Murphy and Smith on NGDP and politics
By Scott Sumner
Ryan Murphy has a post discussing a paper he wrote with Taylor Leland Smith, testing my claim that sharp NGDP declines lead to governments with statist polices:
In a forthcoming paper at Review of Austrian Economics, co-authored with Taylor Leland Smith, we investigate a claim made by Scott Sumner in his 2015 book that severe recessions led voters to throw competent political parties out of office in favor of populist ones, ultimately resulting in ruinous changes in economic policy. Sumner’s historical examples include the U.S. in the Great Depression, Argentina in the 1990s, Sweden in 2013, and (per Godwin’s Law) Nazi Germany. It may also have played a role in the recent rise in parties on the populist right throughout much of Europe. . . .
In our paper, Smith and I investigate Sumner’s claim empirically. We define an event of a recession wrought by severely restrictive monetary policy and an aggregate demand shortfall as occurring whenever the growth rate of Nominal Gross Domestic Product (NGDP) goes negative, meaning the overall level of nominal spending in the economy actually falls. This is very rare. It occurred in the United States during the Great Recession, but had not done so previously for a half century.
We establish a statistically significant fall in economic freedom five years, ten years, and fifteen years after the event, while including several controls. Due to our methodology, we had neither Nazi Germany nor the Great Recession in our sample, and given that these were the two primary motivating examples, it means that Sumner’s hypothesis held true “out of sample” in some sense.
There’s also some interesting discussion of how the Trump phenomenon fits in here. Of course Trump campaigned against free trade, but it’s too soon to say how he’ll actually govern.