Food for Thought: Did the Great Recession Kill the Great Moderation?

For college students, here’s a bit of ancient history.

As recently as early 2008, macroeconomists spent a lot of time talking about the Great Moderation. Then the Great Recession of 2007-9 hit.

What was the Great Moderation?

Well, first let’s review what macroeconomists think about the Great Recession. That’s a cute name, but it wasn’t coined by macroeconomists. But no one really knows when that name was coined: here’s where it gets ridiculous — for a while people have been calling every recession the great recession until it turns out that it didn’t hurt that much. Well, whatever … I think the name has finally stuck to the 2007-9 recession. Second, as emphasized in class, once you treat the data like you actually care about realistically accounting for average growth … the Great Recession of 2007-9 looks comparable to the bad ones we had in 1981-2 and 1973-5.

So, the Great Moderation is the name given to the period from 1982 through 2007 where we had 3 long expansions (2 of them pretty strong ones too), that sandwiched 2 weak and mild recessions. That’s an entire generation where the U.S. macroeconomy was remarkably benevolent to us.

I think if we went outside of macroeconomics, people would say that of course the Great Recession killed the Great Moderation. But for macroeconomists that’s an open question that someone needs to examine.

New research by Gadea, Gomez-Loscos, and Pérez-Quirós checks the U.S. real GDP data for structural breaks — that is, changes in the underlying structural process that’s generating the data. What they look for is 0, 1, or 2 structural breaks: if there’s 0 there never was a Great Moderation, and if there’s 2 there was a Great Moderation but it ended. But what they find is that the data shows just one structural break, in the early 1980’s corresponding to the onset of the Great Moderation.

One hallmark of the Great Moderation was that the last 2 of the 3 expansions started out weak, and stayed weak for quite a long time (2-4 years) before picking up steam.

I’m sure there’s more research to come, but this first shot at the problem suggests that the Great Moderation is ongoing, and as a corollary, that the Obama expansion — which is getting on the long side but which has never been strong — is a continuation of the pattern.

Why Is Macro So Hard: Social Desirability Bias (Or Caplan Channels Landsburg)?

In a piece on social desirability bias (our tendency to be in favor of things that sound good, while not actually doing them), Bryan Caplan asserts that Steven Landsburg would say something like this:

X being good is a reason to do a lot of X - not a reason to do more X.

I’m reminded of the reductio ad absurdum in Monty Python’s series of Dennis Moore sketches. Dennis is a highwayman who steal from the rich to give to the poor … until the rich are no longer rich, and the poor are no longer poor.

We see this a lot in things like policy proposals to help senior citizens financially. Except that seniors are the richest age group. But no one wants to make the distinction that helping Grandma a lot is not the same thing as helping Grandma more than we already do. Perhaps we ought to help Grandma a lot, but less than we actually do. It’s kind of ridiculous if you think about it: we’re so biased we can’t actually even ask if Grandma’s doing OK as it is.

Why Is Macro So Hard? The Things We Won’t Talk About

Here’s a quote:

You can say anything you like about sex nowadays, but the moment the topic turns to fiscal policy, there are endless things that everyone knows, that are even written up in textbooks and scholarly articles, but no one is supposed to talk about in public.

So I make no claims to thinking in tune with the author generally, or approving of the source article.

I would say that the problem is broader than fiscal policy though.

So what are some random things with fiscal policy that we’re not allowed to talk about? How about:

• Government deficits move with the business cycle: lots of politicians claim responsibility for movements toward budget surplus that are nothing more than side effects of business cycle expansions.
• Governments run deficits in some months and surpluses in others. You’d think this would lead to volatile economic outcomes if deficits were actually important. It doesn’t because they’re not.
• If you thought it was good that Clinton ran surpluses, don’t forget that Bush II did too.
• If you though those surpluses were good, don’t forget that they were the aftereffect of large national tax increases in 1990 and 1993.
• Obama is known for his stimulus package. Bush II should be too.
• Republicans: you can be in favor of reducing taxes without tossing out the trope that the Laffer curve operates everywhere all the time. It doesn’t. It’s not even close.
• Reagan didn’t cut government spending. In some areas he cut the growth rate of government spending.

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Obamacare as Redistribution

I don’t think anyone thinks Obamacare was not about a whole bunch of issues simultaneously.

And I don’t think anyone has any doubts that it was about helping the poorest, who have the most trouble affording healthcare, at the expense of the rich.

OK. So Obamacare is partly about income redistribution. Fair enough.

The thing I don’t think many people realize is that many assume that they are in the income category that benefits. For most people, this just isn’t true.

Check out this chart:

That’s not exactly redistributing from the 1% to the 99%.

In terms of deciles, the middle class is typically defined as the 3rd through the 8th. For perspective, most business school professors are in the 9th decile, and I don’t think casual observers would regard us as “rich”. But, the 9th and 10th deciles are what we more-or-less officially classify as rich.

There are a number of sources to figure out where you sit in those deciles, but a particularly fun and easy tool to assess your income percentile is available at Political Calculations. It shows that in 2014 the cutoff between the 2nd and 3rd deciles was at about $22K in annual income for a household (I chose household rather than individual because most health insurance is sold to cover households).

In sum, the redistributive component of Obamacare is from the rich and the middle class to the poor.

The source for this is a paper from Aaron and Burtless at The Brookings Institute. Here’s an executive summary. Neither of those guys, or Brookings, is regarded as supporting Republicans, conservatives, or libertarians. So this is very much Democratically-sympathetic economists telling us that it’s not about helping the middle class.

Inequality Seems to be Mostly About Where You Work

Income inequality is a big deal in contemporary political discussions. Lots of people believe the appropriate response to that is to redistribute from richer individuals/families to poorer individuals/families.

But what if what's making the rich is rich is ... who they work for?

New research indicates that inequality between firms (do people get paid the same at different employers) is a bigger deal than inequality within firms (do people get paid more or less in the same place).

Common thinking is that it must be the latter: the executives are getting paid too much.

But the data doesn't show that. Instead it shows that there are companies that are doing very well where everyone is getting paid more.*

For example, the employee at the 90th percentile earned 1.69 times as much as his firm’s average wage in 1980, and 1.73 times as much in 2013. An employee at the 99th percentile earned 3.57 times his firm’s average in 1980, and 3.48 times in 2013.

They also checked whether it was only the tippy-top executives that were driving inequality:

... They did find the top 0.2% of earners at firms with more than 10,000 employees did see their income grow much faster than other workers at their own firms.

That's not many people: 20 out of 10,000 whose pay is growing faster than everyone else's. We could make an argument about inequality and "those rich", but it isn't a very large group, and would be unlikely to yield enough money to support any sort of redistribution program.

Currently, there are three explanations being explored for inequality between firms:

• Sorting: the more promising firms are getting better at isolating and hiring the more promising job candidates.
• Core Competencies: the firms that are doing so well are outsourcing a lot of their work to contractors (who don't pay as much) reserving a bigger pie for those left behind, or
• Barrier to entry: the successful firms are better at preventing free entry, that might reduce revenue, and ultimately what compensation could be afforded.

My money is on the last one.

Read the whole thing entitled "What’s Driving Inequality: CEO Pay or Company Success?" on The Wall Street Journal's website, or retitled "Inequality — A Company Thing" in the November 5 print issue.

* I can contribute a personal anecdote here. I have a friend who moved to the bay area in 1978. He had zero future (not too bright, not ambitious, undereducated, slacker personality). Anyway, he got a job as a janitor at chip maker in Silicon Valley and retired before he hit 50, mostly on the basis of stock options and the high risk strategy of reinvesting his retirement contributions in company stock.

Why Isn't Pay Increasing?

A common grouse about the economy is that income is not going up for most workers.

This is only partly true. Compensation is going up normally. That's what the firms pay out. But workers are choosing (or complicit with) compensation increases going to things other than income.

And then we complain because our income hasn't gone up. That's kind of immature.

Average hourly wages have grown slowly since the end of the recession in mid-2009, advancing at a pace of about 2% annually or about 12% since the expansion began, despite steady job creation. In the 20 years before the most recent recession, hourly earnings grew, on average, better than 3% annually. Weak wage growth has been blamed for a wide range of soft spots in the economy, including uneven consumer spending, historically low inflation and many renters’ inability to purchase homes.

Benefits, meanwhile, have increased at a slightly faster clip, 15% since the expansion began. That’s actually a continuation of a much longer trend. Since 2001, benefits increased nearly 60%, while wages advanced 40%.

So, all those stories you hear about the great perks of working at, say, Google, contribute to the data showing that wages and salaries aren't going up as fast as we would like. That's been mostly a talking point for the Democrats over the last few years. And yet both parties are showing a modest increase in mandating something like paid family leave.

Read the whole thing, entitled "Paying with Perks May Carry Cost" in the November 2 print issue of The Wall Street Journal or online in the retitled piece "Shift to Benefits From Pay Helps Explain Sluggish Wage Growth".

Young Macroeconomists: Spread the Word

Usually, conservatives writing in conservative publications are trashing Obama and the Democrats. Not this time.

Do note that this is from an opinion piece, so your mileage may vary.

Anyway, macroeconomists don’t push the idea hard enough about how good life on planet Earth actually is, thanks to economic growth. Here’s Kevin D. Williamson writing in Reason:

… Polio has been eradicated everywhere on Earth except for two places where those who would eradicate it are forbidden to operate: Afghanistan and Pakistan. That’s the Taliban’s gift to the Islamic world: paralytic polio.

That’s really good news, right? How come you probably didn’t know about it? That’s weird, right? I suppose it’s bad that you didn’t know about it, but really, it isn’t your area. It’s the sort of thing that someone who cares about making life better should have told you about. What’s weird is that you have to hear it from a macroeconomist, in a class targeted at upper-level majors.

… Economist Angus Deaton, recently awarded the Nobel prize, has spent much of his career working on how we measure consumption, poverty, real standards of living, etc. It is thanks in part to his work that we can say that the global rate of “extreme poverty,” currently defined as subsistence on less than the equivalent of $1.90 a day, is now the condition of less than 10 percent of the human race. In the 1980s, that number was 50 percent — half the species — and as late as the dawn of the 21st century, one-third of the human race lived in extreme poverty. The progress made against poverty in the past 30 years is arguably the most dramatic economic event since the Industrial Revolution. It did not happen by accident. [emphasis added]

The one thing we can be sure of is that it didn’t happen because of government programs. I’m not being anti-government here at all, and neither is Williamson. But let’s be clear: the biggest reason for that is because China moved away from government control of stuff.

Williamson uses a metaphor that I often use in class.

What I sometimes refer to as the black-hats/white-hats school of political analysis.

Too many people start out by deciding who gets to wear the white hats and who has to wear the black hats, and then designing their worldview, or worse their policy prescriptions, around that choice. Some clarity may help you understand why that’s a big problem.

… We have achieved a remarkable thing in that unless we mess things up really badly, in 50 years we’ll be having to explain to our grandchildren what a famine was, how it came to be that millions of people died every year for want of clean water — and they will look at us incredulously, wondering what it must have been like to live in the caveman times of the early 21st century.

Read the whole thing, entitled “From Polio to Poverty, We Are Winning”.