Thursday, July 30, 2015

The $3 trillion cost of bad policies

This post is practically a repeat of my post in April 2014, "Taking the measure of our discontent," except that I've updated the charts and the numbers and adjusted the commentary somewhat. It's appropriate and timely, since the GDP revisions released today show that the recovery has been even weaker than we thought.

The Great Recession of 2008-2009 wasn't your typical recession. In every other recession in postwar history, the economy rebounded within a few years to return to its long-term growth path. But not this time, and it has nothing to do with the rich getting richer or the alleged increase in inequality. Instead, it has to do with the average person and the average family not making the kind of progress to which they've been accustomed. Understandably, people are upset.

The chart above compares the actual growth of real GDP (blue) with its long-term trend of 3.1% per year. Never before has real GDP fallen below its trend by so much for so long—and still, as we are entering the seventh year of recovery, there is no sign of a true recovery. The current "gap" between actual GDP and its long-term trend is about 15% by my calculations. That translates into a national income shortfall of almost $3 trillion.

This is the measure of the country's discontent: $3 trillion in missing income.

We see the same pattern in the chart above, which compares the actual growth of a subset of retail sales (which excludes certain volatile categories) to its long-term trend. These are the expenditures made by ordinary folk, not the mega-billionaires. This helps dramatize just how radically things changed beginning in the latter half of 2008. Retail sales by this measure would have to increase some 20% overnight to get back on their long-term trend path. This is a measure of how much middle class families are hurting.

After growing for decades at about a 1% annual pace, the labor force suddenly stopped growing in late 2008, as the chart above shows. Things have picked up a bit in the past year, but the labor force is "missing" around 10 million people—people who have given up trying to find a job or who have decided they just don't care to work.

If one thing stands out in these charts, it is the abruptness and the severity and the persistence of the divergence from long-term trends that began in 2008. Something REALLY BIG happened; what was it?

It was not demographics, since demographics change at glacial speed. The population didn't suddenly got older and start to retire en masse in late 2008.

It was arguably not monetary policy. The Fed was slow to launch its QE efforts in late 2008, but since then they have been working overtime to make sure the economy is not starved of liquidity and interest rates are as low as possible. (I could be persuaded that the persistence of extremely low interest rates has been a problem for savers, and that this has led to weak investment, but corporate profits have been setting records throughout the recovery and corporations have been very reluctant to invest those profits.)

The one thing that changed in a really big and durable way, starting in 2008, was fiscal policy. The Bush administration launched TARP in late 2008, and the Obama administration followed up with ARRA in 2009. Then came Obamacare in 2010, which purported to restructure fully one-sixth of the US economy within the space of a few years. Then came the Dodd-Frank super-regulation of the financial industry. Beginning in 2013, top marginal tax rates were increased.

As the first of the above two charts shows, massive fiscal "stimulus" (aka deficit spending) increased the federal government's debt from $5.34 trillion in June '08 to $12.45 trillion as of this week. As the second chart shows, that surge of borrowing more than doubled the federal debt burden, raising it from 36% of GDP in mid-2008 to just over 72% of GDP in the span of seven years. The only other time something of this magnitude happened with fiscal policy was WW II.

The federal government borrowed $7.8 trillion over the course of the past seven years and handed most of the proceeds out in the form of various transfer payments (which now make up over 73% of federal spending). Our leaders in Washington did this in the belief that this would stimulate spending and that would convince businesses to create more jobs. The federal government restructured the entire healthcare industry in the belief that this would lower costs and give everyone healthcare insurance coverage. The federal government rewrote the rules for the entire financial industry, in the belief that a more-highly-regulated banking system and greater consumer protections would restore confidence and optimism. And to top it off, the federal government increased taxes on the rich, in the belief that this would benefit the middle class by more fairly distributing the fruits of progress.

But it didn't work. Spending wasn't stimulated; job growth didn't surge; healthcare costs continued to rise, the vast majority of the uninsured are still uninsured, and millions have lost what coverage they used to have; banks are reluctant to lend and consumers are reluctant to borrow; consumer optimism remains weak; and the middle class has taken it on the chin.

If anything, the massive growth of government intervention in the economy since 2008 looks to be the Occam's Razor explanation for what caused the weakest recovery in history.

If there is a reason for widespread discontent, it is our federal government and its overbearing and intrusive ways. Thanks to all the government "help" that has been heaped upon us in the past six years, we have the weakest recovery in history. And the bill for all this is a staggering $3 trillion per year and counting.


CPfeiffer said...

How do rate hikes make sense in such an environment?

Anonymous said...

Yeah, and now they are going after the 'sharing' economy to make independent contractors employees. I know people who are so grateful for having the money they make from Uber and Instacart. The left hates independent contractors. They want the blue model of big corporations and big unions and big benefits. The blue model is a throw back. It is retrograde. All labor regulations including discrimination, no especially discrimination, should be eliminated for companies with under 100 employees. As a start.

Lawyer in NJ said...

If this is true, why has the US grown faster than austerity-obsessed Europe?

Scott Grannis said...

What the Fed is proposing to do is to lessen the degree of monetary accommodation by a modest amount. That is quite distinct from "hiking" rates in an effort to tighten monetary policy. Although the Fed usually only talks about the nominal overnight rate, what they are really targeting is the real overnight rate, which is currently about -1%. They could raise short term rates to 1% and the real funds rate would only be zero, which is hardly what one might consider "tight."

Raising the overnight rate from -1% to zero is not really hiking rates or tightening, it is more accurately described—as the Fed says—as "normalizing" interest rates; getting rates back to some semblance of normality.

It is also important to recognize that for many years there will be a huge amount of excess reserves in the banking system. Those reserves could support an almost unlimited amount of lending. Because the Fed can't drain all those excess reserves quickly, they need to raise the interest rate they pay on those reserves to a level which leaves the banking system content to hold lots of excess reserves, and not seek to expand lending dramatically. Banks must see the rate on excess reserves as attractive, on a risk-adjusted basis, relative to the yield they could obtain by making new loans, otherwise bank lending will accelerate and that could lead to an unwanted increase in the supply of money. Which of course would work to push up inflation.

The Fed can well afford to normalize rates in this environment, since there are no signs of stress that would warrant the continued existence of extreme monetary accommodation. The economy is not fragile nor is it hanging by a thread, nor is it in danger of hitting "stall speed." It is simply growing at a slow, and relatively steady rate with lots of unused and idle capacity.

Lawyer in NJ said...

From June 5:

Term Public Sector
Jobs Added (000s)
Carter 1,304
Reagan 1 -24
Reagan 2 1,438
GHW Bush 1,127
Clinton 1 692
Clinton 2 1,242
GW Bush 1 900
GW Bush 2 844
Obama 1 -702
Obama 2 641
128 months into 2nd term, 110 pace

steve said...

In 2008 bush blinked and abdicated free market capitalism with bernanke's blessing of course and thus started the divergence. Instead of just taking our medicine then we bailed out failed businesses and started on this QE nonsense and the result is mediocrity. it's so obvious it's laughable and now everyone is looking to the FED as the ultimate backstop. Pitiful.

Benjamin Cole said...

Well, I contend that the Fed became too tight in 2008, thus triggering a recession, magnified by lots of leverage in real estate, commercial and residential.

I am against higher taxes and regulations, but I don't think they are meaningfully higher after 2008 them before. The US prospered in the 1960s and even most of the 1970s with much worse regulations and taxes. The top federal marginal tax rate in the boom-boom 1960s was 90%.

What do you had in the 1960s was a growth-oriented central bank. We also saw in the 1990s that Greenspan refused to tighten monetary policy even as unemployment sunk to record lows.

The Fed is still too tight. It is a misconception to say the Fed is accommodative. One could also say that the Bank of Japan was accommodative from 1992 through 2012. Interest rates were near zero. The only problem is the Bank of Japan oversaw a 20-year period of deflation. They were so accommodative, prices were falling.

I'm just an old skinny bald guy, not a real economist. But I think it is obvious that the milieu for central banking has changed in the last decade or so.
The 35-year downtrend in interest rates and inflation has reached its end--both are at zero all the time, if not worse.

Going forward central banks need to consider how to promote the growth and keep deflation well at bay. Historically, moderate rates of inflation are coincidental to robust real growth. Perhaps that is what central banks should seek.

Unknown said...

Steve nails it. I'm shocked that supposedly sophisticated people can't see this. When the crash hit, many said don't repeat the Japanese mistake. These people were treated as heretics. Well, you've got the pitiful Japanese "recovery" all over again. In Sept 2008, the market had decided that all the big banks were no longer viable as going concerns. MBS and CMBS was worth cents on the dollar. The banks go to BK court. The toxic MBS/CMBS sells at market-clearing prices. And the millions of upside-down houses, they are foreclosed, and cleared at market. Same as followed the S&L meltdown. Yes, I know widespread pain & displacement, but you do it that way and you build the basis for a real recovery. Obamacare, Dodd-Frank, please, these are sideshows. The market should have been allowed to work in '08. Bernanke, Yellen, Geitner, Paulson et al should be frog-marched out in handcuffs. They re-inflated the RE bubble (house prices and rents) at the same time we had no growth in wages!

Benjamin Cole said...

Scott Grannis: you have indicated you are concerned that US commercial banks will lend out heavily based upon the extraordinary amount of reserves they have.

This would mean a boom in private-sector lending and spending, and of course, a boom in private-sector employment. It may mean some inflation.

Egads, man that is what I want. I say bring on Full Tilt Boogie Boom Times in Fat City and let's worry about inflation later. It may never come.

When did the right-wing turn against boom times? By the way, the oil booms in Texas and Dakotas hardly produced any inflation even in those regions.

Scott Grannis said...

Benjamin: the banks already have the ability to lend massively. That they haven't is almost certainly not the fault of the Fed. Banks are still reluctant to lend, and borrowers are still reluctant to borrow. The willingness to take risk is not there; that's the problem. The Fed can't force the banks to increase their lending.

Perhaps you should complain about Dodd-Frank, which has placed many onerous burdens on the banking system.

No one is against boom times. Except for the federal government, which seems intent on regulating risk taking out of existence.

Benjamin Cole said...

If I could understand Dodd-Frank, maybe I would be for or against it. Volcker says Dodd-Frank was gutted.

John Cochrane says banks should be compelled to go to 100 percent equity backed lending, no ther regs. Maybe he is right. I like simple regulations.

The Fed needs to go back to QE long term, like the Bank of Japan.

It may be the Fed can pay off the national debt. I like that idea.

Some say the Fed merely financed the Afghanistan and Iraq wars by printing money. Maybe so. Would you have preferred to pay taxes for those wars?

Mighty Wee Man said...

Federal Government: reliably inept, reliably corruct

Mighty Wee Man said...

Federal Government: reliably inept, reliably corrupt

Anonymous said...


If the excess savings in China and its export policies created an imbalance starting mid-1990s which saw US jobs go to China and debt skyrocket in the US, wouldn't the reverse happen if there is to be a "normalization", a re-balance of these capital flows?

Is not this an opportunity for the US to deleverage and increase jobs? Maybe an immense opportunity?

Thinking Hard said...

Bravo! Highlighting key fiscal policy mistakes over the past 7 years is important in deciding appropriate growth oriented fiscal policy moving forward. Another variable to look at is small business formation. People are not starting businesses in the current regulatory environment. I see lower real wages and a more burdensome regulatory environment as a hindrance to small business formation. We need pro-growth fiscal policy to counteract the supposedly (fool me once, shame on you, fool me twice, shame on me – we have been close to a rate hike for years now) upcoming monetary policy tightening. Words are cheap out of our political and monetary leaders. We need action to promote growth, higher real wages, small business formation, and stable inflation. Cut corporate taxes, allow a corporate repatriation holiday (permanent is even better), ease some financial and environment regulations, cut capital gain tax rates, cut personal income tax rates, and simplify our regulatory burden. I read not too long ago that U.S. corporations are now spending over $2 Trillion a year in compliance. That is absurd!

Faith has been lost in our political leaders, hence the congressional approval ratings have hovered around single digits for years. Cynicism has taken hold and people realize the game and the bought and paid for nature of large scale politics. In order to truly see pro-growth policies our political process needs fundamentally altered. We need representatives that will not become lobbyists after their service is over, representatives that will not join large corporations they are passing legislation for or against, representatives that choose not to take FEC itemized campaign contributions (more than $200 per individual), representatives that choose not to associate with a Super Pac and do not approve of such an entity campaigning on their behalf, representatives that have the interests of the populace in mind, and representatives that do not allow special access to their office independent of contribution status. We need to take campaigning online, thus eliminating the need for large scale campaign contributions to increase exposure via television and radio. We are heading down a path that will not be kind to many people, but there is a potential road out, and that is when people use their collective intelligence to create solutions to complex problems. Believe in the collective intelligence because that is the underpinning of the free market.

Scott Grannis said...

Re: China. I wouldn't call the Chinese boom which started in the mid-1990s an "imbalance." It was a fantastic development for the entire world. Hundreds of millions of people suddenly became more productive, and the world was able to afford all kinds of technological goodies at unbelievably cheap prices. We didn't export jobs to China, we imported fabulously cheap electronics. China's growth didn't cause the rise in our indebtedness; that was a function of our failed Keynesian policies (e.g., transfer payments). The maturing of the Chinese economy means that capital is no longer flowing into China, and it is beginning to reverse, to the benefit of the U.S. economy.

Growth is not a zero-sum game: everyone can benefit.

Grechster said...

Re: bank regulations: I too like simplicity and dare I say, so does the market. Cochrane's advocacy of 100% equity-backed financing strikes me as a little extreme. But it does bring up an interesting point that has bothered me for years, since well before the crisis. How does it make any sense whatsoever to have a mere 10% reserve requirement (and in practice, much less) in a fiat currency system? Leveraged just 10:1 all you need is a 10% decline in your asset base and you're el-busto. Wiped out. How did such a system ever pass muster, especially since 1971? I have no idea what Dodd-Frank did to the equation but my understanding is not much has changed on the reserve rate (although various classifications have been altered). I guess I'd be in the theoretical camp of what Martin Wolf advocated (among other things) in his most recent book: a significant raising of the reserve requirement and the removal of roughly all of the various classifications. Make it, say, 20% or 25% or 30%, and be done with it. Of course, in that case, the governmental oversight bureaucracy would be reduced and we simply can't have that, now can we?

Scott, as for the probable Fed Funds rate hike coming later this year, I just don't get the need other than some notion to get closer to normalcy. The idea that inflation is at risk off taking off just doesn't comport with reality. The lending function, as you note, isn't broken so much as the demand just isn't there. In any event, the Fed has an unusually powerful restrictor plate on inflation - just raise the rate you pay on reserves, currently .25%. What am I missing? I am far more concerned that some commodity-based country (Brazil, Indonesia, Russia) has some severe problem based on the rapid decline in commodity prices. Gold has recently taken out important levels to the downside; TIPS spreads are certainly not indicating we should be worrying about inflation. I think the Fed is being way too cute in talking up rate hikes; too, I think urges to get closer to normalcy amid very worrying signs that the Fed is NOT meeting the high demand for money should be suppressed. The Fed is too tight right now.

Thinking Hard said...

What is normal? Are we looking at normal prior to 2008 or after? Seems to me the passage of the Emergency Economic Stabilization Act of 2008 changed the very definition of "normal". The bailout, the allowance of IOER 3 years early, and higher FDIC insured amounts fundamentally changed normal.

Please see the link below for a good article on government debt and the methods to eliminate such debt. The authors conclude debt/gdp ratios have been reduced by: 1) economic growth; 2) a substantive fiscal adjustment/austerity plans; 3) explicit default or restructuring of private and/or public debt; 4) a sudden surprise burst in inflation; and 5) a steady dosage of financial repression that is accompanied by an equally steady dosage of inflation.

Which option do you think the United States is following?

Scott Grannis said...

Re: various. Raising the reserve requirement for banks would directly increase the demand for reserves, as well as making the banking system safer. As for bank lending, if you've been following my posts on C&I Loans, you know that those loans are rising at a 12% annual pace. That's pretty strong. Overall bank credit was flat for several years and is now growing at a 7-8% pace. That's an important pickup on the margin. Conclusion: banks are more willing to lend, and borrowers are more willing to borrow. This supports the Fed's decision to "normalize" interest rates. The Federal debt/GDP ratio has stopped rising and may decline slightly, thanks mainly to strong income tax collections (driven by increasing jobs) and a multi-year freeze in federal spending. This won't last much longer unless we have some social security reform.

Benjamin Cole said...

Latest figures show wages dead in the water. I am waiting for some stats to come out on productivity in which case we can look at unit labor costs which may be negative again.
The question may be should the Fed cut rates or even go to a long-run program of QE, such as they have in Japan.

As for cutting federal outlays please do so. The Cato Institute says we can cut national security spending in half and probably be safer than we are now. That would save about $500 billion a year. Reform Social Security also. And please eliminate entirely the Housing and Urban Development Department the Labor Department the Commerce Department and the USDA.

Hans said...

What is "real" GNP? The other GNP numbers we get are not real?

This decline in GNP has come a long time ago and is not reflected
by the governmental unit chart..

There has been no 7% or 6% increase in GNP since the 60s and 70s
with the exception of 1982..

No, no, Mr Grannis, this is not a recent phenomenon...

Benjamin Cole said...


You are showing your age. GDP, not GNP. My cane and toupee are laughing at you!

On the news: "The Employment Cost Index, the broadest measure of labor costs, edged up 0.2 percent, the Labor Department said on Friday. That was the smallest gain since the series started in the second quarter of 1982 and followed an unrevised 0.7 percent increase in the first quarter...."


And "normalize rates"?

Does that mean the Fed should "normalize" interest on excess reserves also?

After all, the Fed never paid IOER before 2008....

Funny, this "normalize" business goes only one way....

Hans said...

Ben Jamin
"You are showing your age. GDP, not GNP. My cane and toupee are laughing at you!"

LOL, Ben! I refuse too comport to their standards.

Again I axe, what is "real" GNP?

I will said once more, the GNP growth rate has been on a decline
for decades and even more pronounced in the past ten years.

We now have over a 1/3 of all Americans "contributing" to a sinking growth rate.

A micro examination will clearly evident the fact.

Hans said...

Ben, I found the definition.

"GDP, or Gross Domestic Product is the value of all the goods and services produced in a country. The Nominal Gross Domestic Product measures the value of all the goods and services produced expressed in current prices. On the other hand, Real Gross Domestic Product measures the value of all the goods and services produced expressed in the prices of some base year. An example:
Suppose in the year 2000, the economy of a country produced $100 billion worth of goods and services based on year 2000 prices. Since we're using 2000 as a basis year, the nominal and real GDP are the same. In the year 2001, the economy produced $110B worth of goods and services based on year 2001 prices. Those same goods and services are instead valued at $105B if year 2000 prices are used."

Real, is really inflation adjusted aggregates..Real confusion and why people are
turned off economics..

The BEA needs to conference with the BLS, because the latter says the consumer
always substitutes higher priced items for lower price and quality.

Why is this not the case with "real" GNP?

This is the reason the American fleet now averages 11.5 years old..Now this really real!

Hans said...

Ben, I found the definition.

"GDP, or Gross Domestic Product is the value of all the goods and services produced in a country. The Nominal Gross Domestic Product measures the value of all the goods and services produced expressed in current prices. On the other hand, Real Gross Domestic Product measures the value of all the goods and services produced expressed in the prices of some base year. An example:
Suppose in the year 2000, the economy of a country produced $100 billion worth of goods and services based on year 2000 prices. Since we're using 2000 as a basis year, the nominal and real GDP are the same. In the year 2001, the economy produced $110B worth of goods and services based on year 2001 prices. Those same goods and services are instead valued at $105B if year 2000 prices are used."

Real, is really inflation adjusted aggregates..Real confusion and why people are
turned off economics..

The BEA needs to conference with the BLS, because the latter says the consumer
always substitutes higher priced items for lower price and quality.

Why is this not the case with "real" GNP?

This is the reason the American fleet now averages 11.5 years old..Now this really real!

Benjamin Cole said...

Hans--- I share your concerns that economic growth rates have slowed in the United States in recent years. The 1990s were pretty good.

I do not think we have that much in additional structural impediments since the 1990s. Some people say that the criminalization of robust new housing construction, in almost any neighborhood that is desirable, is a factor in limiting output and increasing inflation.

I think the central banks of Western economies have sought lower inflation rates for decades and have largely obtained that goal, although at a cost of constricted output. However now the screw has turned---but being public agencies central banks are extremely slow to change, and have self-exalted their mission for so long it has become embedded in their DNA.

It is like proposing to the USDA that farmers and consumers would prosper more without "crop insurance."

Benjamin Cole said...

Re the Fed:

Oil prices sinking again. Wages dead. Headline CPI in deflation. PPI in deflation. China deflating, Japan near deflation, Europe in deflation.

From Reuters yesterday: "U.S. factory activity slipped in July and consumer spending advanced at its slowest pace in four months in June, indicating the economy lost some momentum recently."

Maybe the Fed should think about "normalization"--of interest on excess reserves.

What is the deal with this? Why not cut IOER and stimulate growth a little?
Is interest on excess reserves a new permanent feature of our banking system? Should not the Fed say so, if true?

Gee, does this sound like regulatory capture? Commercial banks get interest forever---for doing nothing?

Is it time for a wholesale re-evaluation of the Fed? What kind of regulatory body devises an anti-stimultaive give-away to banks in the depths of a recession? And then maintains it?

David Landy said...

This analyst says this recovery isn't so bad and the private economy is growing as it always has.

David Landy said...

This analyst says this recovery isn't so bad and the private economy is growing as it always has.

Scott Grannis said...

David Landy: your analyst is incorrect when he asserts that the WSJ is not adjusting GDP data for inflation in chart 1. That chart is not labelled, as it should have been, to clarify that the growth rates are real and not nominal. But the numbers shown are real growth rates. The rest of his analysis is difficult for me to follow, and I question his methods. I'll stick by my analysis and the assertions of the WSJ. This has been the weakest recovery in modern times.

David Landy said...


marmico said...

Contrary to your assertion, demographics is a major issue. The prime age (25-54 year old cohort) population peaked in 2008.