Explaining Southern California's economy

Econ 474: Whatever happened to the 'Great Moderation?'

I'm introducing a recurrent weekly feature to the blog. It's called "Econ 474," and I'll leave it to the commenters to figure out why. For my part, I'll say that I want to blog about some key economics and business topics that bear on Southern California, but I'd like it to be a bit more involved that good-old Econ 101. 

Today, let's take a look at what, prior to the financial crisis. economists were calling the "Great Moderation." The current Federal Reserve Chairman, Ben Bernanke, summarized it pretty well in a 2004 speech -- before he succeeded Alan Greenspan, and obviously four years prior to the financial crisis:

One of the most striking features of the economic landscape over the past twenty years or so has been a substantial decline in macroeconomic volatility. In a recent article, Olivier Blanchard and John Simon (2001) documented that the variability of quarterly growth in real output (as measured by its standard deviation) has declined by half since the mid-1980s, while the variability of quarterly inflation has declined by about two thirds.1 Several writers on the topic have dubbed this remarkable decline in the variability of both output and inflation "the Great Moderation." Similar declines in the volatility of output and inflation occurred at about the same time in other major industrial countries, with the recent exception of Japan, a country that has faced a distinctive set of economic problems in the past decade....Reduced macroeconomic volatility has numerous benefits. Lower volatility of inflation improves market functioning, makes economic planning easier, and reduces the resources devoted to hedging inflation risks. Lower volatility of output tends to imply more stable employment and a reduction in the extent of economic uncertainty confronting households and firms. The reduction in the volatility of output is also closely associated with the fact that recessions have become less frequent and less severe.


Meet the new recession – same as the old recession? Or worse?


There’s been a fair amount of discussion lately about whether we’re headed for another recession. The last recession -- and I’m not going to call it the Great Recession for reasons that will be apparent in a second -- technically ended in June 2009, more than two years ago. 

If you live in Southern California, you could be forgiven for thinking that the recession didn’t end in 2009 and was in fact a Great Recession that’s still ongoing. California’s unemployment level is at 12 percent and Los Angeles County’s is at 12.4 (both have recently risen, according to statistics released by the BLS). 

But if you feel the recession is still in full swing, consider two things: actual data that points to a recovery since 2009 in some areas; and the business cycle.

Consider corporate profits, which have bounced back vigorously since the onset of the financial crisis. Here’s the LA Times:

Profits aren't rising solely because companies are making and selling more widgets to keep up with customer demand, which would be the case in a healthy, booming economy. Instead, companies are more profitable because it now costs less to make the same widget, often because far fewer workers are needed to make it.

Think it through: High unemployment and a credit crunch has meant that business can’t count on consumers ponying up to buy more stuff. In fact, businesses have created this problem themselves by playing defense and shedding workers. They aren’t paying a percentage of their pre-crisis workforce the money that it needs to buy what business makes. 

So businesses are streamlining productivity to reduce the costs involved with selling roughly the same amount of stuff to fewer people. It’s good for the bottom line -- and in theory when the economy does begin to recover more robustly and demand begins to grow at a faster clip, productivity gains will boost profits even higher.

Sadly, it’s looking more and more like that isn’t going to happen right away. The business cycle is going to dictate that the above-mentioned productivity gains be eroded by things like inflation, which is creeping back into the economy, and the ongoing unemployment problem. Want a double-edged sword? How about layoffs that juice corporate profits but take consumers out of the markets?  

Allow me to quote at some length from a Howard Gold piece at MarketWatch, on the new-recessionary views of economist Gary Shilling:

“I’m predicting another recession next year,” [Shilling] told me.

Not a double dip, he emphasized, because we’re already two years from the end of the last recession and 3 ½ years from the business cycle’s previous peak, in December 2007. Historically, he said, economic expansions last about three years, especially in long down cycles of the kind he thinks we’ve been in since 2000.

So, he’s looking for a brand new cyclical recession beginning in 2012.

Many Americans will be forgiven if they can’t see the difference between that and the recovery we’ve been experiencing.

That’s Shilling’s point. Usually, deep recessions like the one we just lived through are followed by strong snapbacks, like a growth slingshot.

This time, however, the recovery has been “distinctly subpar,” in his words. “As of the first quarter, ..real GDP is barely above its peak in the fourth quarter of 2007, whereas earlier recoveries were well above their previous tops 13 quarters later,” he wrote in a recent edition of his newsletter, Insight.

Translation: More than three years after the peak, we’re still not back to where we were.

Additional translation: After the epic stock market turmoil of the past few weeks, the chances of a new recession are increasing. The UCLA Anderson Forecast already said earlier this year that, for California, there was "no recovery in sight" for 2011. We may not even get the 1.7 percent employment growth that was predicted. That could mean unemployment that won't be reduced to even the current (high) national number of about 9 percent until -- Yikes! -- 2014.  

Photo: Wikimedia Commons