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2014-12-02 11:34:49
Dec 2nd 2014, 10:09 by R.A. | LONDON
TIM DUY, one of the best writers on macro policy issues, is optimistic about
America's economy and wonders why more people aren't:
Overall, I find the pessimism (from the right and the left) inconsistent with
the fact that despite the ups and downs of the quarterly data, throughout the
recovery, GDP has grown at a fairly consistent rate...
The US economy is far more resilient than it is given credit for. None of the
downside risks of recent years have been sufficient to derail the recovery, nor
will the supposed downside risks of next year...
[M]y probability of recession in the next twelve months: 0%. I would place
similar odds on the following twelve months as well...
Perhaps, just perhaps, the US economic expansion has been consistently
undersold, and continues to be undersold. It is worth considering that maybe it
is time to just accept the good news without the desperate search for every
dark cloud.
Have we all been too pessimistic about the American economy? What attitude
should we have?
One metric might be a cross-country comparison. On that score one might suppose
optimism is clearly warranted. America's recovery is the envy of the rich
world. On the other hand, that is not saying much. Being the best of the bunch
when the bunch has done so miserably is not exactly reason for cheer. And while
America is far more insulated from global ups and downs than other economies it
is not immune. Poor enough performance abroad would indeed slow American
growth, particularly if that poor performance were linked to a major financial
meltdown. On a cross-country basis one can make a case for optimism, but it's
not a strong one.
An historical comparison, by contrast, leads to a much bleaker assessment of
the current recovery. The employment recovery since June of 2009 is the worst
of any American rebound in the postwar period, and the GDP recovery is the
second worst, outdone only by the performance after the 2001 recession. America
remains well below the levels of output and employment one might reasonably
have expected it to attain both before the Great Recession and in its immediate
aftermath. It is true that growth in GDP and employment has been surprisingly
even shockingly steady and resilient. But that makes it all the more remarkable
that America has made up so little of the ground lost since 2007.
That brings us to another case for pessimism: the limited nature of the
recovery. GDP is growing, but you can't eat GDP. You can't even eat employment.
Incomes you can eat, if you spend them. Real GDP per capita is only a shade
above its level of seven years ago: $50,675 now to $49,455 in the third quarter
of 2007. At the median the performance has been much worse; real median
household income tumbled from 2007 and has barely recovered.
Still, one might argue that the case for optimism or pessimism rests on what
lies ahead rather than what came before. And I reckon that if Mr Duy's optimism
leads him to give a 0% chance of American recession over the next 24 months,
then pessimism is unquestionably the more appropriate position.
I think it is more likely than not that America will avoid recession over the
next two years, but you wouldn't have to give me particularly favourable odds
to get me to bet on a downturn. Certainly the odds of one are higher than 0%. A
euro zone break-up would send America into recession and the odds on that are
positive if perhaps not especially high.
America is still in a world in which interest rates are effectively zero. It
will be in that world for at least another six months and probably quite a bit
longer. Futures markets reckon we will be well into 2016 before rates reach
even 1%. For most of the next two years, in other words, the monetary response
to any negative shock, domestic or abroad, will come entirely in the form of
unconventional policy. That makes me extremely nervous, as the Fed is obviously
uncomfortable about relying so heavily on unconventional tools. Any delay or
under-response to a shock due to this discomfort makes a recession much more
likely. And I would note that over time and across countries tightening cycles
off of zero lower bound episodes tend to be much more abbreviated than what we
would normally expect. A half point rise would represent the opening act of a
tightening cycle in most cases. Coming off of the ZLB, however, it may well
represent the beginning, middle and end.
Another observation: the average postwar expansion has lasted 58 months. The
current expansion has already stuck around for 66 months, making it the sixth
longest since the records begin, in the 1850s. In two years the recovery will
be 90 months old, making it the fourth longest (and within two months of third
place). As I said, if asked to bet straight up whether the recovery would rise
that high on the list, I would put my money on yes. But I would not put very
much money on yes.
And that, actually, is part of the problem. The Fed wants us all to put our
money on yes, and a lot of it. Sentiment is an important economic variable; if
you want people to buy things and invest, rather than grasp fearfully to their
incomes, then you need them to be confident: indeed, optimistic. Optimism is
self-fulfilling. But it is not detached from reality. Given past performance
and the current state of the American and global economy, I don't find it
remotely surprising that people are glum. That is an indictment of the Fed,
whose job it is to coordinate our expectations so that we all anticipate, and
therefore cause to occur, maximum employment and an average inflation rate of
2%. Maybe this responsibility is beginning to dawn on the Fed; as Mr Duy notes
it downplayed some recent market havoc in its latest statement so as not to
reinforce public pessimism. On the other hand, it shows little interest in
taking positive action to raise people's expectations.
Being down so long things look like up is not optimism. America should be
performing better, and I find it disappointing that it hasn't and that the Fed
doesn't seem particularly interested in working to improve matters. And so I'm
pessimistic. I will turn optimistic when the Fed convinces me such a turn is
warranted.