Representative Ryan on Conditional Macroeconomic Prediction

The Marathon Man [0] channels Ed Lazear [1] [2]

From CNN yesterday:

“Usually when we have a deep recession in America, we come bounding out of it with fast economic growth and job creation. We did that after the ’81/’82 recession with Ronald Reagan. We did that after the tough 70’s recession we had,” he tells the “Piers Morgan Tonight” host. “We’re limping out of this recession right now. Economic growth is stagnant. Job creation is stagnant. The labor force participation rate is stagnant.”

Representative Ryan and the Heritage Foundation have in the past demonstrated a belief in out-of-consensus (to say the least) macroeconomic behavioral relations [3] [4], so it is not surprising that he has a uncertain grasp of macroeconomic prediction and conditioning. In this quote, like Ed Lazear, Representative Ryan does conditional analysis, but conditions only on depth of recession. He doesn’t condition on the source of the downturn – a sharp monetary disinflation in the 1980’s, and a financial crisis/housing bust/balance sheet recession in the most recent. What do formal cross section statistical analyses indicate about post-crisis output paths? From the IMF’s Article IV: Selected Issues report on the US:

…The economic recovery from the Great Recession has been sluggish by most standards, in particular considering the depth of the output loss during the crisis. Whether U.S. output will eventually return to its pre-recession trend or remain on a permanently lower trajectory has important implications for policymaking. A number of research papers have documented that output remains below its pre-recession trend following financial crises, including IMF (2009), Reinhart and Rogoff (2009), and Cerra and Saxena (2008). By contrast, Papell and Prodan (2011) find that GDP tends to return to its pre-crisis trend, but only after a long period (an average of nine years). …

Under all estimates of trend, we find that in the aftermath of advanced economies’ banking crises, per-capita output typically lags behind trend for at least 10 years after the crisis (Figure 5). Estimated output losses vary depending on the definition of trend but remain large, with the average 10-year loss in a range of 15.6 percent to 24.4 percent. Moreover, in the 7 cases for which it is possible to observe real GDP per capita for 20-years following the onset of the crisis, in only three instances—after the 1991 Sweden and Norway crises and the 1973 United Kingdom crisis—does real per-capita output rise above any of the six trend definitions at any point along the 20-year horizon.

The full sample results is shown in Figures 2 and 4 respectively from the IMF study:

Figure 2 from IMF (2012).

Figure 4 from IMF (2012).These graphs confirm that recoveries are significantly weak after financial crises. The paper also notes that recessions are deeper after financial crises — so conditioning on a deep recession without conditioning on the common correlate will necessarily lead to fallacious conclusions, either accidentally, or deliberately.

Since the sample used in the IMF analysis is relatively small, one might wonder about the statistical significance. I turn to a study by Oscar Jorda, Moritz Schularick, and Alan Taylor , who examine 200 episodes over the 1870-2008 period. They focus on the difference in recoveries based upon credit intensities in the buildup (I am hopeful that Representative Ryan agrees there was a lot of debt built up in the run-up to the 2007-2009 recession):

During normal recessions, 10% excess leverage is associated with a further one percent decline in output from norm at the start of the recession but this effect is relatively short lived. During financial crisis recessions, the same amount of leverage generates a decline that is twice as large, nearing two percent, and its effect is felt over many years (except for a mild recovery in the third year). Two to three years into the recovery output remains depressed by an extra one percent.

The effect on consumption is similar overall but with some intriguing differences. The decline in consumption during a normal recession is larger than the decline in output, in fact nearing two percent. However, consumption recovers strongly the year after and the effects of leverage die out perhaps even more quickly than they did with output. In contrast, during financial crisis recessions consumption appears to follow a similar pattern to output, the effect seemingly disappearing by year three but then returning with a decline for years four-to-six that is on a par with or even higher than the decline in output.

Figure 3 from the NBER working paper illustrates these points.

marathon3.gif Excerpt from Figure 3 from Jorda, Schularick and Taylor (2011).The red line is the impact of leverage in the wake of a normal recession, and the blue line the impact in the wake of a financial recession.

But I expect Representative Ryan to take these findings into account at the same time he disavows his belief in the Heritage CDA “scoring” of his roadmap [5], and his fears of imminent hyperinflation.[6]

This post was originally published at EconBrowser and is reproduced here with permission.

One Response to "Representative Ryan on Conditional Macroeconomic Prediction"

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