The economy’s speed limit is a policy variable

February 22nd, 2016 at 8:25 am

Many economists accept the concept of “hysteresis,” which sounds like, and is, a disease that occurs when persistent periods of weak demand chip away at what I call the “big two” supply-side variables: labor supply and productivity. The figure below reveals the serious consequences of our latest bout with hysteresis.

In today’s WaPo, I tout the concept of “reverse hysteresis,” without, in respect to my non-OTE readers, calling it that. The idea is simply one of symmetry: if lousy policy can depress the big two, good policy can boost them. It’s a more widely held belief than you might think, besides being common sense, IMHO.

Sources: CBO, BEA

Sources: CBO, BEA

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2 comments in reply to "The economy’s speed limit is a policy variable"

  1. Bob Wyman says:

    Wealth bubbles up much more than it trickles down. More progressive taxation would lead to higher median wages, greater demand, and increased productivity. Our three decade experiment with lower taxes on the high end, has shown that when taxes on the top go down, wages at the bottom decline.

  2. Nick Buffie says:

    The concept of “reverse hysteresis” is very interesting. Do you think this may somewhat change the interaction between full employment and potential GDP? Normally when people talk about “full employment,” they seem to start with the premise that we won’t see wage gains until more people have entered the labor market and we have a higher prime-age or age-adjusted employment rate.

    I’m wondering, though, if the order may reverse itself here. Basically, if unemployment goes even lower, employers would be competing to hire amongst a diminished group of job applicants. So they’d begin raising wages, and we’d achieve full employment — even without higher civilian labor force participation. Because they saw rising wages, more people would enter the labor force, which would simultaneously 1) slow wage growth (or at least prevent it from going higher than it otherwise would have) and 2) increase potential GDP because we’d now be increasing labor supply.

    There’s even one story I could tell where this would happen rather soon, mostly based on research by Alan Krueger showing that only short-term unemployment seems to accurately predict wage growth (and has done so even during the recession and its aftermath):

    Having said all that, there’s one big caveat I’d give, which is that I think most employers know that they can increase their payrolls without necessarily hiring the “unemployed.” First, we have a really large number of involuntary part-time workers today, so I imagine that employers could do some combination of 1) increasing their own part-time workers’ hours; 2) offering part-time jobs to involuntary part-time workers who want a second part-time job to make a real living; and 3) offering up full-time positions that workers who are currently part-time would want to take. Second, the BLS tracks the number of people who say they want a job but are no longer in the labor force. The ratio of such workers to unemployed workers is abnormally high right now. And if you look at the labor force flows data from the BLS, the data show that employers are increasingly hiring people not in the labor force rather than the unemployed. This seems to indicate that employers actually have a larger labor supply which they can draw their new workers from, so the low unemployment rate wouldn’t indicate strong wage growth or full employment.

    Would love to hear your thoughts on this.