Macroeconomics is Irregular, 7/18
Every episode is different
This recession—if that’s what it is—isn’t like other recessions. According to the latest employment report issued by the Bureau of Labor Statistics, the economy added 372,000 new jobs in June, with the unemployment rate remaining stable at 3.6%. Over the past 12 months, according to the same report, average hourly earnings increased by 5.1%, another sign of a tight labor market. What explains a full-employment recession?
Macroeconomic theories describe regularities. But in the real world, regularities are scarce.
One of the most reliable regularities used to be Okun’s Law, which said that a 1 percentage point decline in the unemployment rate would be associated with about 2.5 percent higher real GDP. This year, the unemployment rate has declined by 3/10 of one percent, which should be associated with an increase in real GDP of close to 1 percent. But instead, real GDP has declined at an annual rate of more than 1 percent. Call the cops: Okun’s Law is being broken.
Consider what we have observed in the past 25 years or so:
The stock market crash of 2000, as the Dotcom bubble ended. An enormous destruction of wealth, with only the mildest of recessions.
The Financial Crisis of 2008. Arguably a smaller destruction of wealth, but the most severe downturn since the Great Depression.
The COVID economy, with all sorts of supply disruptions but a stock market that recovered to rise past its previous peak.
The current economy, with inflation soaring, a lot of “we’re hiring” signs, and a lot of companies shifting production away from Russia and at least thinking about shifting production away from China.
Of course, now we can tell stories that fit these episodes. But if you had tried to predict each episode using a set of equations that fit only the prior history, you would have failed.
Macroeconomics in textbooks and newspaper stories is a science of regularities. But you might be wiser to think of it as just-so stories and 20/20 hindsight.
My just so story is that the recession oddity is mainly due to inflation and getting goods, both intermediate and finished.
A 5% increase in wages is pretty weak after a year and a half of 8-10% inflation; that looks to me like a 3-5% drop in wages. Inflation, unusually, seems to be both due to massive spending/money printing by government and the huge drop in goods production and disruptions caused by the COVID reactions. Prices are going up because there is more money chasing fewer goods.
On the supply side, there are still big shortages in raw materials, intermediate goods and finished goods, with rationing based on things other than prices that are locked in by contract. My company has some lead times of at least a year, others I have seen up to two years. That is, if you order today you will get it July 2024. That isn't for high end, very complex finished goods either, but intermediates that were pretty standard 6 week lead time items. So we need the staff to run as hard as we can with what we can get, but we are paying out the nose for transport (flying stuff in some cases) and it is hand to mouth up and down the chain. No spare money for growth. If that holds true across manufacturing industries, then lots of zero growth due to just scraping by means there is little countering industries with negative growth. A recession due to not being able to get enough stuff to grow.
Many pundits have focused on unemployment as being low and not flashing a recession signal. However, hasn't unemployment generally been a lagging indicator?