I’d like to first demonstrate how we know that the economy did much better in 2021 than in 2009, and then explain why the outcome was better this time around.
In 2009, the main problem was unemployment. Today, the main problem is inflation. So “who’s to say” which economy was better?
To answer this question, we need to also look at real GDP. Inflation doesn’t directly reduce living standards, as when one person pays more for a good it just means that another person receives more. The real problem with inflation is that it may be associated with falling RGDP. With less output, living standards will suffer.
By this measure, we are doing far better in 2021 than in 2009. But average per capita real GDP (i.e. efficiency) isn’t everything; people have drowned in lakes with an average depth of only three feet. What about equity? How has the pain been spread around? We need to consider the famous “equity-efficiency trade-off”.
Surprisingly, the results are exactly the same when we add equity to the equation. Inflation imposes a small amount of pain all across the economy. In contrast, the pain from high unemployment is highly concentrated.
If you want a simple explanation of why 2021 is much better than 2009, consider that unemployment today is 4.6%, whereas it was 10% in October 2009. That’s an enormous difference, and it represents the main cost recessions. A whole generation of young people faced a hostile job market during and after the Great Recession. Today, in contrast, there are more job openings than ever before.
OK, but why did the economy of 2021 end up much better than in 2009? In 2021, there are still enormous challenges related to Covid, such as the difficult problem of “re-allocating” output from the service sector to the goods sector. This reallocation problem is far more difficult than in 2009, when we merely faced the challenge of reallocating output away from residential construction, a much smaller sector than consumer services. So why are we doing better this time around?
In 2009, the bad economy was caused by the Fed’s decision to allow NGDP to languish at a level far below the previous trend line. I recall speaking with one prominent new classical economist back in late 2008, who argued that pumping up NGDP would just lead to more inflation without boosting real GDP. It would have led to more inflation—that part was correct—but it would also have led to much more real GDP, and a much stronger labor market.
This time around the Fed has learned its lesson and pushed NGDP quickly back to the previous trend line. Indeed the current risk is that they’ll overshoot and produce too much NGDP, too much inflation. Let’s hope that doesn’t happen.
PS. I don’t know what public opinion polls would say about the relative performance of the 2009 and 2021 economies, but they are not the best way to look at the issue. Imagine a group of 100 people. At exactly noon today a mosquito bites 99 of them, while the 100th recovers from cancer. Is this group of 100 people better off or worse off? If you polled all 100 people and asked them if they felt better than a few minutes earlier, what would most say? What is the change in aggregate welfare?
READER COMMENTS
Steve Miran
Nov 22 2021 at 7:09am
Respectfully, as someone who helped implement the CARES Act, fiscal policy really deserves credit for the recovery. Monetary policy is not the most effective means of preserving an economy during a pandemic-induced shutdown. Without PPP, the UI enhancements (which were too persistent imo), and EIBs, there would have been a Depression. Smaller businesses can’t survive months with no revenue without permanently shuttering and severing all their economic contracts. The reallocation problem is a symptom of having preserved businesses during what were thought to be temporary shifts in demand patterns– “two weeks to flatten the curve” type of thinking. But there was a choice to be made: allow a Depression, or deal with reallocation problems down the road; the latter was the clear preference.
marcus nunes
Nov 22 2021 at 11:53am
“This time around the Fed has learned its lesson and pushed NGDP quickly back to the previous trend line.”
True. https://marcusnunes.substack.com/p/money-demand-the-oft-forgotten-link
And it was never done in 2009. https://marcusnunes.substack.com/p/monetary-policy-and-the-great-recession
marcus nunes
Nov 22 2021 at 4:35pm
Maybe you agree with this:
From, Urges end of inflation – November 18, 1933 (Izzy — a.k.a “ARGHH debasement fear!”):
Inflation and currency debasement are undermining public confidence and credit and are retarding the natural recuperative forces of business, Eliot Wadsworth, president of the Boston Chamber of Commerce, said tonight in a statement authorized by the chamber’s board of directors.He called upon the national government for prompt assurance of a sound monetary policy and a restoration of confidence in the dollar, which “has been the outstanding symbol of integrity and security since the Civil War period”
Andrew_FL
Nov 22 2021 at 4:55pm
“Muh Great Depression”
Andrew_FL
Nov 22 2021 at 5:03pm
Take note that for inflationist like Nunes, every year is 1933. 2009? 1933. 2020? 1933. 2007? 1933. Every year from the beginning of time to the heat death of the universe? 1933. 2004-2006? Oh, you better believe that was 1933. 2019? 1933 as all get out! The year that never ended, the gift that keeps on giving!
marcus nunes
Nov 22 2021 at 5:32pm
Maybe you would have agreed with Charles Plosser:
Fact: Plosser in July 2008:
In sum, this year and next will be quite challenging. The economy will grow this year but at a slow pace, and the unemployment rate is likely to get worse before it gets better. At the same time, inflation will be uncomfortably high for a while.
I am more optimistic about the outlook for 2009 and I expect we will see economic growth return to near its longer-term trend. But to prevent recent inflation from continuing(!) to plague the economy and to avoid a rise in inflation expectations, I believe the current very accommodative stance of monetary policy will need to be reversed, and depending on how economic conditions evolve, I anticipate that this reversal will likely need to begin sooner rather than later.
marcus nunes
Nov 22 2021 at 9:14pm
You are wrong about that
https://marcusnunes.substack.com/p/monetary-policy-in-the-two-longest
Philo
Nov 22 2021 at 6:02pm
Roughly speaking, Sumner is a 2% inflationist. Why? Because that is the trend line the economy was on in the early and mid aughts, and that is the promised target of the Fed. A departure from the trend, or from the Fed’s announced target, if there is to be one, should be handled very slowly and gently.
Scott Sumner
Nov 23 2021 at 2:46pm
That’s right Andrew, I take responsibility for my own views, and let others take responsibility for their own views. I guess that’s a radical concept in this woke era where I’m supposed to take responsibility for everything ever done by a white person.
Scott Sumner
Nov 23 2021 at 6:06pm
“You are responsible for people who use the things you say to justify extreme perma-dovishness”
Actually, I’m not.
Alan Goldhammer
Nov 22 2021 at 12:41pm
S&P 500 increase is only marginally higher in 2021 with one month to go than in 2009. Of course 2008 was terrible with the index down almost 40% versus an increase in the pandemic year of 2020.
Thomas Lee Hutcheson
Nov 22 2021 at 12:45pm
In other words, the Fed actually carried out its Congressional mandate in 2021 but did not in 2009-2020.
Jose Pablo
Nov 22 2021 at 1:52pm
The FED does not seem to be particularly good carrying out its Congressional mandate at any time.
Some adjustment of expectations seems to be required with them (at least for people that do believe in “central planners”).
https://www.buybitcoinworldwide.com/dollar-devaluation/#:~:text=As%20you%20can%20see%2C%20it's,4%20cents%20back%20in%201913.
Scott Sumner
Nov 22 2021 at 1:41pm
Steve, I would distinguish between “relief” and “stimulus”. I favored relief but not stimulus, and I think that view has since been vindicated. You are correct that it was appropriate to help those most directly afflicted by the pandemic.
Jose Pablo
Nov 22 2021 at 1:47pm
It is widely accepted that the FED did a terrible job in 1929 during the Great Depression by raising interest rate.
It seems now that the FED did a terrible job in 2008-9 with the response to the Great Recession.
Many people think that it did a terrible job before 2008-9 keeping interest rate too low for too long: the (in)famous Greenspan Put (and the response to Covid did show that you really can count on this “put” when needed).
It seems to be a pattern there. So, very likely, it is just a matter of time that the economists find out that the FED did a terrible job in 2020 with its response to the COVID induced recession.
Just wait …
Thomas Lee Hutcheson
Nov 23 2021 at 6:06am
I think that the Fed had done a not good enough job, before March 2020 to persuade markets that it would not allow a fall in inflation below target. Consequently people expected a prolonged recession, the auto companies canceling there chip orders being an example. Likewise, banks were not eager to make bridging loans to firms to ride out the recession, setting up the “need” for the PPP and other fiscal support to affected firms. Markets were right. There was a sharp fall in inflation expectations (thought not as great as 2008). Fortunately it did react pretty quickly, relative to 2008-2020, and by December, inflation expectations were back to the (still below target) level and by March 10 year expectations were at target.The Fed was as surprised as everyone else that real GDP did not recover as quickly as it expected in response to the monetary stimulus, (“supple chain” problems, the “Great Resignation,” and the slow recovery in the Labor Force Participation Rate), leading it to talk about confusingly as inflation being “temporary.” This has sent expectations now well above target and the Fed has been a bit slow to dial back stimulus.
Jose Pablo
Nov 23 2021 at 8:58am
My problem is a little bit more “conceptual”: If there are people outside the FED that knows better than the FED officials what the FED should be doing at a particular time (or as it seems to be the case, at any time) then it should be something deeply flawed in the way that FED officials are elected …
… or, alternatively, there is not such a thing as a “correct” centrally planned course of action and both FED officials and “best experts that were never elected to the FED” are clueless.
In this regard I just love Huemer:http://www.owl232.net/papers/passivity.htm
Roger Sparks
Nov 22 2021 at 2:04pm
“The real problem with inflation is that it may be associated with falling RGDP. With less output, living standards will suffer.”
Why might there be this association? I suspect it is because the source providing more-money-spent distributes money unequally.
New money would be spent by those who receive it, thereby increasing demand for a spectrum of products.
Managers and workers in the supply chain would observe a shift in normal consumption patterns and inquire why a shift has occurred. Understanding the reasons behind the shift would help in predicting what the best response might be.
The response may be to raise prices in an effort to dampen demand. The improved income stream could be shared with workers, leaving RGDP unchanged.
A second response could be shifting production from one product to another. Due to practical production shift lag times, surprising product shortages could emerge. RGDP would fall, at least for a while, depending upon how it was measured.
I also suspect that increased incomes would drive a shift toward higher end products and improve a tolerance of taking vacation time. I am not sure that improved life styles are well measured by either GDP or RGDP.
Jon Murphy
Nov 22 2021 at 2:10pm
Using elementary aggregate supply/aggregate demand analysis, we can see inflation and falling real GDP if there is a shock to aggregate supply. If, say, a war happened and half our factories were bombed, that would decrease aggregate supply leading to inflation and falling real GDP.
rsm
Nov 23 2021 at 9:24am
What if GDP of any flavor is a half-made-up magic number that should have error margins so wide as to make it noise, and thus useless for public policy making?
Why not pay everyone an inflation-adjusted basic income, and if you as an individual believe in NGDP, you can invest your own time and resources into it? But may I be free to live simply, try to self-provision, share freely any self-provisioning technology I might come upon, and generally pursue the path of “the more you know, the less you need”? (As opposed to the “infinite wants” model pitched at me by economists?)
What if what I really want is a restored commons I can escape to, to pursue knowledge by observing nature, avoiding capitalism and money as much as I can? Is basic income the least you can do, given that the commons has been fully enclosed (in flagrant violation of the Lockean Proviso)?
Where do I fit into your model? Am I to be treated as an outlier, and safely ignored, even banned? But what if rising overdoses and suicides are an indication that there are a lot more than just I who want out of your rotten system based on this GDP fetish?
Scott Sumner
Nov 23 2021 at 2:50pm
rsm, You asked:
“What if GDP of any flavor is a half-made-up magic number that should have error margins so wide as to make it noise, and thus useless for public policy making?Why not pay everyone an inflation-adjusted basic income,”
It’s far more likely that inflation is a “half-made-up magic number”.
“But what if rising overdoses and suicides are an indication that there are a lot more than just I who want out of your rotten system based on this GDP fetish?”
And what if rising overdoses are due to our tragically misguided war on drugs?
BC
Nov 24 2021 at 10:58am
“why did the economy of 2021 end up much better than in 2009?”
Because monetary policy mistakes are more economically damaging than viruses that are fatal primarily to non-workers? Viruses don’t disrupt the information communication functions of price signals. (Monetary policy does so when interacting with sticky nominal prices.) Price signals are the most important if not only means through which humans can coordinate economic activity at scale. Losing the ability to coordinate workers is much more (economically) damaging than losing some small percentage of workers. For the same reason, we would also expect price controls to cause more (economic) damage than viruses, which indeed they have historically (rent control damage to housing supply, anti-gouging laws effects during disaster recovery, etc.) Preserving the information content in price signals seems to be the most underrated economic policy imperative.
rsm
Nov 29 2021 at 12:50am
《Price signals are the most important if not only means through which humans can coordinate economic activity at scale.》
Are price signals telling you your supplier wants you to go away, in which case there is really an arbitrary psychological signal sent, not necessarily related to physical supply or demand?
Thus, are price signals just conveying arbitrary, fickle, psychological information about society, not actual information about the non-human, physical world?
If your supplier raises prices and you get a Cost Of Living Adjustment to pay for it, and they still can’t supply what you demand, shouldn’t you figure out why, and address your energies to solving that problem, using perhaps the financial cushion provided by an inflation-protected basic income to relieve you of time-sapping daily work requirements?
MarkLouis
Nov 24 2021 at 4:11pm
Agree with the analysis thus far; but I think you really need a 5-year window to evaluate. Not my base case, but it could be that the 2020 approach simply shifts difficult conditions into the future (when central banks must get inflation back to trend) relative to the 2009 approach.
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