All Hail Lars Christensen!
By Scott Sumner
We are in the midst of a real business cycle. So this should be a feather in the cap for real business cycle theory, right? Actually, it’s looking more like the death knell of RBC theory. That’s because when we finally have an honest to God real business cycle, it looks utterly unlike anything we’ve ever seen before.
For example, consider the unemployment rate, which increased from 3.5% in February to 14.7% in April. The entire 2020 recession lasted for only two months, far less than any previous recession in US history. But the weirdness doesn’t stop there. In the next 4 months the unemployment rate fell by 6.3 percentage points, down to 8.4%.
For comparison, during the recovery from the 2008-09 recession it took an entire decade for the unemployment rate to fall 6.5 points, from a peak of 10% in 2009 to 3.5% in 2019. That means that during the recovery from the 2020 recession, unemployment fell roughly 30 times as fast as during the recovery from the 2009 recession. Read that again. I didn’t say 30% faster, I said 30 times faster.
And before anyone says this is no surprise, let me assure you that when Lars Christensen predicted that unemployment would fall below 6% by November, almost everyone thought he was being wildly optimistic. At the time, the most recent data showed 14.7% unemployment, and many people were throwing out figures like 20% unemployment for the summer months. (Christensen’s May 11 post is excellent, well worth reading.)
I suspect we may end up falling a bit short of Lars’s optimistic forecast (although it’s still very possible he will be correct.) But what is even more amazing is that this striking fall in the unemployment rate occurred against very strong and unexpected headwinds. As of June, Covid–19 deaths in the US were falling very rapidly (down 75% from April), following the previous pattern seen in Europe. Many people anticipated that there would eventually be a second wave, but it was expected to occur when the weather got colder. Instead, in the hottest part of summer the US got hit by a huge second wave, while deaths in Europe and Canada continued at a very slow pace. Many states that had been re-opening their economy reversed course, and started restricting certain business sectors. Here in California, significant parts of the economy were shut down once again.
And yet, despite that backdrop of a severe and unexpected second wave of Covid-19 cases in the US, and renewed shutdowns in many southern states, we saw unemployment fall 30 times faster than during the recovery from the 2009 recession. Imagine our recovery if the pandemic here had followed the European/Canadian pattern! Real recessions look absolutely nothing like normal US business cycles. They are radically different phenomena with radically different causes.
[In fairness, the total employment data is somewhat less impressive than the unemployment rate data, but even total employment has increased at an explosive and unprecedented rate in recent months.]
When market monetarists like me argued that the problem in 2009 was too little NGDP, i.e. tight money, we got lots of pushback on two grounds. One group argued that the real problem was real. The financial crisis was a real shock, and recoveries from financial crises tend to be slow. These pundits were not well informed on US economic history. The US has had lots of recessions associated with financial crises, and economic growth was typically quite rapid after the crisis ended. And when you asked people why a financial crisis would cause RGDP to fall, the explanations tended to center around consumer loss of wealth and a lack of access to credit. But why would a loss of wealth make people want to work less? Why would less access to credit make people want to work less? Ultimately, the answer was that the loss of wealth and access to credit reduced consumer spending and investment spending.
So the problem wasn’t too little NGDP, it was too little consumption and investment spending? Okay . . .
On the left, economists were more sympathetic to the view that a shortfall of NGDP was the problem, but suggested that there was nothing more the Fed could do. (As if the Fed had run out of paper and green ink.) Actually, we now know there were lots more things the Fed could have done:
1. Don’t pay interest on bank reserves.
2. Do much, much, much more QE, buying unconventional assets if necessary to hit the target.
3. Switch to price level targeting, which would raise inflation expectations and lower long-term real interest rates. This policy would have meant the Fed would not have tapered in 2014, or raised interest rates in 2015. Indeed they never would have stopped QE1 or QE2.
The Fed’s recent move toward average inflation targeting is a tacit admission that they blew it in the 2010s with an inappropriately tight monetary policy that caused NGDP to grow too slowly, delaying recovery from the recession.
I’m not sure the recovery in the unemployment rate during the 2010s could have been 30 times faster, but it surely could have been 4 times faster. Indeed in the 18 months after December 1982, unemployment fell by 3.6 percentage points, which is 4 times faster than the 0.9 percentage point reduction in unemployment in the 18 months after the October 2009 peak. Money was clearly much too tight in 2009.
The market monetarist view of the Great Recession is looking increasingly persuasive, and if unemployment falls to 6% by November then Lars Christensen will be crowned king of the market monetarists.
PS. Because Lars made such an extreme contrarian prediction, let’s be generous and assume he meant the actual unemployment rate in November (announced in early December) would be below 6%, not the announced unemployment rate in November, which refers to October.