Arnold Kling  

A Bet on PSST vs. AS-AD?

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Karl Smith is interested in some sort of bet.


I, however, will predict that the US will achieve an average 5% real growth [rate] over a sustained period [of] say 12 quarters [or] more starting within five years.

Tim Pawlenty will see Karl and raise him.

Meanwhile, I believe that real GDP is trend-reverting, and it is hard to see how it gets back to trend without a period of strong economic growth, so I think I am more inclined to bet with Karl than against him.

From the perspective of PSST vs. AD, an interesting bet would focus on the structure of employment post-recovery vs. pre-recession. So let's say that we get back to something like full employment in 2015 (the middle of President Palin's first term). My guess is that the proportion of people holding jobs in 2015 that are similar to those they held in 2007 will be much less than, say, the proportion of people holding jobs in 1999 that was similar to those they held in 1991. That's a harder bet to construct, but I think it more clearly differentiates AS-AD from PSST. I want to suggest that the current recession is due to a severe disruption of patterns of trade, and as a result we will see a more dramatic change in the job structure now than we did during a more tranquil period.


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COMMENTS (6 to date)
Daniel Kuehn writes:

If we could figure out a decisive proposition to bet on, we could figure out a decisive empirical specification to test the question.

Since the latter is always messy and speculative in macro - and we've been trying for decades to get it - it's doubtful you'd be able to ever get the former.

Macroeconomic empiricism is always a combination of theoretical corroboration and good historical narratives (Friedman and Schwartz present one of the classic examples of this approach).

Matt R. writes:

Arnold,

Can you clarify something: How could you believe in PSST and believe that GDP was trend reverting?

I would have thought that PSST implies permanent supply shocks drive the business cycle. As a result, I would have thought that you believed real GDP had a unit root and was not trend reverting.

Am I just too wedded to AD/AS to make sense of PSST?

Noah Yetter writes:

I would also question the idea that GDP growth is trend-reverting in any meaningful way. I think it appears trend-reverting because it arises out of our fundamental natures which don't much change, and because it is substantially limited by both the constraints of the physical universe and of the political universe.

The demographic shock currently underway in the US, combined with the incipient debt crisis, plus a general tendency towards worse economic policy over time, would lead me to bet solidly against Karl Smith.

Dave writes:

What did the "This Time It's Different" authors find that far out from a financial crisis? Were the recoveries still sluggish up to 8 or 9 years out from the crash? That's what I would use as my basis for choosing a side...

Yancey Ward writes:

The only way Smith could win his bet, in my opinion, is for things to get much, much worse before beginning a recovery. Seriously- 5% real growth over a 3 year period?

James A Donald writes:
"Meanwhile, I believe that real GDP is trend-reverting, and it is hard to see how it gets back to trend without a period of strong economic growth,"
Countries that reward failure and punish success suffer major permanent declines in GDP. Bailouts are a reward for failure. That is why Japan has been stagnating. Japanese growth has not returned to trend. Why then should our growth return to trend?
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