Fed vice-chair Stan Fischer gave another interesting (and long!—dude, you don’t have to cover everything in each outing!) speech today wherein he continues to articulate the Fed’s state-of-the-art thinking on all the big issues (here’s an earlier post re Fischer on financial oversight).
Just did this CNBC hit on it so let me summarize the point I found most interesting (btw, all else equal, shouldn’t you listen to the guy wearing the tie?!).
Fischer wades into this portentous question of whether the potential growth rates of advanced economies has slowed as much as a by-now-wide-spate of research shows. I review Larry Ball’s paper on the topic here, but the idea is that the Great Recession did permanent damage to the three inputs that determine potential GDP growth: labor supply, capital investment, and productivity growth.
Stan poses the right question:
How much of this weakness on the supply side will turn out to be structural–perhaps contributing to a secular slowdown–and how much is temporary but longer-than-usual-lasting remains a crucial and open question.
And this part of his answer is particularly important (my italics):
…there are good reasons to believe that some of the surprising weakness in labor force participation reflects still poor cyclical conditions. Many of those who dropped out of the labor force may be discouraged workers. Further strengthening of the economy will likely pull some of these workers back into the labor market, although skills and networks may have depreciated some over the past years.
Later, he adds: “…it may also be possible to reverse or prevent declines from becoming permanent through expansive macroeconomic policies.”
Chair Yellen has made similar points, which I have discussed under the rubric of “reverse hysteresis.”
When a cyclical problem morphs into a structural one, economists invoke the concept of hysteresis. When this phenomenon takes hold, the rate at which key economic inputs like labor supply and capital investment enter the economy undergoes a downshift that lasts through the downturn and well into the expansion, reducing the economy’s speed limit. But what I’m suggesting here is that by running the economy well below conventional estimates of the lowest unemployment rate consistent with stable inflation, and doing so for a while, we can pull workers back in, raise their career trajectories, improve their pay and their living standards, and turn that downshift to an upshift that raises the level and growth rate of G.D.P.
Curiously, in the context of this discussion, Fischer cites the important Fed study that really triggered this debate on the extent to which cyclical problems have become structural ones, despite the fact that the study, running off of the (tweaked-up) Fed macro model, explicitly denies the possibility of reverse hysteresis:
Policy makers cannot undo labor market damage once it has occurred, but must instead wait for it to fade away on its own accord; in other words, there is no special advantage, given this specification, to running a high-pressure economy.
No one knows, but I don’t think that’s right, and I’d say the Fed’s chair and vice-chair at least provisionally agree. The implication for current policy is clear: we need to run a high-pressure economy for a while not just to close existing output gaps but to increase potential growth by pulling more people and capital investment back into the economy. That, by the way, is what I mean by “supply-side economics” (not that Art Laffer silliness!).
Final point: Early on, Fischer asserts that he “…will leave it to others to address the important challenges facing fiscal policymakers as they determine the appropriate roles and paths for fiscal policy at both the macro- and micro-levels.”
To his credit, he doesn’t quite stick to that restriction but I don’t see anything wrong or at all unprecedented for Fed officials holding forth on the macro economy to comment as much as is needed on this critical part their model (Bernanke often complained directly to Congress on this point). I’m not saying he should name names, of course, but no one’s purpose is well served if one of the most profound and impactful economic mistakes in recent years and across many countries—fiscal austerity in the face of weak demand—is cordoned off and “left to others.”