Macroeconomics

Two days ago, I posted James Hamilton’s blog entry on Friday’s GDP numbers and suggested that the 1.6% growth in GDP was not as depressing as it might seem.  Primarily, I noted that inventory growth had slowed and imports had risen.  The latter might be viewed as demonstrating renewed economic strength whether the imports reflect increased household consumption and household income (which they do) or increased business purchases of intermediate inputs (which they also do.)

In today’s Financial Times, economists Carmen and Vincent Reinhart summarize their address given last week at the Kansas City Feds’ annual symposium which features central bankers from all over the world.  The Reinharts warn us that financial crises of the sort we are emerging from do not generate robust rebounds.

Such optimism, however, may be premature. We have analysed data on numerous severe economic dislocations over the past three-quarters of a century; a record of misfortune including 15 severe post-second world war crises, the Great Depression and the 1973-74 oil shock. The result is a bracing warning that the future is likely to bring only hard choices.

But if we continue as others have before, the need to deleverage will dampen employment and growth for some time to come.

Although aggressive use of fiscal and monetary policies may be necessary to avoid the risks of economic depression, they are no substitute for changes in expectations and economic structure required to find a stable long term economic growth path.  Attempts to avoid such “creative destructive” will only deepen the cost of the inevitable adjustment that must take place.

Obviously, to answer this question begs another:  What’s a PLOG? or perhaps:  Should we view central bankers as plumbers?  PLOG, a term coined by IMF economist Andre Meier, refers to Persistently Large Output Gap  or positive deviation between potential GDP and measured GDP.  The big concern raised by the LEX column in today’s Financial Times regards whether central bankers should worry about a deflationary double dip recession.  As Lex puts it:

“The supposed PLOG-effect creates a dilemma: the Scylla of deflation or the Charybdis of extraordinarily easy monetary policy.”

Based on Meier’s study of 25 episodes in advanced economies, Lex argues that recessions slowly reduce inflation rates and generally stop prior to serious deflation.  Therefore,  central bankers should not become preoccupied with such a threat.  Indeed, attempts to further stimulate economies such as ours with monetary policy is likely to be ineffective (or to use the proverbial idea: it’s like pushing on a string.)

I find the final sentence of the opinion piece particularly instructive.

“And while a PLOG may not create deflation, it can only amplify the grim economic effects of over-indebtedness, whatever policies central bankers adopt.”