Nick Rowe has a post discussing the post-2008 slowdown in trend growth, which has occurred in many countries. (I’ll focus on the US, which I know best). He suggests that the failure of monetary policy during the Great Recession may have increased perceptions of risk going forward, particularly relative to during the Great Moderation, when people had grown more confident in economic stability. This increased perception of risk may have depressed investment. Because my previous post predicted that we are in a newer and even greater moderation (and hence that increased perceptions of risk are unwarranted), I feel that I need to address his post. I left a comment:
Nick, You said:
“And it is indeed too big a coincidence to suppose that an exogenous slowdown in long-run growth just happened to coincide with the Great Recession.”
I think that this may be exactly what happened. The growth slowdown would have occurred even if we had not had the Great Recession. (It’s partly demographics). I’d go further and argue that the slowdown in trend growth helped to cause the Great Recession. The slowdown reduced the Wicksellian natural rate, and the world’s central banks were slow to spot this change. Taylor Rule type thinking led to unintentional monetary tightening in 2008. A given interest rate setting (2% after Lehman failed) was much tighter than the Fed assumed.)
Note that this slowdown began before the Great Recession, as the equilibrium real interest rate has been gradually declining for several decades.
And Nick responded:
Scott: The slowdown in labour force growth was clearly partly due to demographics, and that part would have happened anyway. Though that would not have explained slowing productivity growth. And maybe there was a steady slowing of investment that would have happened anyway. But the apparent break in the trends just looks too big and sharp. Like in Simon Wren-Lewis’ chart of UK GDP per capita. The same trend line works pretty well, from 1955 to 2008. Then it doesn’t.
So I decided to check investment (excluding residential) as a share of GDP, and found this graph. (Non-housing investment seemed more relevant to productivity growth, but perhaps that assumption is wrong):
This surprised me. I had no idea that the late 1970s and early 1980s were “peak investment”, especially given the poor performance of the economy. Nor did I expect recent investment levels to exceed all pre-1975 business cycles, including the fast-growing 1960s. It is similar to the late 1980s, or 2002-05, when growth was far higher. Yes, investment is slightly below the levels of the late 1990s, but I’m not seeing a big enough fall in investment to explain trend growth falling from about 3% per year for the entire 20th century to perhaps half that figure today. (Yes, RGDP growth has recently averaged 2%, but that’s during a period of recovery and rapidly falling unemployment, which means trend growth has probably fallen below 2%.)
I think the recent growth slowdown is unrelated to the Great Recession. What do you think?
PS. If output was above trend in 2007, then the post-2008 slowdown may not be as sudden as Nick assumed, just by looking at the graph.
PPS: This article in The Economist presents another problem with the argument that uncertainty is reducing investment:
There is an alternative explanation for the failure of expectations to shift. Both businesses and investors, realising that the economic outlook is uncertain, may be demanding a higher risk premium for starting new projects or buying shares. That explanation is a little hard to square, however, with the repeated new record highs being scaled by stockmarkets or with the high valuations afforded to American equities.
Since the market low in March 2009, dividends have risen by 48% in real terms and real share prices have risen by 167%, according to Robert Shiller of Yale University. The cyclically-adjusted price-earnings ratio (or CAPE), which averages profits over ten years, is 28.7, its highest level since April 2002. In the past, very high CAPEs have been associated with low future returns.
Indeed, having analysed the data, Messrs Dimson, Marsh and Staunton reckon global investors are expecting a risk premium of 3-3.5% relative to Treasury bills—a level that is lower, not higher, than the historic average. So something does not add up.