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Monday, September 01, 2003

Schock Resilience

Brad has been up (or down?) in Jackson Hole commenting on the Stock and Watson paper. In the mailbox Eddie from Singapore has some interesting points to make about flexibility and the capacity to absorb shocks, and a critical voice to express about Brad's short-run long-run distinction on productivity. I'm still waiting for the Kansas Fed to post the papers, so I won't dive in and comment. Brad, however, in a more recent post does ask the interesting question: "if workers are becoming so much more productive so fast, why aren't firms hiring more of them?". Put another way: something is happening to aggregate demand, what and why?

You probably read this :

"Greenspan, who this month began his 17th year in what many see as the second most powerful job in the country, took issue with a paper delivered Friday by James Stock and Mark Watson, two economists from the National Bureau of Economic Research. The two argued that economic shocks that trigger recessions have become less frequent in the last two decades, helped in part by successful implementation of monetary policy by the Fed and other central banks.'I have been watching the economy for over 50 years and I don't think there has been a reduction in the number of shocks,' Greenspan said, noting the 'monumental' shock the economy sustained in the Sept. 11 terrorist attacks. Rather, he said, greater flexibility in the form of government deregulation of major industries and more flexible labor markets and financial markets have helped the U.S. economy withstand shocks that in the past would have triggered major recessions. 'There has been a very significant increase in the flexibility of the U.S. economy and the world economy to absorb shocks,' Greenspan said. 'Deregulation has enabled this country to absorb shocks in a way that it could not in previous periods.'"

I find Greenspan’s enthusiastic belief in the increased flexibility of economies to absorb shocks somewhat perplexing. “very significant” ability of the US economy to absorb shocks ... perhaps, but the world economy? Japan? Europe? For Asia, long used to uninterrupted high growth rates, the onset of frequent recessions is a shock. Asians now think their economies are much less stable as a result of the volatility of high-tech investments and globalisation; that deregulation of capital accounts have increased their vulnerability.

But even in the US, I wonder. I would agree with Stock & Watson and credit Greenspan himself for having contributed significantly to increasing the US’s (and hence the rest of the world) ability to absorb shock. He’s the only central banker most tuned to consumer and biz sentiments. Deeper and broader financial markets? Perhaps. But are Japan and Europe that far behind in terms of sophisticated financial instruments? In any case, there’s considerable controversy here. Isn’t the growth in derivatives now causing worry? People like Warren Buffet think so. And now the increased
volatility in the bond markets?

A more entrepreneur society? Probably. But I think its ageing populations in Europe and Japan ... and their insular societies that are going to play a bigger factor in contributing to less flexible economies in these countries than Greenspan seems to think. Language probably plays a role here too – in that English-speaking societies mostly exhibit a more open mindset. (Not just a coincidence that the Netherlands and the Scandinavian countries are the European nations most comfortable with English?)

As for the US, I can’t help but think there’s a large slice of luck involved. In that, like success breeds success, growth breeds growth. The US is, after all, the world’s consumer of last resort, assisted by a rest of the world eager to sell them goods. Was it partly because the US managed to maintain demand at a high growth rate that allowed the productivity boom to flourish? In the 1980s when the Japanese economy was booming, the productivity buzz came from there – quality control circles, just-in-time inventory. And right now, surely there’s no consumer in the world more confident of their future than the US. So the resiliency in the US economy really is the optimism of the US consumer? Feels like what the Asians felt back in ’93 = on top of the world. Despite stock markets coming off in ’94, Asian property boomed for another 4 years after ‘93, until the Asian crisis hit. Now, Asian countries like Japan, Hong Kong, S’pore have crushed consumer & investment spirits. And governments don’t realize how quickly this spirit can be destroyed when it resides in the hearts of an ageing society.

This brings me to an article by Brad de Long that was published in our local paper, “In the short run, rapid productivity growth posesdilemmas for macroeconomic management, because what would otherwise be seen as reasonably strong demand growth is proving insufficient to keep unemployment low. However, the short-run view is not the important one.
Rapid productivity growth is - in the long run - good news for the US: A higher-productivity economy is better at enhancing human welfare.”

No doubt, “a higher-productivity economy is better at enhancing human welfare.” But he seems to take the current economic problems lightly with the remark “the short-run view is not the important one”. To me, it is the important one. For too often we hear this refrain, in the long run it’ll get better. But how will this long run arrive? Potential growth will always remain potential if not realized. And right now, the threat of deflation places growth firmly in the realm of the possible but not probable.

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