When General Equilibrium is Not Enough: Recession Debates

The recent supposed "normal" is not an inflation story, even though central bankers still use these threadbare descriptions that resulted from a different era of growth. Today's economic conditions also highlight a hefty dose of social and economic exclusion, which in particular don't do justice to inflation or Phillips Curve conclusions on the part of the Fed. Regular readers already know I don't find these aspects of general equilibrium framing to be sufficient, for the circumstance of the present.

When supply side factors hinder inclusion in general equilibrium, real economy factors emerge which - given the chance - can also initiate recessionary trends, such as occurred in 2008. As a result, circumstance in the real economy sometimes needs to be distinguished from the "recession as technicality" garden variety. The latter is the result of Fed overreach - particularly given excessive discretion, instead of a monetary framework which promotes monetary stability.

Even though the supply side factors of real economy conditions aren't responsible for recessions (statistically speaking), supply side factors do have the ability to strongly affect nominal growth direction - be that direction positive or negative. Plus, one does not always know whether better numbers reflect greater marketplace capacity, or simply more wealth capture. In spite of supply side shenanigans in this regard: what is at stake monetarily, is that the wrong Fed response (or overreach) exacerbates a given supply side "direction". For instance, David Beckworth indicated in a recent interview, how the latest U.S. recession was already underway before the Fed finally intervened, but the Fed made it much worse with an inadequate response.

How to think about the larger real economy conditions, which now impact growth potential in the near future? While I have serious issues with Robert Gordon's resignation about future growth, I must admit that the way Larry Summers sums up his viewpoint in this Prospect article, is one I have harbored for some time, due in part to my own family history.

Gordon's most compelling argument is that the greatest generation was also the luckiest generation.

Over the years, I've noticed that family members from my Dad's generation, usually didn't have the same problems with class polarization that now affect family members. In those historical moments when economic access is similar, there's also less need for anyone to judge. While some will still insist luck has nothing to do with it, my response is simply that general equilibrium conditions may no longer be sufficient for economic access. Those earlier conditions Gordon attributed to good fortune, existed in part because crucial elements of today's general equilibrium formation, were still being defined. As general equilibrium has become more exclusive, people will still play musical chairs, even in (statistically defined) non recessionary instances.

Nominal income factors extend well beyond the circumstance of the short run, which contribute to the nominal growth trajectory over time. What's confusing is even though central bankers influence long term growth through immediate action (especially needless destruction of supply side capacity), real economy elements determine the nature of the trajectory as well. Hence these reinforce each other in ways which move beyond simple calculations of recessionary periods. When market monetarists express the desire for a stronger growth trajectory, they are also promoting greater confidence in monetary policy and marketplace conditions. For instance, as Marcus Nunes indicates in a recent post:

I believe that even if there are no rate hikes in 2016, that will not be near enough to get the economy "unstuck"!...What's needed is a reversal of nominal growth expectations that translates into a reversal of actual nominal growth.

Where things get tricky in this regard, are the ways in which real economy conditions intersect with monetary policy conditions. Market monetarists stress the need to keep monetary policy dialogue as simple as possible, with a rule which would limit Fed overreach and overreaction. Ultimately, the long term growth trajectory does depend on supply side circumstance. Even so, that is no excuse which should allow anyone to get off scot free, by refusing to pick up the torch that is future growth potential. There are means to do so, which have yet to be explored. And those means include the fortunate possibility, of being able to overcome present day limitations in general equilibrium conditions.