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September 23, 2009

Economist's View - 8 new articles

"Dark Age in Macroeconomics?"

This is Nick Rowe (it's in response to Paul Krugman and follows up on one of Nick's previous posts):

Dark Age in Macroeconomics? A History of Taught approach, by Nick Rowe: (Or maybe the title should be: "Notes from the Phelps/Lucas Administration"; or "Notes to supplement our fading memories of the late 1970's".)
Is this a Dark Age in macroeconomics? In other words, have we collectively forgotten some (important) stuff that we used to understand?
I want to approach this question by looking at what was taught in the past to economics graduate students, so we can compare what is left out now to what was left out then.
I have a sample of one: my own lecture notes from grad school. I began my MA at UWO in 1977, and continued into the PhD. I took everything in macro/money that was offered. At the time, UWO was arguably the top Canadian department in macro/money (OK, Western grads would argue for; Queens grads would argue against), and would hold up well against anywhere in the world.
Macro 1 (David Laidler). Required course. Review and critique of ISLM (lags, stocks flows and the government budget constraint, are the IS and AD curves really demand curves? [no], the missing AS curve). Crowding out debate. Non-Walrasian macro (Barro and Grossman). Say's Law. Phillips Curve (up to Phelps and Friedman). Consumption function (Friedman/Modigliani). Demand for money. Investment demand.
Macro 2 (Michael Parkin). Required for those continuing to the PhD. (I can't resist quoting from the first page of my notes here: "Economics [is] Understand + Explain Phenomena using Rational models. How could Rational Behaviour [lead to] Disaster? Market Failure."). Review and critique of Neoclassical model of labour market. Lucas and Rapping (from the Phelps volume), and why their model was logically incoherent (Michael Parkin was right on this point). Mortensen's (also from Phelps volume) search theory of unemployment. Theories of implicit wage contracts (sticky wages). Theories of price adjustment (proto New-Keynesian). ISLM plus Phillips Curve (distinction between proto New-Keynesian and New Classical interpretations of Phillips Curve). Adaptive vs. Rational expectations. Policy Irrelevance Proposition ("[deviations of output from y* are] just noise, but obviously false").
Money 1 (Don Patinkin/Peter Howitt). Optional. Hume. Fisher. Lavington. Wicksell. Keynes' Tract, Treatise, and General Theory. Patinkin's Money interest and Prices. Are money and bonds net wealth? Commodity money. Solow/Swan growth model. Money and growth. Optimal quantity of money. Transactions costs. Baumol/Tobin and Miller/Orr models of demand for money.
Money 2 (Joel Fried). Optional. Microfoundations of money, Menger, Ostroy, Jones. Money in general equilibrium theory. Clower constraints. Transactions costs. Financial markets. Tobin. CAPM. Efficient Markets. Modigliani/Miller theorem. Term structure of interest rates. Tobin portfolio choice. Friedman and Monetarism. International finance. Dornbusch overshooting. Exogenous vs endogenous money. Canadian monetary policy.
Advanced Macro (Peter Howitt). Optional. (Lovely quote from the first page: "We are Aristotelian monks, trying to solve anomolies to stop future generations wasting their time doing the same thing.". Non-Walrasian disequilibrium theory (Clower, Leijonhufvud, Barro/Grossman, Malinvaud, Benassy, etc.). Stability. Catastrophe theory(!). Price adjustment under oligopoly. Optimal control theory. Inventories. Phelps/Winter price setting with transient monopoly power (from the Phelps volume, proto New-Keynesian).
(I learned some more money/macro in David Laidler's History of Thought class. But I was the only graduate student in that class, so I'm not going to count it. My colleague Calum Carmichael, who took the same course as an undergraduate, estimates that about one quarter of the Honours economics students took that class.)
I make the follow observations:
1. The Phelps volume was clearly very influential in the late 1970's. This supports Paul Krugman's memory, and my own.
2. The beginnings of the split between New Classical and New Keynesian approaches was already apparent in the late 1970's. I saw several references to the distinction between Fisher and Phelps on the interpretation of the Phillips Curve. (Fisherian market-clearing with misperceptions vs Phelpsian disequilibrium price adjustment). This too supports Paul Krugman's memory.
3. We received a very broad education in short run macroeconomics and monetary theory. Probably much broader than today's students. That tends to support the Dark Age hypothesis.
4. But there is one glaring omission from our education: we did lots of short run business cycle theory but almost no long run growth theory. We briefly covered the Solow growth model, but only as a prelude to money and growth. There was no interest in growth theory per se! If growth theory is important, and it is, that directly contradicts the Dark Age hypothesis. We barely touched on half of macro! The late 1970's were the Dark Age, for growth theory.
Why did we ignore growth theory?
Growth theory wasn't on the agenda. It wasn't that growth was unimportant; just that there seemed to be nothing important to say about it. All the exciting policy debates were about inflation and unemployment, not long run growth. All the exciting theoretical developments were about inflation and unemployment, not long run growth. "Endogenous" growth theories (a stupid misnomer, because growth is endogenous in Solow too, just with an extremely simple functional relationship to the exogenous variables, namely g=n) came later.
Fiscal policy has been off the agenda for much the same reasons, until recently.
(5. We spent surprisingly little time on open economy macroeconomics as well, for a Canadian school.)
OK. Let's compare notes!

This is very similar to my own experience, we also did very little growth theory (nothing beyond Solow-Swan, also as a prelude to looking at whether money was "superneutral"), and I didn't take any international at all - it wasn't part of the macro sequence (the international economy was not considered very important for understanding business cycle fluctuations). The emphasis was on short-run stabilization policy, monetary policy in particular. However, my experience was a bit different in that by the time I got to graduate school in the early 1980s, the split between saltwater and freshwater economists was well underway.

Paul Krugman says:

But by 1980 or 1981 it was basically clear to everyone that the Lucas project – the attempt to explain the evidently Keynesian behavior of the economy in terms of nothing but imperfect information – had failed. So what were macroeconomic theorists supposed to do?

The answer was that they split. One faction said, in effect, "OK: we can't explain what we think we see in terms of full maximization. So we have to assume that there are some limits to maximization – costs of changing prices, bounded rationality, whatever." That faction became New Keynesian, saltwater economics.

The other faction said, in effect, "OK: we can't explain what we think we see in terms of full maximization. So we must be interpreting the data wrong – things like changes in the money supply must not be driving recessions, because theory says they can't." That faction became real business cycle, freshwater economics.

Here's what I said about this just under two and a half years ago (edited slightly). As you can see, even though this was written well before Krugman's statement, it basically agrees with his assertion that everyone knew the New Classical model was in trouble by 1980 or 1981 (the Mishkin paper noted below was published, I believe, in 1982, but given the long publication lags the results were well known long before then). It also agrees with his comments that one faction, the New Keynesians, built upon the old Keynesian structure by giving it rational agents and microfoundations who operated in an environment beset with rigidities of one type or another (these rigidities prevent agents from fully neutralizing nominal shocks such as changes in the money supply), and the other faction reemerged as the real business cycle school:

I entered graduate school in 1980. Though it started with a pretty traditional IS-LM framework with some AD-AS thrown in, most of our time was spent learning the New Classical model. Much of the research effort at that time, at least the effort I was made aware of, was to try and punch holes in the result that comes out of the New Classical framework that only unanticipated money can affect real variables like output and employment.

This assault came on both theoretical and empirical fronts. Mishkin, for example, had published an empirical paper in the early 1980s that challenged work by Barro and others from the later 1970s supporting the New Classical model and its implication that only surprise money matters. On the theoretical front, the old Keynesian model -- which had been criticized for, among other things, lacking microeconomic foundations and lacking rational expectations -- was being reconstructed into the New Keynesian model. This model would eventually overcome theoretical objections that plagued the older Keynesian model, and it would also do a better job than the New Classical model of explaining the magnitude and persistence of business cycles and other features of the macroeconomic data. We learned some about Real Business Cycle models - but for the most part that work went on elsewhere and would surface later with more force as an alternative to the New Keynesian framework. But we were certainly made aware of the real business cycle model, e.g. arguments about reverse causality to explain statistical money income correlations. I'd say the same about growth theory - we did the Solow-Swan basics, but very little beyond that. Stabilization policy was the main issue we worried about at the time.

Does money matter? I thought so, that's what my dissertation was all about, it gave theoretical and empirical reasons to doubt the New Classical result that expected money does not affect output, but the issue of whether money matters was not settled until later. We now accept, for the most part, that the Fed can affect real interest rates and also affect the real economy, but at that time there was a very strong split within the profession on this issue. It wasn't until later that a general belief that anticipated monetary policy was a potentially useful stabilization tool surfaced in the profession. It's sometimes surprising to me today how complete the conversion on that issue has been, though it's certainly not 100%.

So, it wasn't generally agreed that money mattered, i.e. that money was a useful policy tool for stabilizing the real economy. But the Keynesian economics I learned at the time, which was in the implicit and explicit labor contracting framework for the most part, did say that money mattered. In fact, since the point was to challenge the New Classical result that money did not matter, the focus was mostly on monetary policy. As for fiscal policy, the Keynesian model we talked about - beyond the simple IS-LM version we learned at first - paid very little attention to fiscal policy, though papers such as Barro's "Are Bonds Net Wealth" were part of the conversation. Thus, when I went to graduate school - and this was partly due to who was teaching the courses - the primary focus was on whether and how changes in monetary policy affected the real economy.

In any case, even though it was a few years later than Nick's experience, we also spent considerable time on the ideas that Krugman notes have since been lost as we entered our recent "Dark Ages."


What's an Apology Worth?

I'm sorry, I really am. Here's the economics of apologies:

Saying sorry really does cost nothing, EurekAlert: Economists have finally proved what most of us have suspected for a long time – when it comes to apologizing, talk is cheap.
According to new research, firms that simply say sorry to disgruntled customers fare better than those that offer financial compensation. The ploy works even though the recipient of the apology seldom gets it from the person who made it necessary in the first place.
The ... Nottingham School of Economics' Centre for Decision Research and Experimental Economics ... set out to show whether customers who have been let down continue to do business after being offered an apology. They found people are more than twice as likely to forgive a company that says sorry than one that instead offers them cash. ...
[C]o-author Dr Johannes Abeler said the results proved apologies were both powerful and cheap. He said: "We know firms often employ professional apologists whose job is to say sorry to customers who have a grievance.
"You might think that if the apology is costless then customers would ignore it as nothing but cheap talk - which is what it is. But this research shows apologies really do influence customers' behavior – surprisingly, much more so than a cash sweetener.
"People don't seem to realize they're dealing with an expert apologist rather than an individual who feels genuine shame.
"It might be that saying sorry triggers in the customer an instinct to forgive – an instinct that's hard to overcome rationally."
Researchers worked with a firm responsible for around 10,000 sales a month on eBay, controlling its reaction to neutral or negative feedback. Some customers were offered an apology in return for withdrawing their comments, while others were offered €2.5 or €5.
The simple apology blamed the manufacturer for a delay in delivery, adding: "We are very sorry and want to apologize for this." Customers offered money were told: "As a goodwill gesture, we can offer you €5 if you would consider withdrawing your evaluation."
Because customers had no idea they were taking part in the experiment, their behavior was completely natural and unaffected. Some 45% of participants withdrew their evaluation in light of the apology, while only 23% agreed in return for compensation.
The study also discovered that a higher purchase price further reduced the number of customers willing to forgive for cash. Yet the size of the initial outlay had no effect on the willingness of participants to settle for simply reading the magic words: "I'm sorry."
Dr Abeler, an expert in behavioral economics, said: "It's interesting to note our setting should have made it hard for an apology to work.
"The apology was delivered by a large, anonymous firm and wasn't face-to-face, and the firm had a clear incentive to apologize.
"All of this meant the apology should have been regarded by the customers as calculated, insincere and just cheap talk. Yet it still yielded much better outcomes than offering cash compensation – and our results might even underestimate its effects."

Apparently, this also works for doctors:

Apology a tool to avoid malpractice suits, by Lindsey Tanner, Associated Press: ...Some malpractice-overhaul advocates say an apology can help doctors avoid getting sued, especially when combined with an upfront settlement offer.
The idea defies a long tradition in which doctors cultivated a Godlike image of infallibility and rarely owned up to their mistakes.
The softer approach, now appearing in some medical school courses and hospital policies, is drawing interest as national attention has turned to reducing both medical errors and the high cost of malpractice insurance...
The hospitals in the University of Michigan Health System have been encouraging doctors since 2002 to apologize for mistakes. The system's annual attorney fees have since dropped from $3 million to $1 million, and malpractice lawsuits and notices of intent to sue have fallen from 262 filed in 2001 to about 130 per year...
Dr. Michael Woods, a surgeon in Colorado ... said his research has shown that being upset with a doctor's behavior often plays a bigger role than the error itself in patients' decisions to sue. ...
Accountants have also figured this out.


"An Economics of Magical Thinking"

Roman Frydman and Michael Goldberg argue that the behavioral assumptions used to motivate agents in economic models need to change:

An economics of magical thinking, by Roman Frydman and Michael D. Goldberg, Commentary, Economist's Forum: Confidence seems to be returning to markets almost everywhere, but the debates about what caused the worst crisis since the Great Depression show no sign of letting up. Instead, the spotlight has shifted from bankers, financial engineers and regulators to economists and their theories. This is not a moment too soon. These theories continue to shape the debate about fiscal stimulus, financial reform, and, more broadly, the future of capitalism, which means that they remain a danger to all concerned.
Unfortunately, the assumptions that underpin these theories are largely inscrutable to those without a Ph.D. in economics. Indeed, the debate is full of terms that mean one thing to the uninitiated and quite another to economists.
Consider "rationality."
Webster's Dictionary defines it as "reasonableness." By contrast, for economists, a "rational individual" is not merely reasonable; he or she is someone who behaves in accordance with a mathematical model of individual decision-making that economists have agreed to call "rational."
The centerpiece of this standard of rationality, the so-called "Rational Expectations Hypothesis", presumes that economists can model exactly how rational individuals comprehend the future. In a bit of magical thinking, it supposes that each of the many models devised by economists provides the "true" account of how market outcomes, such as asset prices, will unfold over time.
The economics literature is full of different models, each one assuming that it adequately captures how all rational market participants make decisions. Although the free-market Chicago school, neo-Keynesianism, and behavioral finance are quite different in other respects, each assumes the same REH-based standard of rationality.
In other words, REH-based models ignore markets' very raison d'etre: no one, as Friedrich Hayek pointed out, can have access to the "totality" of knowledge and information dispersed throughout the economy. Similarly, as John Maynard Keynes and Karl Popper showed, we cannot rationally predict the future course of our knowledge. Today's models of rational decision-making ignore these well-known arguments.
The unreasonableness of this standard of rationality helps to explain why macroeconomists of all camps and finance theorists find it hard to account for swings in market outcomes. Even more pernicious, despite these difficulties, their models supposedly provide a "scientific" basis for judging the proper roles of the market and the state in a modern economy.
But incoherent premises lead to absurd conclusions - for example, that unfettered financial markets set asset prices nearly perfectly at their "true" fundamental value. If so, the state should drastically curtail its supervision of the financial system. Unfortunately, many officials came to believe this claim, known as the "efficient markets hypothesis," resulting in the widespread deregulation of the late 1990s and early 2000s. That made the crisis more likely, if not inevitable.
Public opinion has swung to the other extreme, as complacency about the need for financial regulation has been replaced by calls for greater oversight by the state to control the unstable behavior of financial markets.
Behavioral economists have uncovered much evidence that market participants do not act like conventional economists would predict "rational individuals" to act. But, instead of jettisoning the bogus standard of rationality underlying those predictions, behavioral economists have clung to it. They interpret their empirical findings to mean that many market participants are irrational, prone to emotion, or ignore economic fundamentals for other reasons. Once these individuals dominate the "rational" participants, they push asset prices away from their "true" fundamental values.
The behavioral view suggests that swings in asset prices serve no useful social function. If the state could somehow eliminate them through a large intervention, or ban irrational players by imposing strong regulatory measures, the "rational" players could reassert their control and markets would return to their normal state of setting prices at their "true" values.
This is implausible, because an exact model of rational decision-making is beyond the capacity of economists - or anyone else - to formulate. Once economists recognize that they cannot explain exactly how reasonable individuals make decisions and how market outcomes unfold over time, we will no longer be stuck with two polar extremes concerning the relative roles of the market and the state.
For the most part, asset prices undergo swings because participants must cope with ever-imperfect knowledge about the fundamentals that drive prices in the first place. So long as these swings remain within reasonable bounds, the state should limit its involvement to ensuring transparency and eliminating market failures.
But sometimes price swings become excessive, as recent experience painfully shows. Even accepting that officials must cope with ever imperfect knowledge, they can implement measures - such as guidance ranges for asset prices and changes in capital and margin requirements that depend on whether these prices are too high or too low - to dampen excessive swings.
Such measures require policymakers to exercise discretion, rather than simply rely on fixed rules. That might not please most economists, but it would leave the market to allocate capital while holding out the possibility of reducing the social costs that arise when asset swings continue for too long and then end, as they inevitably do, in sharp reversals.

In an email conversation with Roman Frydman about this article, I said:

You two have done really good work and have interesting things to say about this whole debate over macroeconomic models, but somehow the ideas have had trouble bubbling into the mainstream, or so it seems – and to me that says something negative about the sociology of our profession. But maybe it's had more impact than I'm aware of and I just haven't been keeping up – sure hope so as it deserves a fair and thorough hearing.

For more on "Imperfect Knowledge Economics," see here, or even better, see "Macroeconomic Theory for a World of Imperfect Knowledge" and "Financial Markets and the State." [Here's an example of their recommendations for regulating ratings agencies within the imperfect knowledge framework, here's an example for exchange rates, and here's an example of their proposal to limit swings in asset markets, i.e. to "pop" bubbles.]


As Expected, Fed Keeps Target Rate on Hold

[Money Watch link] After its rate setting meeting today, the Fed announced that it "will maintain the target range for the federal funds rate at 0 to 1/4 percent," and that it "continues to anticipate that economic conditions are likely to warrant exceptionally low levels of the federal funds rate for an extended period." Very few analysts thought the Fed should raise the rate, calls for higher rates came from a few inflation hawks but that's about it, and nobody I know of expected the Fed to change its interest rate policy. So no surprises here.

Of more interest are the Fed's characterization of economic conditions, its plans for the special facilities and other non-standard monetary policy options it has put in place to deal with the crisis, and its exit strategy.

Here, the Fed seemed more positive about the economy than it has been in the past, and further indication of the Fed's positive outlook comes with its announcement that it will wind down the purchase of mortgage backed securities and stop doing so altogether early next year, and its reiteration of its plans to end the purchase of Treasury bonds.

But while the Fed sees positive signs and is beginning to execute an exit strategy, the fact that it is keeping the interest rate on hold indicates that it expects a slow, drawn out recovery. I also expect a slow recovery, particularly for labor markets, so I'm glad to see that the Fed is being cautious and wants to avoid the mistake of raising rates too soon. It's a delicate tradeoff, if the Fed waits too long to raise rates it could face inflation problems, but if it tightens too soon it could choke off the recovery. My view is that if the Fed is going to make a mistake, it ought to be in favor of employment, and it looks to me like the Fed has similar sentiments.

Here's the Press Release:

Press Release, Release Date: September 23, 2009: Information received since the Federal Open Market Committee met in August suggests that economic activity has picked up following its severe downturn. Conditions in financial markets have improved further, and activity in the housing sector has increased. Household spending seems to be stabilizing, but remains constrained by ongoing job losses, sluggish income growth, lower housing wealth, and tight credit. Businesses are still cutting back on fixed investment and staffing, though at a slower pace; they continue to make progress in bringing inventory stocks into better alignment with sales. Although economic activity is likely to remain weak for a time, the Committee anticipates that policy actions to stabilize financial markets and institutions, fiscal and monetary stimulus, and market forces will support a strengthening of economic growth and a gradual return to higher levels of resource utilization in a context of price stability.
With substantial resource slack likely to continue to dampen cost pressures and with longer-term inflation expectations stable, the Committee expects that inflation will remain subdued for some time.
In these circumstances, the Federal Reserve will continue to employ a wide range of tools to promote economic recovery and to preserve price stability. The Committee will maintain the target range for the federal funds rate at 0 to 1/4 percent and continues to anticipate that economic conditions are likely to warrant exceptionally low levels of the federal funds rate for an extended period. To provide support to mortgage lending and housing markets and to improve overall conditions in private credit markets, the Federal Reserve will purchase a total of $1.25 trillion of agency mortgage-backed securities and up to $200 billion of agency debt. The Committee will gradually slow the pace of these purchases in order to promote a smooth transition in markets and anticipates that they will be executed by the end of the first quarter of 2010. As previously announced, the Federal Reserve's purchases of $300 billion of Treasury securities will be completed by the end of October 2009. The Committee will continue to evaluate the timing and overall amounts of its purchases of securities in light of the evolving economic outlook and conditions in financial markets. The Federal Reserve is monitoring the size and composition of its balance sheet and will make adjustments to its credit and liquidity programs as warranted.

Voting for the FOMC monetary policy action were: Ben S. Bernanke, Chairman; William C. Dudley, Vice Chairman; Elizabeth A. Duke; Charles L. Evans; Donald L. Kohn; Jeffrey M. Lacker; Dennis P. Lockhart; Daniel K. Tarullo; Kevin M. Warsh; and Janet L. Yellen.

[More from the WSJ, the Financial Times, and Bloomberg.]


How Should Regulators be Chosen?

At CBS Money Watch:

How should regulators be chosen?, by Mark Thoma

I argue that most people do not feel like their interests are represented when policy decisions are made about regulation, bailouts, and other matters, including decisions by the Federal Reserve on setting the target interest rate, and that needs to change.


Is Government Helping or Hurting Business?

There's not a populist bone in Robert Reich's body. Not a one:

Why the Dow is Hitting 10,000 Even When Consumers Can't Buy And Business Cries "Socialism", by Robert Reich: So how can the Dow Jones Industrial Average be flirting with 10,000 when consumers, who make up 70 percent of the economy, have had to cut way back on buying because they have no money? Jobs continue to disappear. One out of six Americans is either unemployed or underemployed. Homes can no longer function as piggy banks because they're worth almost a third less than they were two years ago. And for the first time in more than a decade, Americans are now having to pay down their debts and start to save. Even more curious, how can the Dow be so far up when every business and Wall Street executive I come across tells me government is crushing the economy with its huge deficits, and its supposed "takeover" of health care, autos, housing, energy, and finance? Their anguished cries of "socialism" are almost drowning out all their cheering over the surging Dow. The explanation is simple. The great consumer retreat from the market is being offset by government's advance into the market. Consumer debt is way down from its peak in 2006; government debt is way up. Consumer spending is down, government spending is up. Why have new housing starts begun? Because the Fed is buying up Fannie and Freddie's paper, and government-owned Fannie and Freddie are now just about the only mortgage games remaining in play. Why are health care stocks booming? Because the government is about to expand coverage to tens of millions more Americans, and the White House has assured Big Pharma and health insurers that their profits will soar. Why are auto sales up? Because the cash-for-clunkers program has been subsidizing new car sales. Why is the financial sector surging? Because the Fed is keeping interest rates near zero, and ... the government is still guaranteeing any bank too big to fail will be bailed out. Why are federal contractors doing so well? Because the stimulus has kicked in. In other words, the Dow is up despite the biggest consumer retreat from the market since the Great Depression because of the very thing so many executives are complaining about, which is government's expansion. And regardless of what you call it – Keynesianism, socialism, or just pragmatism – it's doing wonders for business, especially big business and Wall Street. Consumer spending is falling back to 60 to 65 percent of the economy, as government spending expands to fill the gap. The problem is, our newly expanded government isn't doing much for average working Americans who continue to lose their jobs and whose belts continue to tighten, and who are getting almost nothing out of the rising Dow because they own few if any shares of stock. Despite ... all their cries of "socialism" -- big business and Wall Street are more politically potent than ever.

It would have been better if the effort to revive the economy had a stronger trickle up component, i.e. give the tax cuts or transfers to the people who need it rather than those who don't, they will spend the extra money, it will trickle up as profits to the owners of businesses as the money is spent and re-spent through the multiplier process, and the owners will use the profits to hire more workers and to make productive investments (and even if the money doesn't trickle up as expected, at least you've helped people in need, when tax cuts for the wealthy don't trickle down, the consolation prize isn't as attractive).


Output, Productivity, Employment, Household Debt, Consumption, and Wealth

Two from the Antonio Fatás and Ilian Mihov Global Economy blog. First, Antonio Fatás notes cross-country differences in how productivity has evolved during the crisis, and he speculates that the difference may be due to differences in how much effort was devoted to reducing the impact of the recession on employment:

Output, employment and productivity during the crisis, by Antonio Fatás: While most advanced economies have displayed significant drops in GDP during the last years, the behavior of labor market variables (employment, unemployment, number of hours) has been quite different across countries.
In countries such as the US or Spain we have seen a large decline in employment/hours and the corresponding increase in unemployment. In countries such as Germany or France or Sweden, employment and hours have fallen much less.
Below is data on labor productivity measured as GDP per hour worked in four countries... In the case of Sweden and Germany we can see that the fall in GDP has been much larger than the decrease in hours worked leading to a decline in productivity. In the case of the US productivity has remained stable. In the case of Spain the fall in employment and hours has been much larger than the decrease in GDP which has produced a doubling of the productivity growth rates in 2007/08 relative to the 2003-06 period.
Behind these figures we probably have a composition effect (different sectors being affected differently by the crisis) but also different labor market responses to the crisis, where in some cases there has been a conscious effort to reduce the impact on employment.

Next, Ilian Mihov argues that consumer indebtedness might not be as bad as you've been led to believe:

Household debt, consumption and wealth, by Ilian Mihov: It is very common these days to hear that the global economy has no way of recovering because the most powerful engine of global demand – the American consumer – is choking in debt. ... Indeed,... debt stands at $14.068 trillion or slightly less than 100% of GDP. Does this mean that the economy is doomed? There are two points that one has to take into account when evaluating the role of household debt in the economy. 1. Debt is only one side of the story. Households also own assets. Consumption is a function of (net) wealth, not only of indebtedness. Up to a first approximation what matters is the difference between assets and liabilities. Indeed, no one thinks that a person with $10 million in debt is going to cut his or her consumption, if you know that this person has $10 billion in assets. So, how do American consumers fare in terms of net worth? Below is a graph with three ratios – assets-to-GDP, debt-to-GDP and net-worth-to-GDP. Although household debt stands at 100% of GDP, assets owned by US households currently stand at $67.2 trillion or 475% of GDP. The net worth of the American households is estimated to be over 375% of GDP.
Are these assets sufficient? This is hard to tell because theory does not provide convincing guidance as to what the wealth-to-GDP ratio should be. But we can look at the data to see how these numbers compare to historical averages. The average ratio of US household net worth from 1952Q1 to 2009Q2 is about 350% (if we exclude the two bubbles, the ratio is 330%). In short, US households today have more net wealth than they had in normal times in the post WWII period. Contrary to all complaints, US households today are richer than at any point in time in the pre-1995 period (and again, this is relative to GDP; in absolute terms no one will be surprised that this statement is true). But maybe it is the composition of debt that matters – people today live off their credit cards. It turns out that consumer credit has increased indeed over the past 20 years but the numbers are not shocking. From about 14% in 1990, consumer credit rose to 17.3% in 2009 (again the numbers are relative to GDP). ... 2. Even if we concede that debt can reduce consumption for an individual, it is a bit trickier to make the same argument for the national economy. The reason is that the liability of one individual is an asset for someone else. In the graph above, the thin blue line is in fact included in the thick red line! ... There are ways in which this "neutrality of debt" may break down. For example, if those who are indebted have a higher propensity to consume than the lenders, then debt will lead them to cut their consumption by more than the lenders will increase theirs (due to the wealth effect). This is possible and even plausible, but it is not clear whether empirically this effect is significant. Second, it might be that household debt is held by foreigners. Again, the data are not very supportive of this hypothesis because the net foreign asset position of the US is not (yet) devastating – less than 20% of GDP.
In general, many other "imperfections" in the market economy can result in the importance of debt for aggregate consumption, and I do agree that some of these imperfections are realistic and important. The main point of the argument is that we need a more nuanced view of why debt matters. We should keep in mind that the net worth of US households is still quite high (375% of GDP) and that debt should be viewed from a general equilibrium point of view and not only in absolute terms.
One quick comment. This is hinted at in the second to last paragraph, but to make it more explicit, the distribution of assets and liabilities can matter, and given the rise in inequality over much of this time period (it coincides with the rise in the green and red lines beginning in the 1970s evident in the diagram above) along with the stagnant wages of the working class, there may well have been important distributional effects.


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