The Journal of Economic Perspectives is a widely read journal that provides economists with relatively accessible (i.e. non-mathematical) articles on important issues. The new issue focuses on the current crisis, with articles by famous economists such as Hall, Woodford and Ohanian. The lead-off article by Robert Hall begins as follows:
The worst financial crisis in the history of the United States and many other countries started in 1929. The Great Depression followed. The second-worst struck in the fall of 2008 and the Great Recession followed. Commentators have dwelt endlessly on the causes of these and other deep financial collapses. Less conspicuous has been the macroeconomists’ concern about why output and employment collapse after a financial crisis and remain at low levels for several or many years after the crisis.
If you’ve followed my blog you know that I don’t think those assertions are correct. Indeed I don’t think they are even defensible. Let’s start with the first two sentences. The US did not suffer any sort of financial crisis in 1929. Rather, the Great Depression began in August 1929, and the first crisis occurred at the end of 1930 (and was itself quite mild.) A severe banking crisis did occur after Britain left gold in September 1931, by which time the US was already deep in depression. Note how Hall’s intro leads the reader to assume causation ran from financial crisis to economic depression, when in fact the causation ran in exactly the opposite direction. It is doubtful the US would have experienced any financial crisis during the early 1930s, if we had not seen NGDP fall in half.
I re-read the passage several times, trying to imagine what Hall could have had in mind. Perhaps he was thinking of the 1929 stock market crash. But there are two problems with that view. First, a stock market crash is not a financial crisis. And second, the 1987 stock crash was almost identical to the 1929 crash, and yet did not cause even a tiny ripple in the economy. So no one would start a paper arguing that big stock market crashes cause recessions. And if stock market crashes really were “crises,” then 1987 should be considered one of the great financial crises in US history, and I think almost everyone would regard that assertion as crazy. So I’m completely perplexed by what Hall (and the JEP editors who approved his manuscript) were thinking. And remember that Hall is right up there with McCallum as one of my favorite macroeconomists.
The second pair of sentences are hardly any better. The Great Recession (also the name I use) started in December 2007, long before the severe crisis of late 2008. In fairness, the recession was not at all severe during the early months. But if you look at the monthly GDP series from Macroeconomics Advisers, you’ll notice that the severe plunge took place between June and December 2008. The financial crisis occurred half way through that severe plunge in GDP (real and nominal.)
Why am I being so picky? After all, we all know that intros are just flowery window dressing before economists get to the meat and potatoes of the paper. To see why, consider the title of the paper:
Why Does the Economy Fall to Pieces after a Financial Crisis?
Hall has written a paper to explain stylized facts “we all know are true,” that in fact are completely false. The paper should be entitled:
Why are Financial Crises Preceded by the Economy Falling to Pieces?
And the intro should read:
The worst depression in the history of the United States and many other countries started in 1929. The Great Banking Panics followed. The worst recession since the 1930s struck in December 2007, and dramatically worsened in July 2008. The Great Financial crisis of the fall of 2008 followed. Commentators have dwelt endlessly on the causes of these and other deep financial collapses. Less conspicuous has been the macroeconomists’ concern about why output and employment collapse before a financial crisis and remain at low levels for several or many years after the crisis.
We know that severe declines in NGDP are likely to cause severe declines in RGDP. The reasons are murky, although I believe sticky wages are an important transmission mechanism. There is more controversy about what causes NGDP to plunge. But given the recession began in December 2007, and given the severe plunge in NGDP occurred between June and December 2008, it seems a bit hard to believe that the financial crisis of the fall of 2008 was the cause.
I was also a bit disappointed by the final paragraph of Hall’s paper:
In the category of blue-sky thinking, a few macroeconomists, including this writer when he has nothing better to do, think about how to work around the zero lower bound on interest rates. The key policy move to eliminate the bound is for the Fed to drop its unlimited willingness to issue currency, given that currency is, in effect, a way that the federal government borrows from the public at above-market interest rates. If the Fed stopped accommodating the swelling demand for currency, the existing stock of currency would appreciate””a $20 bill would buy more than $20 worth of merchandise, just as a British pound buys more than a dollar today. We are still pondering how the public would react to this departure from a century and a half of government currency issuance.
I’d rather see brilliant economists like Hall focus on pragmatic solutions for our AD shortfall, such as my “cocktail” policy of NGDP targeting (level targeting), negative IOR, and QE. People are used to using currency as a medium of account—indeed its great convenience comes from the fact that its nominal price is fixed, making it extremely easy to use in transactions. Suppose we did increase its value by ceasing to issue new currency, and suppose it remained a medium of account; where would we be then? (Hint: the answer starts with the letter “d”.)