How Were So Many Economists So Wrong About the Recession?
Maybe they were wrong. Maybe the fabled soft landing will happen. Maybe it will turn out that high interest rates don't always slow down the economy.
But I would still counsel patience. Economists have been wrong so far, but that doesn't mean they were wrong. It just means that our recovery from pandemic supply chain problems has been strong enough to overcome the headwinds of rate hikes. So far.
But those infamous long and variable lags tend to last anywhere from 1-2 years, sometimes a bit more. We won't be out of the woods until late in 2024. We shouldn't count our chickens quite yet.
The whole point to the rate hikes was to raise unemployment far enough to halt inflation. Inflation is, as you have repeatedly pointed out, pretty much halted, without the unemployment happening. However, you also point out the effect of rate hikes lag by a year or so. So we may well yet get high unemployment and a recession. So far, the Feds actions have been irrelevant. They may yet prove disastrous.
Rate hikes impact the economy immediately - sometimes even before they occur, due to an expectation-setting effect.
Zzzz
Rate hikes impacted the stock markets, but they don't seem to have impacted the economy much. Employment kept rising, profits kept rising, GDP kept rising, and inflation kept falling -- none of which is supposed to happen based on the Fed's plan.
How do ‘expectations’ impact the economy, unless they change behavior — decreasing spending and increasing savings, for example, or, for businesses, cutting back investment, reducing the workforce? We didn’t see those effects. Net-jobs-added slowed and then stabilized, most likely because unemployment was already low; we don’t need to imagine that expectations had anything to do with it.
If you wait long enough, any prediction of recession will eventually come true.
This. You can never be wrong if you keep saying "just wait."
We should all read
https://www.amazon.com/Whats-Our-Problem-Self-Help-Societies-ebook/dp/B0BTJCTR58/ref=sr_1_1
It would really help.
Yes. Kevin's first prediction was one year. Now we get: " lags tend to last anywhere from 1-2 years, sometimes a bit more." So basically we're up to three years now.
Economists are not a monolith who all think the same thing as whatever the media reported Larry Summers thinks.
Krugman, for example, has been following the evidence the whole time and has been sort-of-predicting for months that inflation will come down without a recession. Namely, Team Transitory is being proven correct more than Team Larry-fucking-Summers is.
I feel like I'm going insane reading Kevin whenever he talks about this but the point of raising interest rates is to slow the rate of nominal GDP growth, hopefully slowed more by inflation falling that real GDP falling, which is what's happened.
Real gross domestic product increased at an annual rate of 5.2 percent in the third quarter of 2023, which is hardly falling. The Fed failed in slowing the economy, reducing jobs, etc. The only thing it succeeded in was screwing up the housing market at a time when real estate was in a crisis due to COVID remote work changes.
Bobby, you are getting confused between nominal and real GDP.
Nominal GDP growth was 12% a year ago and is 7% today. That is literally falling.
No, the point of rate hikes is absolutely not to slow GDP growth. The more stuff that is produced, the lower the prices, according to the law of supply and demand. Rate hikes are supposed to cause unemployment, which is supposed to slow wage growth. The Fed raises interest rates on the assumption that inflation is caused by excessive wage growth, not excessive supply of stuff. In fact the recent inflation was caused by supply restrictions, so slowing production even more would be exactly the wrong thing.
How does the Fed expect to cause unemployment without causing a reduction in the supply of stuff, that is reducing GDP growth? Don't ask me, ask Powell or Summers.
So what do you think is the mechanism by which interest-rate increases slow inflation?
tyler cowen unemployment prediction (2013)
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Tyler Long-Term Unemployment Bet
Bryan Caplan
Tyler just bet me at 10:1 that U.S. unemployment will never fall below 5% during the next twenty years. If the rate falls below 5% before September 1, 2033, he immediately owes me $10. Otherwise, I owe him $1 on September 1, 2033.
If you think the stakes are absurdly low, they’re the highest he’d agree to!
https://www.econlib.org/archives/2013/09/tyler_long-term.html
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results (2016)
I Win My Long-Term Unemployment Bet with Tyler
Bryan Caplan
Barely two years ago, Tyler Cowen and I agreed to the following bet:
…U.S. unemployment will never fall below 5% during the next twenty
years. If the rate falls below 5% before September 1, 2033, he
immediately owes me $10. Otherwise, I owe him $1 on September 1, 2033.
Unemployment has been stalled at 5.0% for months. But this January, the rate slipped to 4.9%. I have therefore won the bet with almost 18 years to spare.
https://www.econlib.org/archives/2016/02/i_win_my_long-t.html
This reminds me of the old joke about economists predicting 5 out of the last 3 recessions.
Where the economists were wrong was that we needed the interest rate hikes in order to slow the economy and reduce employment to bring inflation down.
We got the rate hikes, but the economy kept roaring and jobs kept appearing and still inflation fell.
In both the 2001 and 2007/8 recessions, we were 9 to 12 months past the start of the recession before we realized the recession was already under way.
Interest rates act with a big lag, but so does our understanding of current economic data.
Though the reasoning of the Fed rates was always suspect, many economists do believe in a direct correlation between rates and inflation, so a midterm inflation rate of 6% should have a Fed rate of 7 to 7.5%. In macroecomic terms the Federal rate following the inflation rate is just a standard economic model. In other words, the natural Fed rate should now be about 4% - 6 month CPE plus 1.5- we should be getting there sometime in 2024 with a typical Fed response. The point is the Fed is following the economy (nothing wrong with that) and the economy will grow or shrink due to other reasons. As long as the unemployment rate hovers below 4% it would be practically impossible to have negative growth. There are many reasons the American economy is resilient and as long as those reasons remain (continued technological adaptations, energy independence, fiscal investment, lowered barriers of entry, etc.)-, the economy should grow apace.
Many economists believe there is a Non-Accelerating Inflation Rate of Unemployment (NAIRU), too, and they used to believe it was around 5%. What economists believe, and what there is actual empirical evidence for, are quite different things.
as a historical snapshot, here's the transcript of a krugman and summers discussion from jan 2022
https://bcf.princeton.edu/wp-content/uploads/2022/01/Webinar-Transcript-2.pdf
summers (from transcript above)
Here's the issue that I don't have a certain view about that Paul touched on that I think is very difficult. I think there are a lot of reasons for thinking that the impact of interest rates on demand has attenuated over time. Housing and durable goods are a much smaller part of the economy than they used to be. As you reference, with more federal debt and more short term federal debt higher interest rates translate more quickly into higher disposable income than they used to. The fraction of long lived investment in business investment is much larger–much smaller than it used to be and the available empirical evidence suggests the same thing. So in economic parlance, the IS curve has, if anything, probably steepened and Paul is right to emphasize that what happened in 1994, which was a 3% increase in the Fed funds rate in one year with a disproportionate, highly exciting increase in long rates at the same time, did not have a large impact on the level of aggregate demand at a time when monetary policy was probably more potent. And so what I am baffled by is why people believe that an increase of 100 basis points is likely to pose substantial threats to the recovery and, more broadly, why people believe that we can end this whole episode of inflation concern without rates ever rising above 2%, which seems to me possible but doesn't seem to me like a preponderance probability in the current environment, so I take these various comments about how monetary policy operates and the example of 1994 as indicative of why we probably are likely to need to raise rates significantly into positive real terms in order to deal with this. And finally, Marcus, I would say that I know that many are very excited by questions around the sustainability of deficits and debts and issues around fiscal dominance I'd have to say that for a country in the 100% debt to GDP ratio I wouldn't begin to see those as serious issues until I saw meaningfully positive real rates. And as long as real rates were meaningfully negative and substantially below likely growth rates, it does not seem to me that the set of issues around fiscal dominance are of primary importance. Again, one needs to be data dependent and events could change quite rapidly, and if so that situation could change, but I think the I think the emphasis on fiscal dominance is harking back to the kind of monetarism that was badly wrong in 2010 that Paul and I agreed in 2010 was badly wrong and that does not strike me as being a high order concern in the current environment in general, I think that central bankers like generals tend to fight the last war and that the taper tantrum was an extremely minor event in American history that was not 3% as important as the Vietnam War 1970s inflation. And that we are paying a substantial price for the fact that it is looming far larger relative to the broad political and social consequences of inflation in the minds of central bankers than it should.
i think summers comment re the relative importance of the fed/interest rates in today's economy has been borne out by our economic performance over the last couple of years
the fed stomped on the brake pretty hard but we didn't go into the tailspin that lots of people expected, and that real interest rates below growth rates shouldn't be an issue
and part of our success is also due to krugman's point re supply chain bottlenecks/normalization bringing down inflation without crippling the labor market
so there were useful insights on both sides
one question i'd have... playing off summer's comment, it might be that the housing market is less important now than it once was, but it could also be true that interest rates affect different sectors that have longer lag times than housing
just as an example, let's say wind/solar/nuclear/electric veh projects are interest rate sensitive, but maybe these types of long-term capital intensive projects take longer to spin down (and up) than housing did
so we may not be out of the woods yet
Heh. After all, business cycles are known to last for decades, and anything short of that must be the last of the long legs of monetary policy, amirite?
A recession in 2024 might well be a great outcome for Democrats provided it doesn't arrive until late in the year (say, after mid-September). It won't have an effect on the election, but we'd likely be in a strongish recovery in 2026 (good for midterms).
Those who say "it's not a matter of if but when" are surely correct. If you're a Democrat you don't want it to arrive too early (if there's an observable recession by next summer Trump wins). But a recession arriving, in, say, 2027 probably isn't optimal, either. Who's to say Donnie's not their nominee 2028? He'll only be 82!
Predictions have to be time-bound to be worth anything at all.
Many observers predicted a recession *in 2023* and it seems very likely that those predictions were wrong.
Kevin, you were one of those observers.
You used to say that interest rate hikes are not *fully felt* for 12-18 months after they happen. More recently, you've been saying that interest rate hikes do not have *any effect* for 12-18 months. In this post, I note you've extended that time frame to "1-2 years, sometimes a bit more."
At some point you need to draw a line in the sand and say "if XYZ doesn't happen by ABC time, I will admit I'm wrong."
On December 14, of 2022 the Fed raised rates to the 4.25% to 4.50% range. In the past year the Fed raised rates and additional one percent. The last quarter point raise came July 26th, 2023. About 80% of the total rate increase for this tightening cycle happened more than a year ago. While it is still possible that the Fed rate increases could push the U.S. economy into a recession, it is becoming less likely with each passing day. Is Kevin willing to lay down a date when he will admit he was wrong?