Lost Decades

by Menzie Chinn, Econbrowser
Here’s my 25 minute presentation of Lost Decades at the Rotary Club of Madison, on January 4th (as recorded by Wisconsin Eye) Powerpoint. One point I made was that the global financial crisis and ensuing recession have exacted a tremendous cost on the US economy. In the absence of more aggressive action, another 2.4 trillion Ch.2005$ loss will be incurred through 2013Q4. The blithe indifference with which opponents of extended payroll tax reductions, extended unemployment benefits, food stamp expenditures and infrastructure investment contemplate the damage continues to astound me.
Figure 1: from Chinn, January 4 presentation at Rotary Club of Madison. Data source: BEA, 2011Q3 2nd release, CBO (August, 2011), OECD (November 2011), and author’s calculations.Wisconsin’s Lost Year
This presentation by Wells Fargo’s Scott Anderson (h/t WisBusiness 1/18/2012) highlights how the Wisconsin economy is going in reverse, contrary to Walker Administration assertions that we are moving in the right direction (see quote here [1]).
Figure from Scott Anderson, “The Road Ahead,” Wells Fargo Economics, January 17, 2012.Not only is the 12 month change in nonfarm employment essentially zero through November — in contrast to overall United States employment — Wisconsin retains the dubious distinction of one of the few state economies going in the wrong direction, according to the Philadelphia Fed’s coincident index.
Figure from Scott Anderson, “The Road Ahead,” Wells Fargo Economics, January 17, 2012.It is pretty easy to interpret this map; shades of red are bad. For more on the Wisconsin economy, see [2] [3]. Governor Walker’s proposal to increase the number of job fairs could conceivably reverse the trend in net job losses, although I have not seen any independent analyses quantifying that effect. For an analysis of the contractionary effects of Walker Administration policies already implemented, see here.
High Frequency Measures of GDP
Macroeconomic data for 2011Q4 has come in fairly strongly, although a bit below what was anticipated a few weeks ago. Here are two indicators, plus the January 2012 WSJ survey of forecasters.
Figure 2: GDP (blue bars), monthly GDP from e-forecasting (red line), and from Macroeconomic Advisers (green line), and forecasts from WSJ January survey (light blue line), all SAAR, in billions of Ch.2005$. NBER defined recession dates shaded gray. Dashed line at 2009M01. Source: BEA, 2011Q3 3rd release, e-forecasting, Macroeconomic Advisers, WSJ, and NBER.The WSJ survey mean is for 3.1% growth (SAAR) in 2011Q4, while Macroeconomic Advisers is at 3.0. However, 2012 4q/4q growth is forecasted to be only 2.4%. These forecasts are conditioned upon the likelihood of a recession in the euro area.
The Euro Area
Why the pessimism regarding the euro area? From Hooper, Mayer, Spencer and Slok, “Economic adjustment in Euroland: where do we stand?” Global Economic Perspectives, January 18, 2012 (not online):

  • We find that the domestic demand and cost adjustment needed to restore external balance has begun, but is far from concluded. In the meantime, the funding of continuing balance of payments imbalances by the euro area central banks is leading to a widening of the imbalances within the Target2 inter-bank payment system.
  • It seems that exports (and by implication imports) of Greece, Ireland, Portugal and Spain are not sufficiently price sensitive to achieve external balance through relative price changes. From this follows that adjustment has to come mainly from changes in domestic demand. Exports of Italy and Germany, on the other hand, seem to be more price sensitive, making external adjustment there easier.
  • Based on a simple illustrative exercise we find that GDP will probably have to drop by considerable further amounts in Greece, Portugal and Spain to achieve external balance. Hence, with the achievement of sustainable balance of payments positions still not in sight for most of the problem countries, EMU seems to remain at risk for the foreseeable future.
The intra-euro area competitiveness problem is illustrated in Chart 3:
Chart 3 from Hooper, Mayer, Spencer and Slok, “Economic adjustment in Euroland: where do we stand?” Global Economic Perspectives, January 18, 2012.Conditional Inflation Now!
It is because of the rigidity of wages and prices that adjustment will be excruciatingly slow, in both the United States and particularly the euro area (see the model in Schmitt-Grohe and Uribe). That is why Jeff Frieden and I have argued for conditional inflation targeting in Foreign Policy, along the lines laid out by the Chicago Fed’s Charles Evans. [4] [5]
Our proposal received coverage in Stephen Gandel/Time, and approving commentary by Matt Yglesias/Slate. With headline PPI declining, PPI components coming under expectations [6], CPI inflation muted [7] and inflation expectations quiescent, [8] we clearly have room for easing.

Figure 3: Implied inflation calculated as difference between constant maturity TIPS yields on five year Treasurys (blue), seven year (chartreuse), and ten year (red), in percentage points. Observations for January apply to January 13th observation. Source: St. Louis Fed FRED, and author’s calculations.
Related Articles
Analysis articles by Menzie Chinn