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Murray and Monti Professor of Economics Peter Ireland is a research associate at the National Bureau of Economic Research and has published extensively on monetary economics, in particular on testing monetary theories and the business cycle impact of monetary policies. Ireland recently spoke with Ed Hayward of the Chronicle on the American economy’s continuing troubles.
How do economists define a recession?
An economy is in recession when it experiences two or more consecutive quarters of declining real gross domestic product – a measure of economy-wide income. In the US we had four consecutive quarters of declining GDP beginning in the middle of 2008 and running to the middle of 2009.
So by that definition, the US economy experienced a recession in 2008 and 2009, the magnitude of which made this most recent recession probably the worst economic downturn this country has experienced since the Great Depression.
If the recession is technically over, why doesn’t it feel like it’s really over?
In late 2009 and early 2010, we had a period of time where real GDP was growing around 4 percent in annualized terms. That’s nothing to blow anyone away, but still solidly above average.
In the middle of last year, that growth began to slow. We’ve now had four consecutive quarters of growth in real GDP lower than the historical average of 3 percent. So we’ve had a year of sub-par growth in historical terms.
The first two quarters of 2011 saw very little growth at all.
Where do things stand with the economy now?
We’re at a time when there is a great deal of uncertainty. Is the recovery going to regain the momentum we had at the outset or are we in the process of sliding back into a recession? It could go either way. That’s really where things stand now.
What is the most significant factor in play in this anemic recovery?
It has to do with the debt overhang faced by many American households in the aftermath of the collapse in housing prices that sparked the recession in the first place. But it is worth noting that researchers have found that recoveries from financial crises like what we’ve just experienced are measured in terms of years and not months. Against that backdrop, it is unrealistic to expect that we’re going to regain everything we’ve lost in a very short period of time. It is unrealistic to expect that the government or anyone else is going to be able to restore what we’ve lost over a very short period of time.
Is there any “good news” on the economic front?
There are other forces having an impact on the economy that are likely to prove more transitory. This is where the good news comes in. The market slowing that we began to see at the beginning of 2011 has to be attributable to some extent to the disruption in global manufacturing that occurred because of the Japanese tsunami and earthquake. It was a human tragedy for certain that many people will never recover from. But from an economic standpoint, most people expect that Japanese manufacturing is going to come back on line in the next several months and that will replace a headwind with a tailwind that should help improve things going forward.
The political fiasco over raising the debt ceiling, which was mainly politics, led to a great deal of hesitation on the part of businesses and their hiring decisions and may have been the reason in and of itself there was virtually no new job creation in the month of August.
"I fear that many people are making a version of the same mistake that was made during the Great Depression: They look at historically low interest rates, and assume that means monetary policy is at risk of generating higher inflation. Often times, low interest rates do signal a monetary policy that is too accommodative."
-- Peter Ireland
President Obama just spoke about creating more jobs. How important is job creation to the idea of economic downturn?
There is a big problem with high unemployment and long-term unemployment. So it is certainly true that …that supports the idea that anything the government could do to give economic growth a jump start and generate the creation of jobs would really help Americans right how.
Could the Federal Reserve be doing more?
There’s a lot of disagreement on this, among economists and financial market participants, and even among Federal Reserve officials themselves.
Speaking for myself, I fear that many people are making a version of the same mistake that was made during the Great Depression: They look at historically low interest rates, and assume that means monetary policy is at risk of generating higher inflation. Often times, low interest rates do signal a monetary policy that is too accommodative.
But today, you have to pause and ask: If the 10-year US Government bond rate is 2 percent, can that really signal higher inflation ahead? I fear the opposite: Who would invest their money for ten years at only 2 percent, unless they thought there was a fair chance of very low inflation – maybe even deflation – ahead?
To be fair, I think this is something that Federal Reserve Chairman Ben Bernanke recognizes. I would expect to see another round of quantitative easing – where the Fed uses newly-printed money to buy Government bonds and offset deflationary pressures – if the economy continues to struggle. And I would certainly support that policy.
Has the US taken the necessary steps to safeguard our financial system?
I want to echo something Carroll School of Management Professor Ed Kane said when he testified before Congress and pointed out that for most Americans the bailouts of large financial institutions during 2008 seemed arbitrary and unfair. It has done a considerable amount of damage to confidence and people’s trust in government.
In most macroeconomists’ eyes, they have not done enough to resolve people’s doubts about what would happen the next time around. What we really need to hear from the Fed, Treasury, Congress and the Senate is the next time a large financial institution goes bankrupt, are they going to get bailed out again, or will they be shut down and liquidated like any other bankrupt American business? The answer has to be putting an institutional mechanism in place to have that happen, or to require these firms to hold enough equity capital to prevent them from failing in the first place. We haven’t seen initiatives strong enough to prevent that and that is casting a pall over the US financial system.
Stock market volatility has captured everyone’s attention. What does it tell us?
I’m not an economic historian, but the hour-by-hour and day-by-day volatility is something I’ve never seen in my lifetime. Stock prices have always fluctuated on a daily basis and it’s hard to explain why that is. You sort of have to ignore the day-to-day volatility and look to broader trends and the economic outlook. Yet, there doesn’t seem to be much of a disconnect between the market’s performance and the broader trends of the economy. The market is down but we’re not in a full-blown recession. The market isn’t down 20 percent; it’s down 5 to 10 percent. Curiously, it seems like the month-to-month and year-to-year movements of the stock market are tracking economic fundamentals pretty well.
How does the debt crisis within the European Union threaten the US recovery?
The EU debt crisis is another headwind we’re running into. The problem in Europe is similar to the one we face here, but on a larger scale. They too need to come to grips with the fact that a set of medium sized countries – as opposed to large corporations – may not be able to pay back the money that they borrowed. Deeper problems arise because there are systemic effects because banks hold the debt of insolvent governments and everyone is worried about a chain reaction.
The key for the survival of the EU is to come up with some institutional mechanism that can allow for a partial or total default of a government on its sovereign debt. Simply wishing that the problem would go away, or constantly bailing out delinquent borrowers, neither of those can form the basis of a satisfactory resolution.
What key indicators should we watch for signs of recovery?
GDP, which is essentially economy-wide income, and unemployment, which reflects the state of the labor market, are clearly two of the most important indicators to watch. What we’d like to see is a continuation of positive trends that we saw briefly in late ’09 and early ’10. But my hope is that all problems not withstanding, some things will start to mitigate and we will start to see cumulative change and a self-sustaining spiral from negative to positive trends.
I think that follows not only improved financial performance, but also an improved political dialogue and a sense that we are focusing on fixing the right problems.
What does history tell us about the likelihood we’ll see a return to something approaching normalcy in the economy?
The country has seen hard times before – a Civil War, a Great Depression, a pair of World Wars, Vietnam. Each crisis has found resolution somehow, be it through collective action, political leadership or heroic individuals. And each downturn has been followed by a period of growth or economic expansion. Nothing guarantees that the future is going to be like the past. But when we look at economic trends of the past, we see that sooner or later the problems are solved. Good times return. As you get older, you realize there is always something that goes wrong. It’s about thinking over the long term. Otherwise, we give into the sins of shortsightedness.