ skills and employers’ needs. It’s the old-fashioned Keynesian diagnosis: Too little demand in the economy.
“The overwhelming weight of the evidence is that the current very high—and very disturbing—levels of overall and long-term unemployment are not a separate, structural problem, but largely a cyclical one. It reflects the fact that we are still feeling the effects of the collapse of demand caused by the crisis. Indeed, at one point I had tentatively titled my talk “It’s Aggregate Demand, Stupid”; but my chief of staff suggested that I find something a tad more dignified,” Ms. Romer said in remarks prepared for a conference at Princeton University today.
It doesn’t have to be this way, she argued, essentially making the case for more government stimulus to help the economy. “We have the tools and the knowledge to counteract a shortfall in aggregate demand. We should be continuing to use them aggressively.” Her comments contrasted with a recent flurry of optimism among some forecasters that the recovery may turn out to be stronger than the lackluster one many anticipated. “We we are growing again, but not booming,” she said. GDP is rising at a solid pace, but not as quickly as after other severe recessions and not as quickly as it needs to. As a result, the unemployment rate remains painfully high and is not predicted to reach normal levels for an extended period.” The jobless rate, at last report, was 9.7%
The view gaining strength is that additional stimulative policies won’t do much good because much of our current employment i “structural.” This is,best as I can see, simply not true: there is no evidence for it. But that if we let unemployment linger above 9 percent for several years, it is highly likely to become structural–and then we will have even more huge problems than we have now.
And at the moment it looks like getting unemployment below 9 percent will take some luck. Certainly fiscal policy and monetary policy are unlikely to provide much additional stimulative force going forward.
Every time there’s a downturn a certain swathe of the elite starts to label it unfixable and structural. And the worse the downturn, the louder come the calls. Look at the history of the Great Depression and you see an enormous chorus of voices from the right arguing that nothing could be done and people would just have to suffer through it. They were countered by a chorus of voices from the left arguing that nothing could be done and people would just have to stage a revolution. It wasn’t true then and it wasn’t true now. The fact of the matter is that key people responsible for running the global economy—people at the European Central Bank and the Federal Reserve Board, and the Bank of Japan, people in the United States Senate, people in the Germany cabinet—are screwing up. In the developed world, those countries who’ve been able to respond aggressively to the crisis with aggressive expansion-via-devaluation are all doing pretty well. The bigger developed economies can’t do that exact thing, but they can mount more aggressive expansionary responses—they just aren’t.
It seems to me that if the problem is aggregate demand, then there should be some sectors that currently are temporarily depressed where you think that employment will recover. Are there inventories to be worked off in automobiles and steel? Do we think that lots of job growth is going to come in the capital goods sector? Should the state and local government sector that Romer moans about, which has lost–what, 100,000 jobs?–be the engine for employing the six million or so people who have lost private sector jobs?
Also, Romer writes,
The recent recession was obviously not caused by tight monetary policy. Interest rates were not especially high when it began, and so the Federal Reserve had only limited room to cut them. It has brought short-term rates down to virtually zero, but it cannot push them below that. The result is that we have not had the strong monetary stimulus that we would normally have in these economic circumstances.
She’s telling Scott Sumner to move along, also. Note that she focuses on short-term interest rates as a monetary indicator. But long-term interest rates are not zero, and the Fed certainly has not run out of securities to buy.
Basically, her speech is a plea for more Obaminations. She admits that recovery is needed in the private sector, but her top priority is aid to state and local governments. I can remind you that state and local governments can balance their budgets without cutting jobs simply by reducing pay to workers.
I don’t expect Romer to turn a speech into an academic debate and in this sense I don’t fault her. Nonetheless I did not find her account very persuasive.
I would start with the fact that output has bounced back more robustly than employment has. AD theories per se do not explain that differential. One simple possibility is that better management and better measurement have allowed us to identify (and fire) hundreds of thousands of low-wage people who just weren’t producing much of value. That’s a real shock, even if it does not qualify as a sectoral shift in the traditional sense.
It’s also the case that the rate of new job creation has been especially low. Yet the nominal wages on those jobs-to-be are not constrained by previous contracts or agreements. Tell stories as you may, but it’s hard for me to see that as exclusively an AD problem.
I wonder what is the behavioral postulate for how long all these unemployed workers are all staring jobs in the face yet persistently stubborn about their appropriate nominal wage. I’m all for behavioral economics, but I don’t buy the necessary story here.
I don’t want to oversell the minimum wage hike + unemployment compensation extension + means-testing hypothesis here, but surely it deserves a mention as one relevant factor. Those are real factors too.
I also see that wages, and the job market, are more flexible today than in a long time, with so much service sector employment, so much flex-time and part-time, and such a low rate of unionization. In most AD theories that implies the job market bounces back relatively quickly yet that is not what we observe.
A separate question is what Romer believes the major AD shock to have been. She clearly repudiates the Scott Sumner story that monetary policy was too tight. Is it all from the collapsed bubble in the housing market? Keep in mind those are paper values and that the real services from the country’s housing stock haven’t declined. Again, you can tell behavioral stories about the asymmetric perception of losses vs. future gains (for many people, buying a future home is now much cheaper, though perhaps they don’t notice the positive wealth effect), but is that going to drive the whole cycle?
To be sure, AD is a major factor in this recession but it is not the entire story by any means. In major recessions usually it is AD and AS forces together.
Most of all, the Romer essay convinces me that current economic policymakers — not to mention many bloggers — should not be so certain they understand what is going on.
Still, I broadly concur with Tyler and Arnold Kling: I don’t think you can explain this all by falling aggregate demand. Consider that, as Romer notes, unemployment is about 1.7 percentage points higher than can normally be explained by the change in GDP. That doesn’t sound like so much. But it’s really quite a lot. If you assume that the natural rate of unemployment is probably somewhere around 5.3%, that means the total shift has only been 4.4 percentage points. In other words, almost 40% of our currently elevated unemployment rate comes from something other than the decline in GDP.
Moreover, we know that there are large sectors that require structural readjustment: autos and construction. Those workers are geographically and skill-constrained. To think that the current level of unemployment is all about aggregate demand, you have to think that there are lots of jobs into which those displaced workers could easily transition. But if you own a house in the Detroit era, or have a spouse who still has a job, this is just clearly not the case.
Joseph Lawler at The American Spectator:
I find it interesting that Romer is so eager to dispel the idea that structural changes and not aggregate demand has caused the current jobless recovery because I presented that argument in the December-January issue of the Spectator.
Arnold Kling and Tyler Cowen are both unimpressed with Romer’s thesis. For what it’s worth, I do think that there are clearly structural forces at play in the current economy, and that these problems are not “easily amenable to correction” in the sense that Romer means “correction,” i.e. more government spending. But I don’t think that any of the economists I interviewed or read in laying out the structural narrative are resigned to a “new normal” of high unemployment and slow growth.
Basically, there are two sides to this debate: One is that the meltdown either exposed or created an economy where the level of unemployment is simply much higher. That is to say, it’s not just the recession pushing unemployment up, but the new reality of a post-high consumption, post-housing boom, or post-something else America.
Romer’s view is different: “This rise in long-term unemployment is readily explained by the prolonged collapse in aggregate demand.” She sees five factors pushing down demand: Tight credit markets, state and local budget problems, burnt-out consumers, subdued foreign demand, and the Federal Reserve’s inability to stimulate the economy by further cutting interest rates.
The neat thing about a demand-side explanation is that policy can help. Demand, after all, is another way of saying “someone spending money to buy things.” The economy doesn’t much notice if that someone is a household, a business, or the government, So if households and businesses are too weak to play that role right now, the government can, and should, step in and create the demand that will get the economy moving again. Romer suggests a couple of policies in addition to those currently in place, with the most promising being further aid to state and local governments and a lot of money to jump-start lending to small businesses.
The question isn’t whether those policies will work to ease the recession and move us toward recovery. They will. If states don’t have to lay off teachers, those teachers don’t have to stop buying groceries, which means those grocers don’t have to fire their employees, and so on. The question, rather, is whether we actually want to do something about unemployment, or whether we’d prefer to just complain about it.