Tuesday, March 06, 2007

Productivity Slowdown?

Today’s US productivity data were rather unpleasant (see Mark Thoma’s post and the links therefrom), but I’m far from ready to throw in the towel on this one. By my reckoning, the slowing of productivity growth still falls in the category of cyclical variation, and the long-term trend of productivity growth remains at least as high as it was during the late 1990s.

With the latest data, I’ll repeat the analysis from the last time I posted on this topic. (Click on the “productivity” label link at the bottom of this post.) The premise is that productivity goes in cycles, related to, but not necessarily coincident with, the business cycle. (For example, the 1990s business cycle contained two distinct productivity cycles.) I’m measuring cycles from peak to peak, and I’m making the conservative assumption that we have not yet reached the peak of the current cycle. (Obviously we are long past the peak.) Here are the average annual growth rates of business sector productivity:

1.4% 1986q1 to 1990q2
1.6% 1990q2 to 1994q4
2.5% 1994q4 to 2000q2
2.6% 2000q2 to 2006q4

An alternative, less conservative, approach, is to measure from trough to trough, with the assumption that we are currently at a trough:

1.4% 1987q1 to 1991q1
1.6% 1991q1 to 1995q3
2.6% 1995q3 to 2001q1
2.8% 2001q1 to 2006q4

Taken together, these results suggest that the current trend is approximately the same as it was in the previous cycle.

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Sunday, March 04, 2007

Congratulations for Not Forecasting Recessions

Mark Thoma at Economist’s View cites an article by Daniel Gross about the inability of economic forecasters to forecast recessions. A maintained assumption of everyone who discusses this seems to be that this failure of economic forecasting reflects badly on economists if reflects on them at all. I would suggest, however, that the inability to forecast recessions in practice is, when properly understood, actually a point in economists’ favor.

Suppose that we can represent the consensus forecast in one number that indicates the consensus probability of recession. A consensus recession forecast would then refer to a situation is which this number exceeds 50%. But we know that the consensus usually changes slowly, so a 51% recession forecast is likely to have been preceded, with some lag, by a 40% forecast, and that by a 35% forecast. But what happens when the consensus calls for a 35% or 40% chance of recession? What happens is that policymakers – usually at the Fed – start aggressively trying to prevent a recession. (That is if they didn’t already start when the consensus was at 30% or lower.) If they do a good job, the consensus never gets to 50%. So if the Fed is doing a good job, it’s unlikely that one will ever see a consensus recession forecast, successful or otherwise.

And the Fed’s ability to do a good job of preventing recessions depends in part on its economists – as well as on those various economists over the years that have studied the implementation of monetary policy and helped the Fed learn how to use it effectively. If it were the case that forecasters could successfully forecast recessions, it would indicate that these economists had failed in their task.

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Thursday, March 01, 2007

Typology of Anti-NAIRUvians

The NAIRU Theory or Natural Rate Theory of Unemployment essentially consists of two propositions about the Phillips curve (the relationship between inflation and unemployment as nominal aggregate demand* varies):
  1. The Phillips curve is downward-sloping in the short run.
  2. The Phillips curve is vertical (or possibly upward-sloping) in the long run.
Accordingly, there are essentially four ways to challenge the theory:
  1. Argue that the Phillips curve is vertical in the short run, as in many real business cycle models.
  2. Argue that the Phillips curve is horizontal in the short run, as in my suggestion here
  3. Argue that the Phillips curve is downward-sloping in the long run, as in Tobin’s “greasing the wheels” theory.
  4. Argue that the Phillips curve has the required NAIRU properties in theory but that it is so unstable and unpredictable as to render the concept useless in practice. (This seems to be roughly the argument made by Bob Hall recently.)
(I have ignored the possibility of an upward-sloping short-run Phillips curve because it just seems too silly to me. Any upward-sloping short-run Phillips curve that anyone is likely to advocate will either be approximately vertical or approximately horizontal.)

It is clear that these different challenges to the NAIRU theory have very different policy implications. For example, if you believe challenge #1, you might argue for aggressive policy tightening in response to any increase in the inflation rate above your preferred target, whereas if you believe challenge #3, you might argue for no tightening at all. And while challenge #4 is perhaps the most viable, it also raises the question of what alternative one might use to guide policy, and if there is no viable alternative, one has to wonder how Fed policy has managed to be so successful over the past 20 years. Anyhow, it is incumbent upon those who challenge the NAIRU theory to identify the specific nature of their challenge.

* I use the word “nominal” to accommodate those who don’t believe in the concept of aggregate demand. If you don’t like the phrase “aggregate demand,” how about “velocity-adjusted nominal money supply.”

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