By Gabriel Martinez, December 20, 2010 in Uncategorized
If the evidence that the recession is over is so clear (see my previous post), why are we still in “tough economic times,” as the hackneyed phrase has it? Why are there so many unemployed resources? Why are so many people out of work?
To say, “the patient has stabilized” is not the same as to say that the patient is healthy. Consider a country’s ability to produce. This is given by the amount of people willing and able to work, the amount of machines, buildings, and tools available, the state of technology, etc. These factors determine how much output can an economy produce at a point in time (at least without endangering price stability). Here’s the CBO’s guesstimate for Potential Output (the maximum that can be produced without running into inflation).
If less output is produced than can be produced, people will be out of work, machines will be under-utilized, buildings will be empty, etc. A comparison of potential output with actual output (which can be done pretty easily if you know how to manipulate FRED Graph) suggests that even though the economy might have found the bottom of the barrel, it is quite far from getting out of it.
Put differently: in the second quarter of 2010, real GDP grew by 3%, which is just as fast as the average growth rate between August 2004 and July 2006. Back then unemployment averaged 5%; today it’s almost double that rate.
What this means is that it is not enough for the growth rate of GDP to have stopped falling or for it to have become positive. To get out of the barrel, GDP has to grow much faster than the average “good years” growth rate.
(This actually understates the magnitude of the problem. Potential GDP grows every year. Technological progress does not keep still. Competition is still a force. Population – at least in the US – keeps growing. Capital accumulation may have slowed down by is still positive. The amount of production that would be necessary to bring back “full-employment” of resources is larger today than it was when the recession started.)
Typically, after a recession has ended GDP spurts up, led by businesses’ purchases of fixed capital (which we call investment). Low demand for loans reduces interest rates; high unemployment ‘moderates’ wages; high vacancy rates keep rents down. Businesses sense a buying opportunity: those that can afford it, snap up market share by jumping in early. This has happened, to some degree, at the beginning of this expansion.
The problem is that, proportionately to the size of the recession, even very robust private investment has proved to be insufficient. In my next installment, I will discuss some of the factors behind this.