Opposite Sides Agree on Recession/Inflation Bogosity


Can you still believe anybody in this crazy, hill-of-beans, overstimulated, double-dipping world? 

From the United Queendom, Steve Stone's Keynesian take on the mismeasurement of recessions is getting heavy #recession-hashtag rotation, and while it's not especially deep or broad, it's got a kernel of truth: 

A recession now only 'officially' exists in an economy if there are three successive quarters of negative growth, and as soon as that's no longer the case, it's 'officially' over, and we can all look to the future.

The definition is of course a load of old tosh. If it were true, the long and deep British recession of the 1970's was barely a recession at all—there was just one case of three successive quarters of negative growth, 1973-4, see GDP changes since 1955. And yet I lived through the miners' strike, the power cuts, the three-day week, and the 1978 Winter of Discontent….

Stone concludes by urging readers, "If you enjoyed reading this, please take a look my series of time travel novels," which you should definitely do unless you live in China. But his imagination fails him when he predicts based on past econometric models that "without doubt…the number one indicator of economic activity is house prices."

That may have been true once, and it may be true again, but at least on this side of the pond we're still working our way back through nearly four decades of well-above-CPI real estate inflation. And although, as Reason's Anthony Randazzo is diligently showing, our rulers have come pretty close to nationalizing the industry, real estate markets are still subject to a vast number of distortions by local busybodies, planners and property tax laws. If your predictive measure is the recovery of a market that still needs double-digit percentage price declines just to get back to historical inflation, you should get a new measure. 

Note also that the U.S. National Bureau of Economic Research is more flexible in measuring recessions than the GDP-only measure Stone describes, though I don't know that it's any more accurate:

Q: The financial press often states the definition of a recession as two consecutive quarters of decline in real GDP. How does that relate to the NBER's recession dating procedure?

A: Most of the recessions identified by our procedures do consist of two or more quarters of declining real GDP, but not all of them. In 2001, for example, the recession did not include two consecutive quarters of decline in real GDP. In the recession beginning in December 2007 and ending in June 2009, real GDP declined in the first, third, and fourth quarters of 2008 and in the first quarter of 2009. The committee places real Gross Domestic Income on an equal footing with real GDP; real GDI declined for six consecutive quarters in the recent recession. 

Q: Why doesn't the committee accept the two-quarter definition?

A: The committee's procedure for identifying turning points differs from the two-quarter rule in a number of ways. First, we do not identify economic activity solely with real GDP and real GDI, but use a range of other indicators as well. Second, we place considerable emphasis on monthly indicators in arriving at a monthly chronology. Third, we consider the depth of the decline in economic activity. Recall that our definition includes the phrase, "a significant decline in activity." Fourth, in examining the behavior of domestic production, we consider not only the conventional product-side GDP estimates, but also the conceptually equivalent income-side GDI estimates. The differences between these two sets of estimates were particularly evident in the recessions of 2001 and 2007-2009. 

From the other end of the spectrum, Independent Institute economist Robert Higgs has an interesting take on another popular question: Why have we not seen massive price inflation from the nearly $3 trillion The Ben Bernank has conjured in the last three years? Higgs considers the possibilities

The most obvious answer, of course, is that the banks are simply sitting on the reserves, rather than lending them to customers. And why are they doing so? The usual answer is that since late 2008, the Fed has paid the banks a rate of interest on their reserves at the Fed. This interest rate has recently been in the range 0-0.25 percent. Although this is not nothing, it verges very closely on nothing. And if one notes that the purchasing power of money has fallen at least a bit, it is clear that the banks are realizing a negative real rate of return on their holdings of excess reserves at the Fed.

Moreover, they are doing so notwithstanding that they appear to have the option of lending at 3.25 percent to their best corporate customers and at higher rates to their less creditworthy customers. Why are they forgoing the opportunity to earn huge sums by switching out of excess reserves at the Fed into commercial loans and investments? The answer would seem to be that that are so frightened of the risk associated even with loans to their best customers that they are loath to lend. 

I'm sympathetic to this last point, in part because this monetary binge has coincided with some of the heaviest deflationary pressures, in both wages and prices, we have ever seen. The fact that prices only went down for one quarter in 2009 while wages have actually seen an ominous spike tells me where all that monetary expansion has gone. The anti-deflation campaign that began in 2008 will, I believe, someday be recognized as one of the biggest ripoffs in the history of this country. But for right now, it leaves everybody with the knowledge that there is still a vast nation of deadbeats out there, yet even after three years of famine we're not sure who they all are. Remember that it's not just the supply of loans that has fallen but the demand

But wiser lending practices don't explain everything. There are very good reasons to believe that the Fed's 2008 interest on reserves (IOR) program is more important than Higgs suggests.  

"For once I'm not in agreement with Bob," said University of Georgia economist George Selgin, author of the essential deflation study Less Than Zero [pdf], when I contacted him. Selgin says the low (25 basis points) rate on IOR is not insignificant: "What matters is how that rate compares to rates earned on Treasury securities. By that measure the rate is actually pretty high. That is, banks have relatively little to gain by investing their excess reserves in safe securities instead of just holding the cash."

Selgin continues: "And yes, if banks decide to start lending, the Fed will have its work cut out for it trying to mop up excess liquidity to avoid high inflation.  But it isn't clear that they can't take the necessary steps to prevent high inflation when the need to do so arises.  My guess is that when the shit hits the fan the Fed will make excuses for letting the inflation rate climb—invoking alternative inflation measures and such. But to speak of impending 'hyperinflation' seems like hyperbole to me at this stage of things."

I'd like to suggest one more possibility: that the problem is regime uncertainty, but not of the kind Higgs mentions. The existence of IOR has turned what used to be an imperfect but straightforward process of Fed-watching into something nobody really understands. (In my experience most regular humans don't even know IOR exists.)

Let's suppose that the Fed's more sophisticated tools have made the central bank better able to manage outcomes (not likely given the dire experience of the last three years, but just suppose). It's still a non-trivial problem that the rest of us have no idea what to expect from massive new money creation, or from monetary tightening (if that ever happens again), or from changes to the Fed Funds rate, or from any other traditional central bank shenanigans. In the past you may not have had any power over the Fed but you could at least say, "That thing you're doing—stop doing that thing." Now you're not even sure what the thing is. You just know it's extremely unpleasant to experience. 

Update: Steve Stone responds, graciously glosses me as "well-known columnist."