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Pessimistic views on possibilities for US economic recovery

In Melbourne last night Nobel Laureate Dale Mortensen gave a talk “After the Great Recession: Recovery or Stagnation”. After discussing his flow model of unemployment which essentially links levels of employment to numbers of job offers he moved to more familiar grounds.  Mortensen argued that job mismatches (unemployed construction workers trying to get jobs in finance) accounted for at most 1.5% of US unemployment.  The remaining excessively high levels of unemployment (of around 4 per cent) reflected deficient demand by those consumers with high debt – the 11 million Americans with mortgages “under water” for example.  There is empirical evidence on this by Sufi et al who estimate that 65% of jobs lost in the US are due to deficient demand. The solution – guess what?  Yes get the public sector to increase its spending to compensate for deficient private spending – a position that, in fact, most of the economics profession endorse.  Mortensen sees this outcome as unlikely given the impact of Republican stupidity on US politics. Overall he is pessimistic – a fairly long-term stagnation of the US economy driven by wrong-thinking austerity ideologues and the severe crisis in Europe which further deflates the demand for US goods and services.

Debt problems? For sure there are but deal with them without inducing worse deficits now through a consequence of resource underutilization that will in fact worsen longer-term debt problems not reduce them.  It is a standard story I have long believed.

An interesting and obviously well-informed talk though one whose conclusions did not surprise me in the least.  I notice that this morning the IMF are warning the US against cutting the deficit too quickly.  Mortensen is pessimistic about the US economic future because he believes it will not pay heed to such well-informed and reasonable warnings.

1 comment to Pessimistic views on possibilities for US economic recovery

  • Jim Rose

    I recall that Mortensen made similar remarks about deficient demand in his Nobel Prize lecture. The ghost of Keynes!

    Co-laureate Peter Diamond’s said that if much of the current unemployment is caused by a lack of adequate demand, the Fed can act in a measured way to reduce it without touching off inflation.

    This talk of deficient demand suggests that Diamond and Mortensen have not accepted the ideas that founded the great moderation and modern macroeconomics. as Martin Eichenbaum (1997) put it: “There is now widespread agreement that counter-cyclical discretionary fiscal policy is neither desirable nor politically feasible”

    Back to the 70s it is for Peter Diamond and Dale Mortensen in theory and policy.

    Friedman defended his policy ideas by pointed to where they and worked and where rival policies had failed.

    Did Mortensen (or Diamond) mention any prior empirical success of this proposed policies or how he would overcome the leads and lags on monetary and fiscal policy or the mounting unpleasant monetary arithmetic?

    To recall Robert Lucas in 1981:
    “Proponents of a class of models which promised 31/2 to 41/2 percent unemployment to a society willing to tolerate annual inflation rates of 4 to 5 percent have some explaining to do after a decade such as we have gone through [i.e., the 1970s, when inflation rose to 16 percent and unemployment to 8 percent in the United States, and to 30 percent and 6 percent in the U.K. Inflation rose as high as 25 percent in Japan and 7 percent in Germany, though unemployment remained relatively low].

    A forecast error of this magnitude and central importance to policy has consequences, as well it should.”

    Thomas Humphrey wrote a 250 year long literature survey of the rules versus discretion debate in the 1998 Richmond Fed Quarterly. He found that:
    • Keynesian ideas and their many antecedents gain currency when unemployment was the main concern; and
    • Monetarist ideas tended to reign when price stability was the main problem.