Wednesday, July 14, 2010

Some gems from Robert Hall

This interview has been blogged about elsewhere but I wanted to save the bits that I found interesting:
[on automatic recession dating]:
Actually, long ago, in the 1980s, we sponsored a project that informally, unofficially put out a recession probability index that Jim Stock and Mark Watson prepared. It didn’t work very well in the 1991 recession, so they stopped doing it after that.

And it didn’t work for fairly typical reasons. That was the first recession that wasn’t accompanied by a decline in productivity, so it looked somewhat different. So their historical relationships weren’t as stable as they hoped.

That’s one of the main reasons why automatic rules haven’t worked. People have done research on the machine approach for years. In fact, when I was a graduate student and took a computer science course, my project was to write software that would automate this. So it’s not a new idea. But it’s never worked very well.

Region: It would have missed the 1981 recession if we’d used the two negative GDP quarters rule.

Hall: You mean 1980.

Region: Right, 1980.

Hall: 1981 was no problem. The 1980 recession was just one quarter. And people have said that the 1980 recession was actually just sort of a prelude to the ’81 recession. We say no, but it’s been said.

Region: It seems it’s more of an art than a science then. Hall: It’s a classification problem that the world seems to want an answer to, but it has a shifting structure, and dealing with the shifting structure is the issue. We try very hard to achieve historical continuity.

We don’t doubt for a second—and I don’t think anyone else does either—that we know when there’s a recession. In all the data we look at, certainly in the period when we’ve had reliable data, which is since World War II, there’s never been an episode that’s somewhere halfway between a recession and a nonrecession. Every recession has been clear. And they all see unemployment shoot up and typically see GDP decline.

We do face issues though. With the most recent revisions of GDP, the 2001 recession essentially doesn’t exist. It was a flattening, but as emphasized on our Web site, there are issues of depth, duration and dispersion, but there was neither depth nor duration in what happened in ’01. By the alternative measure of total output, real gross national income, the 2001 recession is quite apparent.To me, it’s not an issue because that’s just looking at GDP. If we look at employment, as I did in a 2007 Brookings paper on the “Modern Recession,”—by “modern recession” I mean one in which productivity rises…

[on the state of macroeconomics]
Region: The past few years seem to have brought about a crisis of confidence in the economics profession, with critics suggesting that macroeconomics has failed in some fundamental way. It’s a topic addressed by [Minneapolis Fed President] Narayana Kocherlakota in our Annual Report this year. Do you agree that the macro profession failed the nation during the financial crisis?

Hall: I don’t. There are two parts to the issue. First, did macroeconomists fail to understand that a highly levered financial system based in large part on real-estate debt was vulnerable to a decline in real-estate prices? No way. Many of us pointed out the danger of thinly capitalized banks. We had enthusiastically backed the idea of prompt corrective action in bank regulation, so that banks would be recapitalized well before they became dangerously close to collapse. We watched in frustration as the regulators failed to take that action, even though they had promised they would.

Second, did macroeconomists fail to understand that financial collapse would result in deep recession? Not at all. A complete analysis of that exact issue appears in an extremely well-known and respected chapter in the Handbook of Macroeconomics in 1999, written by Ben Bernanke, Mark Gertler and Simon Gilchrist. Depletion of the capital of financial institutions raises financial frictions to levels that distinctly impede economic activity. In particular, credit-dependent spending on plant, equipment, inventories, housing and consumer durables collapses. That chapter is an excellent guide to the depth of the current recession.

I would have liked him to have answered the question: How should the government response? Although he does talk a little about fiscal policy in the beginning of the interview, I did not think that he adequately responded to how the fiscal stimulus should have been structured (he says in the interview that too little of it went into increasing aggregate demand directly) and whether monetary policy would have been prefered i.e. he did not answer Kocherlakota's claim that economists were not able to provide a play book to respond to the crisis.

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