Reversion to Trend

John Cochran’s Wall Street Journal op-ed complaining about the “Johnny One-Note” prescription of some Keynesians (particularly folk Keynesians) opens with this paragraph:

Output per capita fell almost 10 percentage points below trend in the 2008 recession. It has since grown at less than 1.5%, and lost more ground relative to trend. Cumulative losses are many trillions of dollars, and growing. And the latest GDP report disappoints again, declining in the first quarter.

Now let’s stop right there. I’m broadly sympathetic to what comes next—that when your model fails you need to adjust your model, that the assumptions in the model which lead to the inadequate stimulus package of 2009 were absurdly wrong, and more measures based on the same assumptions will be just as inadequate—but I’d go farther. What makes him think that trend prior to 2008 was anything but an illusion? I think that our persistent (and IMO endemic) slow growth has been the case since 1992-1993 when China pegged the yuan to the dollar, we received an enormous flood of low-priced Chinese goods, the American economy was hollowed out, and every sector but those that were in bubbles (technology, housing) or directly subsidized by the government, e.g. education and healthcare, languished.

IMO the last six years haven’t been bucking the trend. They’ve been a reversion to trend.


If you look hard at New-Keynesian models, however, this diagnosis and these policy predictions are fragile. There are many ways to generate the models’ predictions for GDP, employment and inflation from their underlying assumptions about how people behave. Some predict outsize multipliers and revive the broken-window fallacy. Others generate normal policy predictions—small multipliers and costly broken windows. None produces our steady low-inflation slump as a “demand” failure.

These problems are recognized, and now academics such as Brown University’s Gauti Eggertsson and Neil Mehrotra are busy tweaking the models to address them. Good. But models that someone might get to work in the future are not ready to drive trillions of dollars of public expenditure.

I think that’s obviously right but, sadly, while correctly characterizing the past it doesn’t show a way forward. He goes on to critique Brad DeLong, Lawrence Summers, etc. for wanting to return to Keynes’s actual policy prescriptions. In my view their basic mistake is in not wanting to return to them enough since they continue to long for a federal government that’s a consumer of last resort rather than Keynes’s view of the central government as the employer of last resort.

His prescription:

In the alternative view, a lack of “demand” is no longer the problem. Financial observers now worry about “reach for yield” and “asset bubbles.” House prices are up. Inflation is steady. The Federal Reserve evidently agrees, since it is talking about taper and exit, not more stimulus. Even super-Keynesians note that five years of slump have let physical and human capital decay, which “demand” will not quickly reverse. But we are stuck in low gear. Though unemployment rates are returning to normal, many people are not even looking for work.

Where, instead, are the problems? John Taylor, Stanford’s Nick Bloom and Chicago Booth’s Steve Davis see the uncertainty induced by seat-of-the-pants policy at fault. Who wants to hire, lend or invest when the next stroke of the presidential pen or Justice Department witch hunt can undo all the hard work? Ed Prescott emphasizes large distorting taxes and intrusive regulations. The University of Chicago’s Casey Mulligan deconstructs the unintended disincentives of social programs. And so forth. These problems did not cause the recession. But they are worse now, and they can impede recovery and retard growth.

I agree with that as far as it goes but, again sadly, it doesn’t go far enough. Even if by some miracle all of the issues complained about above were remedied, we’d still be left with the fundamental problems that we import too much, export too little, and don’t produce enough of what we consume.

But even getting to that point will be insurmountably difficult. Those who have become accustomed to subsidies including bankers, teachers, doctors, consumers of healthcare, and consumers of cheap imported goods will not relinquish their subsidies cheerfully.

18 comments… add one
  • Guarneri

    I guess I’m more sanguine than viewing the economy as hollowed out by the Chinese, but I think the essential point on the pre-2008 trend is simply correct. Debt fueling, misdirected allocation to certain industries and a relative shift in available resources from (more productive) private sector to a less productive govt sector leaves one asking “what the hell is real trend?” Further, as the nation reaches terminal debt capacity and reduced debt fueling must inevitably retard growth……..what now?

  • The list of things that we used to make or otherwise produce here and no longer do and would be necessary for us to start making things again is lengthy. Let’s just take one example: rare earth metals.

    We used to be the world’s largest producer. We may still have the world’s largest reserves. We aren’t producing them for a variety of reasons including environmental restrictions, reluctance to invest, and labor costs.

    By controlling exports of rare earth metals the Chinese are in a position to control the rate at which we might conceivably increase our production of anything dependent on them. The Japanese have been worried about this for some time.

  • Modulo Myself

    China has been able to dominate rare earths production by producing product at a remarkably low price. The China price is about one quarter of the price that had previously prevailed in the rare earths market. China achieved this low price in three ways. First, the Chinese producers make only minimal efforts to deal with the environmental impacts of the mining process. As a result, the rare earths mining regions in Inner Mongolia are classified as some of the most polluted regions in the world. Second, rare earth mines pay low wages and provide little or no health or safety protection to miners. The resulting poverty and health problems for the workers are well known. Third, rare earths mining has traditionally been conducted by numerous small operations. These operations ruthlessly bid against each other on price terms. This “ruinous competition” results in a price that barely covers the cost of production. Though China has recently pushed to consolidate the mining in fewer and larger companies, there are still a sufficient number of players so that the intense price completion continues.

    So this is the market the US should be just dying to enter? Pay the workers $1 an hour, but tell them that they’re doing their duty to help us fight off the Chinese?

  • ...

    Yes, Modulo, that is entirely it: subsidize the Chinese or force Americans to work for one dollar an hour in toxic waste dumps. There are no options in between.

  • TastyBits

    Nuclear power is not exactly environmentally friendly, and yet, it is more environmentally friendly than almost any other industry in the US. The US could produce rare earth metals in an environmentally safe manner. Rare Earth Metals Regulatory Commision (REMEC) – problem solved.

    If US manufacturers are subject to restrictions, US manufacturers should want US importers subject to similar restrictions. If not, why?

    If I understand correctly, Wall Street is only invested in manufacturing credit only because there are too many restrictions to manufacturing goods. Somebody has been hitting the bong.

  • ...

    Rare Earth Metals Regulatory Commision (REMEC) – problem solved.

    I’m sure it will work just as well as the oversight the Federal Reserve Banking system and the SEC provided Wall Street!

  • My view is that we should impose duties on products entering the United States in the amount of what it would have cost the exporting companies to come into compliance with U. S. environmental, health, and labor regulations.

    In other words, polluting the soil, air, and water and mistreating your workers should not result in competitive advantage.

  • ...

    My view is that we should impose duties on products entering the United States in the amount of what it would have cost the exporting companies to come into compliance with U. S. environmental, health, and labor regulations.

    In theory that sounds great. In practice, imagine the opportunities for corruption in the agency that gets to decide what those duties could be! Especially with a Chicago President in office.

  • jan

    The part time job surge that will get little air time in the latest jobs report.

  • TastyBits


    There are some regulatory bodies that have done well: FAA, NRC, FDIC (not really regulatory) and a few others.

    Of course, as you have noted, when your Sec. of Treasury cannot work TurboTax, the country is screwed anyway. Maybe it is just me, but Timmy always seems to have that stupid dog look.

  • Sam

    Didn’t Cochrane, Taylor etc. all predict massive inflation? Seems to me the best predictors have been market monetarists. In any case I think Cochrane presents a false dichotomy, it’s not ALL demand vs. ALL structural. I think the U.K. is a much better example than the U.S. for Cochrane’s point (and one which Krugman was wrong about in terms of the ability of monetary policy to offset structural changes).

  • ...

    TB, the regulatory bodies that seem to work better are the ones that have oversight responsibilities that are largely utilitarian in outlook, it seems to me. The ones that deal more with money or politics (the FEC, the FCC, the SEC, etc) seem more susceptible to regulatory capture. After all, no one really wants planes falling out of the sky or leaky nuclear plants. But some people are always up for manipulating finances. How many people really believe that the SEC’s failure to investigate Madoff didn’t have undertones of being bought and paid for, to cite one example.

    I have no doubt that a regulatory body setting duties on imports based on the importing nations environmental/labor/et al laws would be a very likely target for capture and corruption.

  • Guarneri


    Yes, it’s only a net number rotating out full time and in part time. In my eyes that makes it a disaster.


    I really have no problem with the level playing field argument as a concept as long as it’s not true competitive advantage being regulated away. But I think ice is right that it would largely be an administrative and corrupt affair in practice. I’m old enough to remember when Mexico was the bogeyman. Then came china. And as a last point, I think people would be surprised at the howls from consumers at their new price realities. Everyone wants US jobs until THEY have to pay them. Kind of like taxes.

  • TastyBits


    You would need something more than Congress passing regulations and collecting fees for goods imported not meeting those regulations. There needs to be a feedback loop to disincentivise increasing regulations.

    The US market is enormous, and cooperation from other countries would be much easier than it may seem.

    I have not taken the time to work out a system, but it should be as simple as possible. A 1000 page bill is way too much. If it is too complicated for the average voter to understand, it is too complicated, and it will be corrupted.

    It is not an accident that we have an overly complicated system that just happens to be corrupt. (Another one of those damn weird ideas.)

  • ....

    The US market is enormous, and cooperation from other countries would be much easier than it may seem.

    Hmm. I just keep thinking autarky has its appeals, particularly for a country as large and resource rich as ours.

  • steve

    jan/Drew- Now, for the rest of the story. From Marketwatch.

    One interesting nugget in the June jobs report was the rise in the number of people who worked part-time.

    While it’s a number that flops around from month to month — the standard deviation is 287,000 — it jumped by 799,000, which was the largest one-month gain since January 1994. At the same time, there was a 523,000-person drop in full-time workers, the first decline since October.

    “It is unusual,” said Stuart Hoffman, chief economist at PNC Financial Services Group. But he said it could be noise. And he notes that most of the part-time rise in June was not in those who want to find full-time work but couldn’t, and instead in those who voluntarily opted to do so.

    One concern with the Affordable Care Act was that some small employers might opt to get around the 50-person work requirement by replacing full-time workers with part-timers.

    That said, over the past 12 months, 10,000 new part-time jobs have been created — versus 2.12 million full-time jobs.”

    Wow! I now agree that we should repeal the ACA. Over the last year it is creating full time jobs to part-time jobs at a ratio of 212:1.

    What kinds of jobs?

    “And looking at the survey of establishments, it was high-paying sectors that were creating jobs in June. “These are not McDonald’s, Mickey Mouse kind of jobs,” Hoffman said. “This is a better-quality jobs story.”

    Bottom line? It is one month.


  • jan


    Our economy seems to exist in two parallel universes. You have your stats above, which frankly look like better jobs are being offered –yea!

    Then we have this latest prediction countering the above description of jobs: JPM Cuts It’s Original 2014 GDP Forecast in Half, Sees Slowest Full Year Growth Since 2009.

  • steve

    Yours is a forecast. Mine is a summation of what has really happened. Two different universes, one being fictional.


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