The Slowdown at Home and Abroad

The news from the European core of near zero growth shouldn’t have been so surprising. [1] [2] Growth is slowing in the US and abroad. Why are some US policymakers so dead set on withdrawing stimulus?

First, to the US: Despite the somewhat surprising jump in industrial production, many indicators are highlighting the fact that the pace of economic activity is slowing.


Figure 1: GDP (2011Q2 advance release), e-forecasting monthly GDP (red line) and Macroeconomic Advisers (green line), all in billions of Ch.2005$, SAAR. Source: BEA, 2011Q2 advance release,, Macroeconomic Advisers.

Second, looking abroad, the news is not so positive, even when casting one’s eyes to East Asia. Last week, the OECD circulated the August release for leading indicators (discussed in these posts: [3] [4]). Europe is near 100, which is the long term trend. Surprisingly, so too is China.


Source: OECD, “OECD composite leading indicators continue to point to slowdown in economic activity,” August 8, 2011.

Returning to the issue of stimulus in this economic context, for the latest primer on what happens in the short run when spending is cut and tax breaks for liquidity constrained households are reduced, see this letter from the CBO. See also IMF MD Lagarde’s views.

31 thoughts on “The Slowdown at Home and Abroad

  1. A.West

    The answer is: even though politicians are short term thinkers, they at least have some slight concept of the long term, unlike the knee jerk static Keynesians who wouldn’t mind building useless anti-alien machines, as long as it “creates jobs” and “demand”.

  2. 2slugbaits

    What’s all this treacherous and treasonous talk in the CBO paper about supply and demand curves? Doesn’t Director Elmendorf know that there’s only one curve…the supply curve? Director Elmendorf is still thinking old school commie pinko Keynesian economics. He needs to get with the program before Kansas politicians treat him ugly.

  3. Moopheus

    “Why are some US policymakers so dead set on withdrawing stimulus?”
    Because they don’t really care about creating jobs? Or at least, not enough to overcome other political constraints. Their campaigns are funded by people and corporate interests who do not want stimulus. People who fundamentally do not accept the notion of a “public interest.” They see anything public–whether it’s a utility, a school, a park, a highway–as an imposition, a cost they derive no benefit from. Also, an opportunity for profit and control, if they can get there hands on it. Sure, they’re okay with certain parts of the government they see as protecting their interests–defense, some parts of the court system–but otherwise it’s an obstacle to be gotten rid of. Stimulus and social programs are helping people that they have already written off.

  4. Samuel Conner

    Re: “anti-alien machines”; that’s rather unfair. Keynesians prefer useful investments to useless expenditures. But they do believe that even unproductive public expenditures can be short-term stimulative. That was the point of Paul Krugman’s recent celebrated comment about the stimulative effects (within the US) of US war preparations and war expenditures.

  5. Bryce

    “Why are some US policymakers so dead set on withdrawing stimulus?”
    1) An interest in averting the eventual bankruptcy of our country.
    2) A realization that the best thing our govt can do to aid the economy is to reduce the burden that govt inflicts upon the economy. It worked superbly in the deep recession of 1920-21.

  6. The Rage

    Bryce, no it didn’t. It lead to a continuation of poor financial state after WWI and it imploded wildly in 1929. Which ended up so bad, all the growth was lost from the 22-28 period.
    Britan’s economy outright struggled in the 20’s and never recovered.

  7. tj

    The stimulus congress passes with respect to tax cuts and investment stimulus is nothing more than a scaled up version of cash for clunkers.
    It creates a temporary blip in consumption then dies. It’s laughable to think that such temporary stimulus could create new and long lasting jobs at firms.
    The temporary stumuli might have worked if the slowdown was a 6 month slowdown. However, the slowdown is longer and stimuli should be aimed at investment projects and permanent policy changes. This temporary/ad hoc/partisan/keynesian stimuli increases federal debt with no long term return in the form of increased tax revenue (through future growth).
    So please, no more temporary keynesian pump priming.

  8. Ricardo

    Stimulus is very important and President Obama’s Ag Secretary and Paul Krugman show the way.

    Obama’s Secretary of Agriculture Tom Vilsack: “Well, obviously, it’s putting people to work. Which is why we’re going to have some interesting things in the course of the forum this morning. Later this morning, we’re going have a press conference with Secretary Mavis and Secretary Chu to announce something that’s never happened in this country — something that we think is exciting in terms of job growth. I should point out, when you talk about the SNAP program or the foot stamp program, you have to recognize that it’s also an economic stimulus. Every dollar of SNAP benefits generates $1.84 in the economy in terms of economic activity. If people are able to buy a little more in the grocery store, someone has to stock it, package it, shelve it, process it, ship it. All of those are jobs. It’s the most direct stimulus you can get in the economy during these tough times.”

    What a great idea for recovery! Everyone rush down to the food stamp office and pick up your booklet.
    The Paul Krugman has an even better idea, War with Space Aliens! What makes it even better is Mr. Krugman says we don’t even have to actually have a war with space aliens. If we just pretend that is all that is necessary. Oh, that man is so, so intelligent. I just don’t know how that argue with such an idea. Wow!
    If you would like a specially autographed tin foil hat to protect you from space beams please email Paul Krugman at the NYTimes – boy, I am sure they are proud of Krugman’s brilliance.
    And you wonder why the Obama administration hasn’t revived the economy. It is of course because we just need to try a double dose of this wisdom. We just haven’t distributed enough food stamps and tin foil hats.
    Who says the “Broken Window Fallacy” is dead?

  9. Rich Berger

    One thing that occurs to me about the “stimulus” and the quantitative easing that Gov. Perry is rightly concerned about is that both are attempts at creating the illusion that the economy is in better shape than it is. Essentially, both are magician’s tricks and it is not surprising that they are ineffective at best, harmful at worst.

  10. ppcm

    1. Housing starts
    2. Money supply M2, CPI-deflated (1975 prices)
    3. Treasury bill rate
    4. Share prices (Standard & Poor’s)
    5. Net new orders, durable goods;(industrial)
    6. Average weekly claims for unemployment benefit;
    7. Changes in crude materials prices and sensitive prices, smoothed
    8. Changes in credit (business and consumption);
    9. Net business formation.
    It is and has been easier to move the financial components of the LEI,than the industrial and commercial.It is, has been more and more costly to do so.
    Real Investment

  11. Bryce

    you couldn’t be more mistaken: The Great Depression stemmed from the credit bubble of the late 20’s primarily & the Hoover/Roosevelt responses secondarily.
    Seriously, you are blaming the 1930 collapse on the fact that in 1921 the govt responded correctly by reducing spending & taxes? To wit reducing its burden on society?

  12. Menzie Chinn

    A.West: Thankfully, you didn’t invoke cannibalism as you did in several of your previous comments. Re: your characterization of “static Keynesians”, you do know that there is a literature broadly termed “New Keynesian” which incorporates expectations, and even intertemporal optimization?

    aaron: Yes, I do. And then I think of what models would generate that result. And then I return to a set of more plausible models.

  13. aaron

    How implausible is it that spending largly does not produce productive or cost saving assets while further increasing our debt. And that people would be react by deciding they need to save more.
    And that the consumption of resources drives up living costs relative to income for most people, deceasing the ability to save, invest, pay down debt. That this expected future burden (living expense as a portion of disposable income) drives up the need for savings at the same time the ability to save is declining.

  14. Randy

    Aaron, perhaps you would like to explain how the implementation of your theories in the UK have led to slowing growth and worse economic performance than here or before they were implemented. I will be kind and not ask you to comment on the European benefits from austerity because that is more complex due to a flawed unified currency, but the UK is pretty much a perfect experiment of your position. I await your analysis.

  15. 2slugbaits

    Bryce You might want to do a little more research on the 1920-1921 recession. It is true that government decreased spending somewhat relative to 1920; however, there was a huge drop in tax revenues, much larger than the reduction in spending. The net effect was to dramatically reduce the large surplus in 1920. This could hardly be described as fiscal expansion through austerity. A tax cut does stimulate aggregate demand; it just isn’t a very efficient way to go about stimulating demand. Going from a very large surplus to a small surplus is the same as going from a balanced budget to a deficit. So I would describe the 1920-1921 experience as an inefficient application of Keynesian principles. Also, the New York Federal Reserve dropped the interest rate throughout the “recession.” Another standard piece of Keynesian economics. Finally, why did I put “recession” in quotes? Because it is not at all clear that there actually was a recession. If you look at the Dept of Commerce data, then there was a recession. But there is a reason why most economists ignore the Dept of Commerce pre-Depression GNP data…because it’s not trustworthy. It is not at all clear that there really was a drop in actual output. There was a big drop in the price level, but the evidence for a drop in output is weak. For example, Christina Romer wrote a paper a number of years ago that showed the Kendrick GNP series was superior and gave a different interpretation to the 1920-1921 recession.

  16. aaron

    Randy, your comment makes no sense. I suggest no policy other than less spending. That alone won’t help us, we also have an income distribution problem, which will take significant policy changes (tax structure and regulatory) to change before any budgetary policy can do any good. With the financial industry unwilling to lend to anyone but the government, there’s going to be some gdp claw back with austerity, naturally. But I’ve have no problem with debt if it not used just to goose short term numbers.
    If the British government had instead of austerity borrowed and then lent money at low rates to pay off existing debt or instituted a bubble debt forgiveness program, as I have advocated rather consistently for almost 3 years…
    I do wish I had the time and tools to do a case study. Is suspect you are making some rather naive assumption about British policy and the similarity to the US social structure.
    Alternatively, higher interest rates may benefit us in the long run. Short term pain that may put us on the road to recovery.

  17. Mark A. Sadowski

    I’ve studied the 1920-21 recession, and it sounds like your view of it has been heavily influenced by Powell, Woods and Murphy.
    First of all, according to the most widely accepted current estimates, the recession was relatively mild. On an annual basis real GDP only declined by 3.3% between 1919 and 1921 despite the end of wartime production. Romer estimates that unemployment only reached an annual average of 8.7% by 1921.
    Furthermore, the timing for the role of tax policy in the recovery is all wrong. The recovery from the recession started in August 1921. The Revenue Act of 1921 was not signed into law by Harding until November and was not implemented until 1922. By the time the Revenue Act was passed industrial production had already risen over 10%, and by the time it was implemented it was up over 15%. Furthermore it’s not clear that the Revenue Act of 1921 was really a tax cut. The top rate was reduced from 73% to 58% but the base at that rate was broadened from all income over $1,000,000 to all income over $200,000. The average effective tax rate actually rose from 3.7% to 4.0%.
    The recession of 1920-21 involves a shift from a wartime to peacetime production and a sudden deflation in the price goods that were severely inflated during the war (clothing and food). But I think it’s clear that monetary policy was the primary driver in both the recession and the subsequent recovery.
    The discount rate was the policy instrument in those days. It was raised from 4.5% in January 1920 to 7% in July 1920. The recession started in January but industrial production didn’t begin its swift decline until August. The discount rate was reduced steadily to 4.5% between April and December 1921, and it was further reduced to 4% by July 1922. Although technically the recovery began in August, industrial production didn’t begin to recover in earnest until October. It’s fairly well established that monetary policy lags were somewhat shorter in the pre-WW II period.
    A good paper on the 1920-21 recession is here (paid content unless you’re associated with a university):

  18. Bryce

    You say there was a huge decrease in tax revenue, but you are not sure there was a recession in 1920-21. Hmn.
    The govt was so much smaller then in relation to GDP that I suspect Keynesian analysis makes even less sense than normal. But you cannot deny that the govt did what I think they should have [in contrast to every subsequent recession]: They reduced the burden they were placing on the economy. And the 20’s were a period of stellar growth, tho’ ruined by the credit bubble of ~1927-8.
    I would speculate that the Fed Reserve–at that time teathered to a gold standard–may not have been the spring behind the drop in interest rates. I suspect the interest rate fell because free market prices ruled, & that this was another key to the excellent recovery.

  19. Bryce

    Mark Sadowski,
    Thanks for the details & the paper link. I would like to delve into this & earlier recessions in more depth.
    With govt smaller & the effective tax rate 3.7-4.0%, I suspect the US wasn’t on the 1st rung of the Laffer curve in 1920. [ & Damned few people made 100k in 1920.] So I would tend to make the modest claim that the govt’s contribution to recovery was trivial but positive. Not the trigger, consistent with what you present. Honest prices–relatively undistorted by the Fed–probably did the major work of the recovery.

  20. 2slugbaits

    Bryce You say there was a huge decrease in tax revenue, but you are not sure there was a recession in 1920-21. Hmn.
    Why the “Hmn.”? Revenues fell, but so did prices. The point is that the Dept of Commerce data for that time period really sucks. If there was a recession, as opposed to a large drop in the price level without any corresponding drop in real output, then it may have been a very weak recession. Even the govt does not trust its own data for this period. Read the Romer paper.
    And as I said before (and as Mark A. Sadowski also points out), the Fed lowered interest rates throughout the period.
    As to the 1920s being a period of stellar economic growth, have you checked the NBER dating of recessions? If you want to count the 1920-1921 period as a recession, then there were three recessions in less than 10 years. The 1920s was a boom/bust period fueled in large part by wild speculations in land and home prices.

  21. Ricardo

    Wow, it has taken decades for the central planners to even look at the recession of 1920-21 and they are spinning like a top.
    They would have you believe that markets don’t move based on the debate and sentiment in the country. To them markets only move after the bill is passed. The fact that Harding ran on a “return to normalcy” and won by a landslide had nothing to do with recovery. So, no one anticipated Harding’s election and the tax bill he would sign. Investors never are forward looking.
    But then the real question is how could the economy recover so quickly without stimulus from the government?
    Check this out:

    The 1920-21 deflation: the role of aggregate supply
    by J.R. Vernon
    The 1920-21 recession in the United States was brief relative to the Great Depression of a decade later, but it included a remarkably sharp price deflation. The decline in the GNP price deflator from 1920 to 1921 is the largest one-year percentage decline in the series in the more than 120 years covered. This is true whether the Department of Commerce [1986] estimates or the recently provided Balke and Gordon [1989] or Romer [1989] estimates are used. These estimates produce one-year deflation figures of 18 percent, 13.0 percent, and 14.8 percent, respectively. The closest competitor is the 11.5 percent deflation recorded for 1931-32, the third year of the Great Depression. (1)
    Annual data for wholesale prices tell a similar story. Wholesale prices declined by 36.8 percent for 1920-21, the largest one-year decline on record, going back at least to the American Revolutionary War period.
    The 1920-21 deflation contains another striking feature. Not only was it sharp, it was large relative to the accompanying decline in real product. The ratio of the percentage decline in the GNP deflator for 1920-21 to the percentage decline in real GNP is 2.6 using the Department of Commerce figures, 3.7 using the Balke and Gordon data, and 6.3 using the Romer data. By contrast, during 1929-30, the first year of the Great Depression, the GNP deflator declined by 2.7 percent and real GNP by 9.4 percent, for a ratio of 0.3. The ratios of the percentage decline in GNP prices to the percentage decline in real GNP for 1930-31, 1931-32, 1932-33, and 1937-38, the other Great Depression years in which real GNP declined, were 1.0, 0.9, 1.2, and 0.3, respectively, all well below the 1920-21 figures.
    This paper examines the 1920-21 deflation. It asks why the deflation was so sharp, both in itself and in relation to the decline in real product. The answer, the paper concludes, is that the deflation was produced by a sharp decline in aggregate demand combined with an increase in aggregate supply, a supply increase in which deflationary expectations played a prominent role.

    While the conclusion is in Keynes-speak it is true that the 1920-21 recession’s rapid recovery was because government did not intervene to prop up demand, so demand declined and savings increased leading to increased supply and *poof* no more recession.

  22. Randy

    Aaron, your response makes no sense to me, though I do not claim to have read all of your posts (or any, for that matter, until this one.). However, the facts are that the Cameron government cut government spending based on the theory it would spark economic activity. What has happened instead, as predicted in nearly any intermediate micro textbook, is contraction. So we are still waiting for austerity to lead to growth. And as Minzie wrote, General Franco is still dead.

  23. aaron

    Randy, what was the size is the spending reduction and the size of the contraction (nominal). How does that compare to other economies during the same economies?
    However, this year analysis isn’t very useful. What you call a contraction is more likely a price correction. What we are concerned with is the long term.
    Did Britian’s private sector contract more than others? After the cut spending is added back in? More important is how its private sector growth rate compares after the initial contraction and adjustment.
    Britains government is also a larger portion of their economy, they are more urbanized, have higher population density (makes civil unrest more of an issue)…

  24. Mark A. Sadowski

    You wrote:
    “Wow, it has taken decades for the central planners to even look at the recession of 1920-21 and they are spinning like a top.”
    If by “central planners” you mean economists other than Austrians, it’s actually the other way around. Hayek mentioned the 1920-21 recession only casually in “Monetary policy in the United States after the recovery from the crisis of
    1920” (1925), instead choosing to focus on monetary policy as a precursor to the Great Depression. Rothbard would do a similar thing, but that would not happen until 2002 (in “A history of money and banking in the United States: The Colonial Era to World
    War II”). And Mises does not appear to have written about the 1920-21 recession at all. So the first Austrian economists to have written about the 1920-21 recession seem to have been Murphy, Powell and Woods, and their (separate) articles were all published in 2009.
    If you go to Google Scholar, a search of economics articles on the 1920-21 recession will turn up literally hundreds of entries. And I believe the first person to write extensively on the 1920-21 recession was actually Thomas Wilson in chapters 11 and 12 of “Fluctuations in Income and Employment”, which was published in 1941. So it’s actually the Austrians that have only recently discovered the 1920-21 recession, and as usual they get most of their facts wrong.
    You also wrote:
    “They would have you believe that markets don’t move based on the debate and sentiment in the country. To them markets only move after the bill is passed. The fact that Harding ran on a “return to normalcy” and won by a landslide had nothing to do with recovery. So, no one anticipated Harding’s election and the tax bill he would sign. Investors never are forward looking.”
    The problem with that theory is that Harding would have to have actually represented meaningful change. The things that Austrians usually refer to, cuts in spending and taxes, are all a bunch of piffle if one actually bothers to research the facts:
    1) As Kuehn notes, the 3-month moving average of the difference between federal expenditures and federal tax receipts turned and remained positive (indicating a budget surplus) in November 1919. Thus, net federal borrowing ceased a whole year before Harding was elected to office, and two whole years before he even passed his first budget. When Harding took office in March of 1921, the Wilson administration had already reduced monthly federal spending to 17% of its war-time high with the bulk of this reduction having been achieved by the end of 1919.
    2) I’ve already addressed the tax issue above. The Revenue Act of 1921 mainly reduced taxes for those households whose adjusted gross income exceeded $1,000,000, hardly a great change.
    So in short no one really expected Harding to cut spending because it had already been cut. And I don’t know about you, but if I wasn’t a member of one of the 21 households whose adjusted gross income actually exceeded $1,000,000 in 1921, I don’t think it would have made much of a difference in my “sentiment”.
    The theory that landslide elections lead to booms is novel though. But, I sure you’ll agree, it certainly doesn’t jibe with the 1937 recession.
    You also wrote:
    “But then the real question is how could the economy recover so quickly without stimulus from the government?
    Check this out:”
    Have you read Vernon’s paper? It’s actually very consistent with most of the other mainstream literature on the 1920-21 recession. It’s main distinction is that it focuses on the positive shift in AS in order to explain the sharp deflation of 1921. But nowhere in the paper does Vernon suggest that Harding’s policies, or even the expectations of Harding’s policies, had anything remotely to do with that shift.
    Furthermore, although Vernon isn’t really concerned with the cause of the recovery, he implicitly alludes to it in his discussion of the cause of the downturn:
    “Friedman and Schwartz [1963, 205-39] attribute the severe phase of the 1920-21 recession and its attending deflation to monetary restraint. Monetary policy was expansive throughout World War I, including the period of U.S. neutrality. Policy remained expansive during most of 1919, even though by summer an inflationary boom was underway. The Federal Reserve was pegging interest rates at a low level using its loan discount rate in order to accommodate the Treasury’s funding of the war debt. The Fed also had an interest in protecting commercial bank portfolios, which contained substantial quantities of war bonds and loans secured by war bonds.
    Monetary policy began to shift in December 1919, then changed markedly in January 1920. The Federal Reserve Bank of New York’s discount rate, which had been pegged at 4 percent since April 1919, was raised to 4.75 percent in December 1919, to 6 percent in January 1920, and to 7 percent in June 1920. Similar discount rate increases were made at the other Federal Reserve Banks.
    Friedman and Schwartz argue that these sharp increases came too late to be responsible for the January 1920 turning point but that they produced the severe contraction and deflation which came after mid-year. The monetary base and the M2 money supply merely leveled off during the first half of 1920, as the higher discounting costs had only a moderate effect on commercial bank discounts at Federal Reserve banks for a time. However, both the monetary base and the M2 money supply peaked in the autumn and then declined substantially over the next year. The decline in the monetary base from October 1920 through January 1922 was the largest recorded for so short a period in the Friedman and Schwartz series, a series dating back to 1867. The M1 money supply peaked earlier, in March 1920, but Friedman and Schwartz emphasize the behaviors of the M2 money supply and the monetary base in their discussion.”
    Of course the flip side of this is that the Fed subsequently dropped the discount rate and allowed the monetary base, M1 and M2 to increase, which is what most economists consider to be the cause of the recovery from the 1920-21 recession.
    In fact, if you read then NYFRB President Benjamin Strong’s writings from this period (“Federal Reserve Bank Policy 1914–1921”), being the central planner that he was, it’s pretty clear that at least he thought that he (necessarily) caused the recession, and in turn was responsible for the recovery.
    And Friedman and Schwartz appear to be in full agreement.

  25. endorendil

    Here’s a thought. The eventual bankruptcy of the US federal government is guaranteed due to the fact that an annoyingly persistent majority of voters wants the US to look like a modern, developed nation, combined with the fact that the financial and economic system would collapse if taxes were used to pay for it.

    If we can just accept that as a given, the question remains when we want it to happen. In my view, the longer the US staves off bankruptcy, the better prepared the rest of the world will be to deal with it. That is bad for the US because it means that after the bankruptcy, the world will enact prepared responses. It would be much more desirable to catch the world unawares, because it should cause much less damage. Case in point: the US dollar remains strong and treasuries command extremely low interests because instability causes a flight of capital to the US, even if the instability is caused by the US.

    So shouldn’t there be a strong case to cause a real bankruptcy (i.e. not a small technical default) as soon as possible? Who is China going to lend to, if not to the country it has the highest trade surplus with? What would replace treasuries as safe havens after the US fiscal crisis is solved for decades by wiping out most of the debt? Yes, interest rates will go up, but with little debt to pay off, it won’t matter. Yes, the dollar will lose value, and will probably lose its supremacy as a reserve currency, but that is inevitable, and international trade will still be done largely with dollars for decades to come. The main point is that the US will still be able to borrow what it needs to finance its deficit, and the crisis will allow the drastic measures that are needed to fix the problem indefinitely (more taxes if the US wants to remain a modern nation, less spending if the US wants to become more like China).

    Just thinking, you know. It seems that a surprise, unstructured bankruptcy would put the US back in a position like it had at the beginning of the last century: a large economy that gets little or no respect internationally but which has potential.

    Too Pollyannaish? Perhaps. But to me it seems clear that an early, unexpected bankruptcy would be preferable to a long decline into it. Bring on president Bachmann…

  26. Michael-Jay Perlman PhD

    RE: Foodstamps and etc. as a stimulus. How many of y’all out there can live on under $21,000 with children and a mortgage or rent to pay? The farm price supports alone are greater in total value of the entire Foodstamp program. And Congress did away with the WIC program or cut it to the bone. Given the theory that any government assistance is a stimulus, what about Social Security or Medicare? Should these be put under the cutting knife, too?

  27. Bryce

    Sadowski, slug, Ricardo:
    I believe 1920-21 was indeed a deep recession beyond debate. Industrial production fell 30%; unemployment went from 2% to 12%.
    With the severest deflation in consumer prices, for the Fed “allow” the discount rate from 7% to 4% seems like nothing in the days of the Bernanke.
    That the gov’t did little [& what little it did was un-Keynesian] certainly seems positive. Perhaps the fact that they didn’t muck up the price system & let prices quickly reflect economic reality it the key lesson to be learned as to why the recovery was swift.

  28. Randall Parker

    My advice for people who are only making $21k per year: Don’t get a mortgage and don’t make a baby.
    The US is running over 10% of GDP fiscal deficit. Why isn’t this big fiscal stimulus leading to growth?
    My answer: Peak Oil. The economy can’t afford this level of oil prices. Debates about what is the best fiscal or monetary policy miss the point that no fiscal or monetary policy can fix the root cause of our stagnant economy.
    With or without a federal debt default the US does not have big potential for economic growth over the next 10 years.

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