Why We No Longer Have Sharp Recoveries From Recessions

Paul Krugman offers his explanation for our jobless recoveries from recessions since 1982.  He asserts that we had V shaped recoveries prior to 1982 because they were engineered by the Fed. The Fed raised interest rates in order to fight inflation's prior to 1982.  The higher interest rates caused a slow down in the housing market which is very sensitive to interest rates.  In order to end the recessions, the Fed lowered interest rates and produced quick recoveries led by a recovery in the housing market.  Krugman argues that this  experience led to the expectation that recoveries from recessions should be V shaped.  He concludes that our recessions since 1982 are different.  They were not triggered by the Fed and they cannot be reversed simply by lowering interest rates.  They were caused by the bursting of credit bubbles.  Most of the recessions were caused by the bursting of credit bubbles.  They were not deep, but the recoveries took longer.  In other words, U shaped recoveries have been the new normal since 1982; we have a new business cycle.  He can't understand why economists in the Obama administration predicted a V shaped recovery.

Dean Baker has a slightly different take on this topic than Paul Krugman.  He agrees with Krugman that we can't depend upon the housing market to get us out of the jobless recovery that we are experiencing.  The decline in the housing market was not caused by higher interest rates engineered by the Fed.  Therefore, it will not rise above normal levels, which would be needed to stimulate the economy, by the lower interest rates provided by Fed policy.  He also points out that personal consumption and business investment as a percent of GDP are at normal levels.  He argues that we still have negative net exports which are not discussed by Krugman.  He believes that emerging market countries have been keeping the dollar at a premium relative to their currencies by purchasing treasuries with the dollars that they get by running trade surpluses with the US.  He expects that they will step up their efforts to stimulate consumption in their domestic markets and become less dependent upon exporting to the US.  When that happens the dollar will depreciate in value and stimulate growth in US exports.

Baker's analysis is not very encouraging for a couple of reasons.  It may take a long time for the dollar to depreciate due to the rationale that he provides.  Furthermore, we are no longer the manufacturing powerhouse that we once were.  The export market is primarily a market for tradable goods that are currently being manufactured elsewhere.  We have an advantage in products that are related to the defense industry, which includes commercial aircraft as well as weapons, but it would take a long time to regain our lost share in many consumer products.  Moreover, our multinational corporations believe that it is advantageous to locate manufacturing closer to the more rapidly growing emerging markets that they covet.

Unfortunately, we are having a debate about the shape of our recoveries from recession.  We know why recoveries take longer than they took prior to 1982, but neither Baker or Krugman provide us with a set of polices that will increase the employment outlook even in the long term.  They both believe that Congress could provide a stimulus, which would help in the short term, but that is no longer a topic of discussion in our current political climate.  Moreover, its hard to find economists who have a good grasp of the structural problems in our economy, or a positive vision of the future with which we will have to grapple.  Even worse, many of them believe that the economy is self-correcting, and that includes most of the New Keynesians.