It is understandable when a model is wrong due to a major and unexpected shock like the war in Ukraine. But that is not the case here. The US may be dodging a recession for mysterious reasons specific to the aggregate demand model. Indeed, the Federal Reserve’s monetary policy has been tighter, and disinflation usually carries high economic costs.
It gets even more curious. Perhaps Summers will be proven right about a recession. Recessions often come suddenly. It cannot be helpful to consult every possible macroeconomic theory.
Or think of the 1990s. President Bill Clinton believed that government deficits were too high and crowded out private investment. The Treasury Department was working with a Republican Congress on a fiscal consolidation package. Real interest rates fell and the economy boomed – but that’s just the observed correlation. The true causal story remains obscure.
Two of the economists behind the Clinton package, Summers and Bradford DeLong, later argued against fiscal consolidation, even during President Donald Trump’s years of full employment. The new concern was instead secular stagnation due to insufficient demand, although the final years of the Trump presidency saw debt and deficits well above Clinton-era levels.
The point here is not to criticize Summers and DeLong as contradictory. Rather, it should be noted that they could have been right both times.
And what about that idea of secular stagnation – the notion that the world is heading towards a period of little to no economic growth? The theory was based in part on the premise that global savings were large relative to investment opportunities. Are all those savings gone? In most places, measured savings increased during the pandemic. But the problem of insufficient demand has disappeared, and so secular theories of stagnation no longer seem valid.
To be clear, the secular stagnation theory may have been true before the pandemic. And it could become a legitimate concern once again if inflation and interest rates return to pre-pandemic levels. The simple answer is that no one knows.
Again, these aren’t just intermediate surprises that inevitably confound all attempts to apply natural and social science. We economists are not sure which model to use at all. For example, how did Japan go so quickly from a fast-growing economy to a bubble economy to a slow-growing economy? I haven’t seen any good answers to this question.
How tight can the Fed control real interest rates? In the 1990s, economists worked very hard to demonstrate the existence of a modest “liquidity effect” on real interest rates from monetary policy. More recently, the Fed pushed the ZIRP – Zero Interest Rate Policy – and real lending rates have been negative for the US Treasury for many consecutive years. It’s hard to say how important Fed policy was, but suddenly it felt like a different world, at least until emergency pandemic relief came.
A practical result is that perhaps people shouldn’t pay as much for expensive private sector macroeconomic forecasts. Every economist has their models, but there is no way of knowing when one model will stop working and another will gain traction.
As for politics, beware of any statement that there is “no reason to worry” about an upcoming crisis – be it monetary, fiscal, financial or whatever. “Everything has been fine up until now” is a relevant observation, but it’s hardly reassuring. Macroeconomics doesn’t quite warrant the confidence the world wants to place in it.
More from the Bloomberg Opinion:
• Don’t be disoriented by recession talk fatigue: Jonathan Levin
• Even the masters of the universe are at a loss: Robert Burgess
• The job market is struggling to solve the recession puzzle: Kathryn Edwards
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Tyler Cowen is a columnist for the Bloomberg Opinion. He is Professor of Economics at George Mason University and writes for the blog Marginal Revolution. He is co-author of Talent: How to Identify Energizers, Creatives, and Winners Around the World.
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