Arnold Kling  

Scott Sumner Fights Dirty

Two Notes on PSST... Bet on Inflation...

He looks at data.

Housing starts peaked in January 2006, and then fell steadily for years: January 2006 -- housing starts = 2.303 million, unemployment = 4.7% --April 2008 -- housing starts = 1.008 million, unemployment = 4.9% --October 2009 -- housing starts = 527,000, unemployment = 10.1%

Ouch. I would prefer to use residential construction activity, rather than housing starts (which tend to lead construction spending by several months), but the point remains. Most of the decline in housing construction was behind us by October of 2009.

The other point I would make is that it is unfair to compare almost any variable to employment over the past 2+ years. That is the point of Brad DeLong's post. In terms of explaining weak employment, the aggregate production function approach falls short also. Or, as Ed Leamer puts it,

the national job markets certain structural problems that have created a mismatch between what employers are looking for and what unemployed workers have to offer. These structural issues include the loss of manufacturing jobs to a variety of "competitors" both technological (robots, microprocessors) and human (foreign workers and recent immigrants willing to work for less) and the housing crisis that continues to jeopardize the construction sector. Unlike in previous recessions, Leamer opines, workers today are not easily returning to the jobs they lost and as a result the economy must find a way to create jobs for millions of workers whose skills lend themselves more suitably to manufacturing and construction.

I think that the behavior of macroeconomic variables in this recession poses some awkward issues for everyone.

1. The big drop in GDP occurs after most of the drop in home construction.
2. The financial indicators, including risk spreads, stock prices, and bank profits, recover fairly nicely, but real GDP does not.
3. Whatever recovery shows up in GDP is not matched by a recovery in employment.
4. A simple linear Phillips Curve of the form inflation = 7.0 - unemployment would say that we should have prices falling at an annual rate of 2 percent now, rather than rising. (Admittedly, this is not a powerful point, because inflation can be measured in various ways, and nobody said that the Philips Curve was linear.)
5. In my recollection (which may be wrong), steep recessions tend to be followed by brisk recoveries. Not so this time.

In short, there is a lot about this recession that I think is puzzling. Sumner has a story for (1) and (5), but it is hard to reconcile with (2) and sidesteps (3) and (4). The recalculation story helps with (2)-(5), but it is hard to reconcile with (1).

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CATEGORIES: Macroeconomics

COMMENTS (8 to date)
Steve Sailer writes:

You also need to consider the importation of a huge number of Spanish-speaking construction workers during the Housing Bubble, and the largely successful efforts to freeze them in place in hopes of getting in on an amnesty during the Housing Bust.

Phil Rothman writes:

I don't agree that Scott Sumner 'sidesteps (3),' since weak employment growth may simply reflect very weak GDP growth (and a highly nonlinear Okun's Law). Also, I don't know if your recollection in (5) is wrong per se, but it is not consistent with the rather substantial macroeconometrics literature on 'business cycle asymmetry' (fast 'downs' followed by slow 'ups') that developed over roughly the past 25 years and which can be motivated by, e.g., Milton Friedman's 'plucking model' of the business cycle.

Elvin writes:

Oil, don't forget about oil.

My off-the-head guess is that the drop in housing construction dropped GDP growth by 1% to 1.5%. Rising energy prices created another 1.5% to 2.0% hit in early and mid-2008. Finally, the drop in asset prices, especially housing, hits household wealth and stops mortgage-equity extraction--a key component of consumption growth in the mid-2000s--and slows growth another 1.0%. Then the bad news hits the financial sector and we spiral to into a mini-depression. (Didn't Bernanke write about the financial/credit accelerator?)

The recovery is tepid because of a very low level of housing construction and household net wealth is still not up to the 2007 peak. Until we work off the high inventory of homes, growth will be below normal for a recovery.

Steve Sailer writes:

Right, and one of the lessons we learned in 2008 is that oil prices could go through the roof, which makes all those newly built homes in the long commute exurbs bad bets.

Dave Schuler writes:

Aren't many of your questions resolved if, rather than thinking of the structural changes as something that has only happened recently, it is considered to have been something that actually occurred fifteen or more years ago and the reckoning has been postponed by two successive bubble economies?

Tom Grey writes:

Steve S. is more correct, I flatly do not believe the April 2008 4.9% unemployment accurately reflects the illegal aliens.
But I also think many started going home, and that's when GDP really fell. Much much less demand, as well as fewer actual prime-working age people. The loss of illegal alien rental payments and cash purchasing is not caught in the data.

The data is too polluted to trust.

Um, also American workers are overpaid. The Global Recalculation is going on, and global growth continues, and the really really non-American poor in China and India are looking at better living standards.

Noah Yetter writes:

Unlike in previous recessions, Leamer opines, workers today are not easily returning to the jobs they lost and as a result the economy must find a way to create jobs for millions of workers whose skills lend themselves more suitably to manufacturing and construction.

WHICH previous recessions? I've lived through the 1990, 2001, and 2007 (current) recessions and none of them fit this imagined ideal of a simple blip from which we recover in the same pattern as before. What's more, I literally cannot imagine the circumstances that would lead to such a chain of events.

fundamentalist writes:

There is a danger of the post hoc fallacy in Sumner's analysis. Before this crisis people committed the same fallacy with oil prices. Oil prices and the housing bubble/collapse are merely symptoms of a larger problem. They are not causes of anything. Besides, there was a bubble in autos, too, and probably many other areas, such as eating at restaurants and commercial real estate.

The cause was credit expansion, which caused the Ricardo Effect to kick in. The housing bubble and collapse were merely the working of massive credit expansion.

As for the lag between the housing bust and the rise in unemployment, the explanation could be as simple as business owners wanting to hang on to good employees as long as possible and hoping for a quick turn around.

And concerning the jobless recovery, that would be explained by the Ricardo Effect as well. Massive stimuli keep labor cheap relative to consumer goods, so consumer goods makers use more labor and buy less capital equipment. Since the highest unemployment is in the capital goods manufacturing sector, unemployment remains high because of the stimuli.

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