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Posts Tagged ‘Macroeconomics’

How fast will the US economy grow? When mainstream forecasters consult their crystal balls, they typically see real economic growth around 2 percent annually over the next decade. The Congressional Budget Office (CBO) and midpoint estimates of Federal Reserve officials and private forecasters cluster in that neighborhood.

When President Trump looks in his glowing orb, he sees a happier answer: 3 percent.

That percentage point difference is a big deal. Office of Management and Budget director Mick Mulvaney recently estimated the extra growth could add $16 trillion in economic activity over the next decade and almost $3 trillion in federal revenues.

But could our economy really grow that fast? Maybe, but we’d need to be both lucky and good. We’ve grown that fast before. But it’s harder now because of slower population growth and an aging workforce. And there are signs that productivity growth has slowed in recent years.

To illustrate the challenge, I’ve divvied up past and projected economic growth (measured as the annual growth rate in real gross domestic product) into three components: the growth rates of population, average working hours, and productivity.

d_marron_20170807

The link between population and growth is simple: more people means more workers generating output and more consumers buying it. Increased working hours have a similar effect: more hours mean more output and larger incomes. Hours go up when more people enter the labor force, when more workers find jobs, and when folks with jobs work more.

Productivity measures how much a worker produces in an hour. Productivity depends on worker skills, the amount and quality of capital they use, managerial and organizational capability, technology, regulatory policy, and other factors.

As the first column illustrates, the US economy averaged 3 percent annual growth over more than six decades. Healthy growth in population and productivity offset a slight decline in average hours. Of course, that six-decade average includes many ups and downs. The Great Recession and its aftermath dragged growth down to only 1.4 percent over the past decade. In the half century before, the United States grew faster than 3 percent.

Mainstream forecasters like the CBO and the Federal Reserve expect slower future growth along all three dimensions. People are having fewer children, and more adults are moving beyond their child-rearing years, so population growth has slowed. Our workforce is aging. Baby boomers are cutting back hours and retiring, and younger workers aren’t fully replacing them, so average working hours will decline. Productivity growth has slowed sharply in recent years, for reasons that are not completely clear. Productivity is notoriously difficult to forecast, but recent weakness has inspired many forecasters to expect only moderate growth in the years to come.

Proponents of President Trump’s economic agenda offer a rosier view. Four prominent Republican economic advisers—John F. Cogan, Glenn Hubbard, John B. Taylor, and Kevin Warsh—recently argued that policy, not just demographic forces, has brought down recent growth. They claim supply-side policy reforms—cutting tax rates, trimming regulation, and reducing unproductive spending—can bring it back up. They argue that encouraging investment, reinvigorating productivity growth, and drawing enough people into the labor force to offset the demographic drag would generate persistent 3 percent growth.

Many analysts doubt such supply-side efforts can get us to 3 percent growth (e.g., here, here, here, and here). Encouraging investment and bringing more people into the labor force could certainly help, but finding a full percentage point of extra growth from supply-side reforms seems like a stretch. Especially if you plan to do it without boosting population growth.

The most direct supply-side policy would be expanding immigration, especially among working-age adults (reducing our exceptional rates of incarceration could also boost the noninstitutional population). But the Trump administration’s antipathy to immigration, and that of some Republicans in Congress, pushes the other way. Cutting legal immigration in half over the next decade could easily take 0.2 percentage points off future growth (see this nifty interactive tool from ProPublica and Moody’s Analytics). Three percent growth would then be even more of a stretch.

Another group of economists believes that demand-side policies—higher spending and supportive monetary policy—could lift growth above mainstream forecasts.

One trio of economists took a critical look at past efforts to forecast potential GDP growth, a key driver of long-run growth forecasts. They conclude that forecasters, including those at the Federal Reserve and the CBO, have overreacted to temporary economic shocks, overstating potential growth when times are good and understating it when times are bad. We’ve recently had bad times, so forecasters might be underestimating potential GDP almost 10 percent. If so, policies that boost demand could push up growth substantially in coming years. (For a related argument, see here.)

So where does that leave us?

Well, every crystal ball (and glowing orb) is cloudy. We should all be humble about our ability to forecast the economy over the next decade. Scarred by the Great Recession and its aftermath, forecasters may be inadvertently lowballing potential growth. Good luck and good supply- and demand-side policies might deliver more robust growth than they anticipate. But those scars remind us we can’t always count on good policy, and luck sometimes runs bad.

We can hope that luck and good policy lift growth to 3 percent. But it’s prudent to plan for 2 percent, and pray we don’t fall to 1 percent.

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Because macroeconomists have messed it up for every one else , says Noah Smith at The Week:

To put it mildly, economists have fallen out of favor with the public since 2008. First they failed to predict the crisis, or even to acknowledge that such crises were possible. Then they failed to agree on a solution to the recession, leaving us floundering. No wonder there has been a steady flow of anti-economics articles (for example, this, this, and this). The rakes and pitchforks are out, and the mob is ready to assault the mansion of these social-science Frankensteins.

But before you start throwing the torches, there is something I must tell you: The people you are mad at are only a small fraction of the economics profession. When people in the media say “economists,” what they usually mean is “macroeconomists.” Macroeconomists are the economists whose job is to study business cycles — booms and busts, unemployment, etc. “Macro,” as we know it in the profession, is sort of the glamor division of econ — everyone wants to know whether the economy is going to do well or poorly. Macro was what Keynes wrote about, as did Milton Friedman and Friedrich Hayek.

The problem is that it’s hard to get any usable results from macroeconomics. You can’t put the macroeconomy in a laboratory and test it. You can’t go back and run history again. You can try to compare different countries, but there are so many differences that it’s hard to know which one matters. Because it’s so hard to test out their theories, macroeconomists usually end up arguing back and forth and never reaching agreement.

Meanwhile, there are many other branches of economics, doing many vital things.

What are those vital things? Some economists find ways to improve social policies that help the unemployed, disabled, and other vulnerable populations. Others design auctions for Google. Some evaluate development polices for Kenya. Others help start-ups. And on and on. Love it or hate it, their work should be judged on its own merits, not lumped in with the very different world of macroeconomics.

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The Council of Economic Advisers just released an interesting paper examining the macroeconomic harm from the government shutdown and debt limit brinksmanship. To do so, they created a Weekly Economic Index from data that are released either daily or weekly (and weren’t delayed by the shutdown). These data include measures of consumer sentiment, unemployment claims, retail sales, steel production, and mortgage purchase applications.

The headline result: They estimate that the budget showdown cost about 120,000 jobs by October 12.

Looking ahead, I wonder whether this index might prove useful in identifying future shocks to the economy, whether positive or negative. As the authors note:

In normal times estimating weekly changes in the economy is likely to detract from the focus on the more meaningful longer term trends in the economy which are best measured over a monthly, quarterly, or even yearly basis. But when there is a sharp shift in the economic environment, analyzing high-frequency changes with only a very short lag since they occurred can be very valuable.

P.S. I am pleased to see CEA come down on the right side of the “brinksmanship” vs. “brinkmanship” debate.

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Ray Dalio, founder of the remarkably successful Bridgewater Associates, has released a 30 minute video explaining his vision of “How the Economic Machine Works.” Well worth watching, particularly his description of a beautiful deleveraging.

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James Bullard, head of the St. Louis Federal Reserve Bank, gave a nice presentation on “The Tapering Debate” today. See the whole thing here.

One question he considers is whether the Fed balance sheet is getting scarily big. It’s certainly large by U.S. historical standards — the only time is was bigger, relative to the size of the economy, was in the 1940s.

By current international standards, however, the Fed balance sheet isn’t an outlier. In fact, Japan, Europe, and the United Kingdom all have larger central bank balance sheets, relative to their economies, than we do (FRB = Federal Reserve Bank):

Bullard

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By many accounts, Sweden did a great job managing its financial and fiscal crises in the early 1990s. But more than 20 years onward, its unemployment rate is still higher than before the crisis, as noted in a recent commentary by the Cleveland Fed’s O. Emre Ergungor (ht: Torsten Slok):

2013-03-3w

And its labor force participation rate is still lower:

2013-03-4w

Does Sweden’s experience portend similar problems for the United States? Ergungor thinks not. Instead, he attributes this shift to a structural change in Swedish policy that has no direct analog in the United States:

One study of public sector employment policies published in 2008 by Hans-Ulrich Derlien and Guy Peters indicates that for many years, the labor market had been kept artificially tight by government policies that replaced disappearing jobs in failing industries with jobs in the government. The financial crisis was the breaking point of an economic system that had grown increasingly more unstable over a long period of time. It was a watershed event that marked the end of an unsustainable structure and the beginning of a new one. Public sector employment declined from 423,000 in 1985 to 240,000 in 1996 mainly through the privatization of large employers—like the Swedish postal service, the Swedish Telecommunications Administration, and Vattenfall, the electricity enterprise—and it has remained almost flat since then.

With such a large structural change, what came before the crisis may no longer be a reference point for what will come after. Having corrected the root of the problem, the Swedish labor market is now operating at a new equilibrium.

That doesn’t mean smooth sailing for the United States, as he discusses. But it does leave hope that perhaps we do better than Sweden in creating jobs in the wake of a financial crisis.

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