In the Wall Street Journal today, Alan Blinder, talks up the economy and show’s his optimism (naivete) of things to come.
By ALAN S. BLINDER
The U.S. economy is digging itself out of a deep hole. You have probably heard a lot of doom and gloom lately, including talk of a jobless recovery, an L-shaped recovery (which means no recovery at all), or even a W—the feared double-dip recession. The Scrooges have a point: There are serious dangers to the nascent recovery. But you’ve heard all that many times. Let me offer instead, in deliberately one-sided fashion, the case for optimism. It is, after all, the holiday season.
The case begins with the “slingshot effect” I wrote about on this page last summer (“The Economy Has Hit Bottom,” July 24, 2009). When the growth rate of any component of GDP rises, it gives overall GDP growth a boost. And going from sharply negative growth to zero is a notable rise. In July, the slingshot scenario was hypothetical—though likely. In today’s economy, it’s a real phenomenon.
During the first half of this year, the investment component of GDP declined at a stunning 38% annual rate. Since the investment share of GDP was then about 14%, this implosion accounted for minus 5.4 percentage points of GDP growth. But since overall GDP declined “only” 3.6% in those two quarters, the rest of GDP (the 86%) actually rose. It was a small but real reason for optimism in a stormy sea.
Then came the third quarter. Like a woozy prizefighter lifting himself off the canvas, the battered investment component of GDP managed to rise (at an 11% annual rate), which added 1.3 points to GDP growth rather than subtracting 5.4 points. That 6.7 point swing was the start of the slingshot effect, which is not yet over.
Investment has three components: business investment, inventory stocking, and homebuilding. Inventory stocks were still declining at near-record rates in the third quarter; they simply must level off within a few quarters because sales are rising and firms will not want to deplete their stocks indefinitely. Business investment remains 20% below its 2008 peak; its likely course is up, not down, because plants and equipment wear out. And housing? Well, you know. Homebuilding is still in the doldrums—limping along at less than half the level of 1960. The only way to go is up.
This is where Keynesians think they have things right by using their assumptions to prove their assumptions. Blinder says while investment decreased, the other GPD components picked up the slack, so GPD didn’t decline as much as it would have otherwise. The problem is the slack was government spending. This is how they reinforce their own assumptions. They believe the government can boost the economy with stimulus, printing money, etc. Then they create a GDP calculation that includes government spending as one of it’s components. Then to increase GDP, they use that component to minupulate the calculation. The problem is that component does nothing to create wealth for our economy. It does not create real economic value. Gross Domestic Product is about production, but the government produces nothing. If this was the way to economic growth, why don’t we just focus on that component of GDP? Why not just quadruple the government spending? GDP would skyrocket!
Of course, the investment slingshot won’t last forever. Sometime in 2010, consumer spending must take over. And this is where the pessimists go into full throttle. Burdened by huge losses of both wealth and jobs, American households will start saving like mad, we are told. Sounds plausible, but it hasn’t really happened. True, the average personal saving rate has risen to 4.5% of disposable income so far this year from 2.7% in 2008. That’s higher, but a long way from the 8%-10% saving rates the doomsayers have foreseen. A saving rate near 5% is consistent with 3%-4% GDP growth in 2010.
Let’s hope consumers don’t listen to Blinder. Our country is badly in the need for savings. Savings are used for investment, which is what creates real economic growth. Yes, ultimately consumers need to spend, because we need to buy much of what we produce. If we don’t, it won’t be produced. The problem is when that consumption is heavily leveraged as it has been. I’m sure the Fed will eventually trick the public into going more in debt as things start to get back to normal.
The second major source of optimism is the amazing performance of productivity during the recession. To be sure, that performance had a downside: While real GDP was falling 3.7%, payroll employment dropped 5%, devastating many American families. But by definition, that discrepancy means that productivity—output per hour of work—rose substantially during the recession, which is pretty unusual.
The last two quarters were even more extreme: Productivity in the nonfarm business sector grew at a shocking 8.1% annual rate. There are two possible explanations. One: The last two quarters were among the most technologically innovative and entrepreneurial in the history of the United States. Two: Fearful businesses pared payrolls to the bone. If the second is closer to the truth, payrolls are extraordinarily lean right now. Which means that firms will need to hire more workers as their sales and production grow. Which means that employment may start growing sooner than the pessimists think.
I have been pointing this out for months, but until the last employment report, it was a hypothesis supported by no evidence. Not anymore. While payrolls continued to decline in November, it was by only a scant 11,000 jobs; and the job counts for September and October were revised upward. The data now show a clear trend that suggests that net job creation may be only a month or two away. We’ll see.
Here again, the problem is Blinder is counting the government as if all jobs are created equal. Jobs do the economy no good if they aren’t producing value to the economy, and government jobs do not produce value. The latest jobs report showed increases in government jobs and temporary employment. All other jobs, the ones we want, were down. More government jobs, used to distort the jobs report, is not a good thing.
There is more to the case for optimism. For one thing, less than 30% of February’s $787 billion fiscal stimulus has been spent to date; over 70% is still in the pipeline. Pessimists dote on the fact that the rate of increase of stimulus spending has probably peaked and will be lower in 2010. True. But the level of GDP will continue to get support from fiscal policy, and a second job-creation package (“Please don’t call it a stimulus!”) looks to be in the works.
Back to increasing the government component of GDP. See why government spending should be taken out of GDP?
Then there is the Federal Reserve’s stupendously expansionary monetary policy. It is well known that interest rates work on the economy with long lags. But the Fed’s last rate cut came a year ago. So isn’t the monetary policy pipeline empty? The answer is no, for at least three reasons. First, history suggests that the time lag is closer to two years than to one. So even the normal policy lags are not over.
But second, and more important, the lags are likely to be abnormally long this time around. As long as the economy’s credit-granting arteries were blocked, they could not carry the Fed’s lower-interest-rate medicine into the economy’s bloodstream. Sadly, some of these arteries remain blocked today—such as for small business lending. But the Fed, Treasury, FDIC and others have created a bewildering variety of stents and bypasses to get credit flowing again. The credit markets are now healing, though slower than we would like. Hence there is still monetary stimulus in the pipeline.
And third, the Fed continues to inject more medicine. Not by cutting interest rates, of course. Zero is as low as you can go, and the Fed arrived there a year ago. But “quantitative easing” is still in play. One example is the mortgage-backed securities (MBS) purchase program, which is adding MBS to the Fed’s balance sheet and providing vital support to the mortgage market. Yes, the Fed has begun to think about its exit strategy. But that is for the future, not for now.
The Fed’s “stupendously expansionary monetary policy” is what we should fear the most. The author may be right on the lag, and that would be the most devasting blow to the economy. Many are predicting massive inflation as the Fed’s stimulus finally leaves the reserves and enters the economy. I wouldn’t call that a case for optimism. As I highlighted in a previous blog, even the best case inflation scenario is not too comforting. If not severely contracted, we’ll have massive inflation. If severely contracted, we could be looking at a serious contraction in the economy. Pick your poison.
I warned at the outset that I would present a deliberately biased case. So let me admit, once again, that serious downside risks remain. The investment slingshot and the fiscal stimulus will both peter out in 2010. Consumer finances and confidence are shaky. Banks are still failing and commercial real estate is a mess. We cannot count on exports to pull us out of this slump. All true. And all reasons not to expect the kind of exuberant boom that typically follows a deep recession—such as the 7.7% growth spurt in the six quarters following the 1981-82 slump. No one expects that.
So my optimism is guarded. The 3%-4% growth rate that I anticipate for the rest of this year and for 2010 is a lot worse than 7.7%, to be sure. But compared to what we’ve been through, it will feel a whole lot better.
Mr. Blinder, a professor of economics and public affairs at Princeton University and vice chairman of the Promontory Interfinancial Network, is a former vice chairman of the Federal Reserve Board.
via Alan S. Blinder: The Case for Optimism on the Economy – WSJ.com.
Blinder doesn’t even consider the effects of the health care takeover, national debt, etc. Then again why would he? Keynesians think government spending is as valuable as business investment. Why? Because GDP says so.