John Cochrane* On the Weak Recovery

From an interview in the Federal Reserve Bank of Richmond’s Econ Focus:†

EF: What do you think are the biggest barriers to our own economic recovery?

Cochrane: I think we've left the point that we can blame generic "demand" deficiencies, after all these years of stagnation. The idea that everything is fundamentally fine with the U.S. economy, except that negative 2 percent real interest rates on short-term Treasuries are choking the supply of credit, seems pretty farfetched to me. This is starting to look like "supply": a permanent reduction in output and, more troubling, in our long-run growth rate.

Long-term growth is like a garden. You have to weed a garden; you don't just pile on fertilizer — stimulus — when it's full of weeds. So let's count up the weeds. A vast federal bureaucracy is going to be running health care and has cartelized the market. Dodd-Frank is another vast federal bureaucracy, directing the financial brains in the country to compliance or lobbying. The alphabet soup of regulatory agencies is out there gumming up the works. Then there are social programs. The marginal tax rates that low-income people face, along with other disincentives to move or work, mean that many of them are never going to work again. When the economy was steaming ahead, this didn’t really cause much trouble, but now many recovery mechanisms have been turned off. If a Martian economist parachuted down, would he not be struck by the vast number of disincentives and wedges the government places between willing employer and employee? Would he or she really say "the one big wedge between you hiring someone to make something and sell it is the zero bound on nominal Treasury rates"? Finally, uncertainty is surely a part of it. Investing and hiring has some fixed, irreversible costs, and the chance that policy could be even worse gives people an incentive to delay.

This is all really hard to quantify, and it's time somebody did. Unfortunately, it's much easier to focus on "demand," or the zero bound, or fiscal stimulus — one big magic bullet, and not the thousands of weeds.

Cochrane’s argument that the weak recovery looks like a supply problem echoes the posts I’ve made on this blog over the last two years that it looks like the U.S. economy has managed to cut loose a part of the labor force that (presumably) wasn’t carrying its weight.

I like the Martian metaphor, but I don’t think it’s well stated. Let me try and do better (and let me know if I don’t). If a Martian came to Earth and tried to figure out why the recovery was weak, would they accept the 1) simpler, single explanation that businesses aren’t expanding because our near zero interest rates aren’t low enough to justify the investment, or 2) the more complex set of explanations about why it’s harder for managers to hire people to expand production. Cochrane’s point is that a lot people accept the first argument because they don’t want to expend the effort to understand the second one.

* John Cochrane is a macroeconomist working on the borderline of macro and finance (sort of like me, except he’s a superstar). He has been on the faculty at the University of Chicago for close to 30 years, wrote one of the top graduate finance texts, and may win a Nobel Prize in the next 20 years or so. When he talks, you should listen.

† Each Federal Reserve Bank publishes free several things, weekly to annually, that cover macroeconomics and finance at a level that undergraduates can understand. If you’re curious, start looking.