In Tuesday’s WSJ, Edward Lazear argued that we are now experiencing the “Worst Economic Recovery in History”. Before dissecting this remarkable document, it would behoove the reader to recall that while he was Chair of George W. Bush’s Council of Economic Advisers, he stated unequivocally in May 2008 (also in the pages of the WSJ):
“The data are pretty clear that we are not in a recession.”
He wrote this less than five months before US GDP took a remarkable dive; in 2008Q4 q/q growth was -8.9 percent SAAR. In the available series, this loss was only exceeded in 1958Q1 (-10.4 percent). Despite Professor Lazear’s less than stellar record on reading the data, we should assess his statement at face value.
Was the Slow Recovery Such a Surprise?
Indeed, that was the expectation [that the economy was in rapid catch-up mode and would eventually regain all that had been lost]. As economist Victor Zarnowitz of the University of Chicago argued many years ago, the strength of the recovery is related to the depth of the recession. Big recessions are followed by robust recoveries, presumably because more idle resources are available to be tapped. Unfortunately, the current post-recession period has not followed the pattern.
The 2007-09 recession was induced by a financial crisis and some, most notably economists Carmen Reinhart and Kenneth Rogoff (authors of “This Time is Different: Eight Centuries of Financial Folly”), argue that financial crises pose more difficult recovery problems than do policy-induced recessions.
After recounting the Reinhart-Rogoff thesis, Lazear essentially dismisses it, apparently in favor of John Taylor’s argument that the crisis was Fed induced.
I want to take exception to the argument that the expectation was for a rapid recovery. In fact Econbrowser readers will recall my August 6, 2008 post, ”Synergies of the unpleasant kind: recessions, credit crunches and housing busts”, in which I cited IMF research by Stijn Claessens, M. Ayhan Kose and Marco E. Terrones:
… If these statistics, based on a large number of episodes, provide any guidance, they suggest that the adjustments of credit and housing markets in the United States are only in the early stages relative to historical norms and might still take a long time. The earlier episodes suggest that the process of adjustment in the United States might persist in the coming months with further difficulties in credit markets and drops in house prices. This could bode consequently poor for the path of overall output, which, as we showed, falls more in recessions associated with credit crunches and house price busts than in recessions without such events.
Interestingly, the increase in unemployment has been substantially below what one would have expected given the financial crisis. This point was noted in the last Economic Report of the President.
Figure 1-3 from CEA, Economic Report of the President, 2012, p.28.
Why was the increase in unemployment relatively muted? As the IMF noted in Chapter 3 of its April 2009 World Economic Outlook (p. 104):
Fiscal stimulus appears to be particularly helpful during recessions associated with financial crises. Stimulus is also associated with stronger recoveries; however, the impact of fiscal policy on the strength of the recovery is found to be smaller for economies that have higher levels of public debt.
In other words, Professor Lazear might have thought the conventional wisdom was for a quick bounceback, but there were a number of non-fringe observers that thought otherwise.
Professor Lazear’s most disingenuous moment comes here:
The Great Depression started with major economic contractions in 1930, ’31, ’32 and ’33. In the three following years, the economy rebounded strongly with growth rates of 11%, 9% and 13%, respectively
The sheer scope of the output collapse in 1930-33 is not conveyed by this quote, so here is a graph to place matters in context:
Figure 1: Log GDP, Ch.2005$, rescaled to base year, current recession/recovery (blue), and Great Depression (red). Source: Measuring Worth through 2010, and BEA for 2011, and author’s calculations.
When output declines by one-third, one would be surprised if subsequently output didn’t increase by double digits. That doesn’t mean one would want a 30% decline in GDP just to get that subsequently rapid growth.
Evaluating the Recovery We Have, and Not the Recovery We Wish We Had
So, why did Professor Lazear write this article now? I think some of has to do with trying to burnish his forecasting credentials, after his resounding forecasting failure in 2008 (perhaps coming second only to Don Luskin!). But I think it has more to do with an attempt to distract attention from the accumulating evidence of a sustained, albeit extremely modest and fragile, recovery, than setting the record straight.
Figure 2: Real GDP (blue bars), and monthly GDP from e-forecasting (red), and Macroeconomic Advisers (green). NBER defined recession dates shaded gray. Source: BEA, 2011Q4 3rd release, e-forecasting (3/19), Macroeconomic Advisers (3/15), and NBER.
Figure 3: Philadelphia Fed leading index (blue, left scale) and annualized m/m private payroll growth rate, both seasonally adjusted. March observation (red triangle) is implied Bloomberg consensus as of 4/4/12. NBER defined recession dates shaded gray. Source: Philadelphia Fed via FRED (as of 4/3), BLS via FRED, Bloomberg, and NBER.
GDP is recovering, private payroll growth in March is estimated to be in excess of 200,000 according to Bloomberg, and the Philadelphia Fed’s leading index (released 4/3) is at the highest levels since February 1993. (As an aside, the bivariate VECM I estimated  yields forecasted monthly private employment growth averaging in excess of 200,000 per month throughout 2012. [inserted “averaging” since model is quarterly — 4/6, 7:30am Pacific]
The Regulatory Uncertainty and/or Burden Thesis, Yet Again
The final piece of data-deficient analysis in Professor Lazear’s piece:
Are there other factors that may have contributed to the slow recovery that we are experiencing? It would be difficult to argue that government polices over the past three years have enhanced confidence in the U.S. business environment. Threats of higher taxes, the constantly increasing regulatory burden, the failure to pursue an aggressive trade policy that will open markets to U.S. exports, and the enormous increase in government spending all are growth impediments. Policies have focused on short-run changes and gimmicks—recall cash for clunkers and first-time home buyer credits—rather than on creating conditions that are favorable to investment that raise productivity and wages.
As I noted in this post, when reputable academics attempt to quantify economic uncertainty, they point primarily to fiscal(particularly tax) uncertainty (Baker, Davis and Bloom, 2011). And claims to find a relationship between regulatory burden and macroeconomic activity have been found wanting (to say the least). And of course, “the enormous increase in government spending” depends on one’s definition of “enormous”. Here’s my take.
Professor Lazear’s Forecasting Record in Context
Looking back in time, I also noted that Professor Lazear criticized the ARRA in July 2009, purportedly because the spending would occur after the need for it was over, thereby illustrating in yet another case his penchant for definitive statements that ultimately proved wrong.
Update, 8:30PM Pacific: Reader MarkOhio notes that the mean forecasts from the SPF for the succeeding quarters were positive. Still, 23 respondents in the May 2008 WSJ survey forecasted negative growth for 2008Q2.
Figure 4: Quarter on quarter SAAR growth forecasts for 2008Q2, from Wall Street Journal May 2008 survey. Source: WSJ.
In fact the modal forecast is negative 1%. So, I think Professor Lazear could have been more circumspect.
Update, 7:30PM Pacific, 4/6: What Did Ed Lazear Know as of May 8, 2008?
Reader James Kahn asserts Ed Lazear’s strong declaration of no-recession was justified, given the data of the time. Reader Jeff criticizes my post as: “another installation in a long series by Menzie “I spew politicized nonsense under the guise of legitimate academic research” Chinn.” Let me remind people of what Ed Lazear knew as of May 8, 2008, relying upon the St. Louis Fed ALFRED database, and let them decide whether an unconditional no-recession statement was reasonable.
Figure 5: Log nonfarm payroll employment (blue), industrial production (red), real retail sales (green), and real disposable income excluding transfers (purple), all normalized to zero at 2007M12; data available as of May 8, 2008. Source: St. Louis Fed ALFRED database, and author’s calculations.