The US economy has been far more successful in recovering from the coronavirus shock than it was in dealing with the aftermath of the 2000s housing bubble. As I noted in my latest column, four years after the start of the 2007-2009 recession, employment was still 5 million jobs below its pre-recession peak. This time, the number has increased by nearly 6 million.
And then there was a wave of inflation, which seems to have broken down. This is especially evident when we measure inflation in the same way as other countries. The harmonized consumer price index differs from the regular consumer price index in that it does not include owner-equivalent rent, which is the imputed cost of housing that no one actually pays, and is a very lagging indicator. Masu. And by this measure, inflation has already been brought down to the Fed’s inflation target of around 2%.
Essentially, the United States quickly returned to full employment while experiencing a temporary economic boom. level Prices that do not rise sustainably inflation, rate of increase in price. Not bad, especially considering all the dire predictions made along the way.
But could it have been better? And were we just lucky in that we got it right?
My view is that we did very well, and the US response to the Covid shock was pretty close to optimal in retrospect. But the miracle of 2023, a combination of rapid deflation and a strong economy, was something of a coincidence. Policymakers thought raising interest rates would cause a recession, and they thought a recession was necessary, so they raised them anyway. Fortunately, they were wrong on both counts.
What does it mean that policies were near-optimal? The coronavirus has disrupted the economy in ways previously associated only with wartime mobilization and demobilization. There was a sudden and significant shift in the mix of demand, with consumers moving away from in-person services and purchasing more goods, a change that was amplified and perpetuated by the coronavirus outbreak. About remote work. The economy was not able to quickly adapt to this change, and we found ourselves facing supply chain problems of insufficient capacity to deliver goods, along with overcapacity for services.
How should policy respond? As nicely formalized in a 2021 paper by Veronica Guerrieri, Guido Lorenzoni, Ludwig Straub, and Ivan Werning presented at the Jackson Hole Fed Conference that year, However, there was a clear case for strong expansionary monetary and fiscal policies to limit service sector job losses. Even if it means a temporary rise in inflation. And that’s more or less what happened.
The big risk in following such a policy was that the rise in inflation might be more than temporary, that it would become entrenched in the economy, and that it would take years of high unemployment to bring it back down. . This was an infamous argument by Larry Summers and others. But that argument turned out to be fundamentally flawed. It wasn’t just a bad prediction that happens to everyone, it was also a misunderstanding of how the economy works. Inflation lasted longer than Team Transitory expected, but as expected it subsided without a significant rise in unemployment. It is worth noting that inflation was not anchored in expectations as it was in the 1970s.
In fact, the United States has had the strongest recovery in the developed world without experiencing significantly higher inflation than other countries.
So American policymakers seem to have gotten it more or less right. But as already suggested, this was definitely a lucky accident.
It’s instructive to look at the projections made in December 2022 by members of the Fed’s Open Market Committee, which determines interest rates, and compare them to what actually happened.
The FOMC has been raising interest rates since early 2022 in an effort to rein in inflation, and forecasts make clear that members believed the effort would cause and necessary a recession. Their median prediction was that economic growth would nearly stall, the unemployment rate would rise by about 1 percentage point, and a sarm rule would be triggered, linking rising unemployment to recession. And if growth had actually stalled, it probably would have been negative. This is because a significant slowdown in growth tends to cause a sharp decline in capital investment.
What actually happened was that the economy turned out to be much more resistant to rising interest rates than the Fed expected, so growth held steady and unemployment did not rise significantly. But inflation fell anyway, lower than the Fed expected. Thus, the economy surprised his Fed in two ways, both of which were positive. It turns out that disinflation did not require a sharp rise in unemployment. However, it turns out that the rate hike did not hurt employment as much as expected.
In my view, the initial fallacy that high unemployment was necessary is indefensible – there was good reason to believe that the 1970s were a bad model for post-pandemic inflation – while the economy Rates that no one could have predicted would be avoided. But then I will say so, because I did not make the first mistake, but I did make the second mistake.
In any case, what is noteworthy is that these errors canceled out. The Fed’s mistakes on inflation could have resulted in imposing an unnecessary recession on the economy, but rather than triggering a recession, the rate hikes were meant to offset a spike in spending that could have caused inflation. was found to be appropriate. Overall, the policies seem to have been about right, producing an economy that was neither too cold nor suffering from unnecessary unemployment, nor too hot and experiencing inflationary overheating.
Yes: Policymakers have stumbled upon Goldilocks.
What worked? As we’ve said, the claim that inflation is difficult to control never made sense, given what we know. The economy’s resilience in the face of high interest rates is difficult to explain, but immigration may have been a driving force. Slower population growth has been one of the common explanations for secular stagnation, so the influx of working-age adults may have been exactly what we needed.
I think the more important point is that in macroeconomics, as in life, it’s important to be good, but it’s also very important to be lucky. And this time I got lucky.
quick hit
Immigrants did not take jobs away from native-born people, but they did boost growth.
In countries like the United States, where most mortgages have fixed interest rates, the effect of interest rates is smaller.
Another temporary one is the spike in homicides due to the pandemic.
Our favorite policy guideposts have become vague. (Can a signpost do that?)
