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Macroeconomics of Persistent Slumps,Robert E Hall,NBER Working Paper No 22230. JEL No E24 E32 J21, In modern economies sharp increases in unemployment from major adverse shocks result in long. periods of abnormal unemployment and low output This chapter investigates the processes that. account for these persistent slumps The data are from the economy of the United States and the. discussion emphasizes the financial crisis of 2008 and the ensuing slump The framework starts. by discerning driving forces set in motion by the initial shock These are higher discounts applied. by decision makers possibly related to a loss of confidence withdrawal of potential workers. from the labor market diminished productivity growth higher markups in product markets and. spending declines resulting from tighter lending standards at financial institutions The next step. is to study how driving forces influence general equilibrium both at the time of the initial shock. and later as its effects persist Some of the effects propagate the effects of the shock they. contribute to poor performance even after the driving force itself has subsided Depletion of the. capital stock is the most important of these propagation mechanisms I use a medium frequency. dynamic equilibrium model to gain some notions of the magnitudes of responses and propagation. Robert E Hall,Hoover Institution,Stanford University. Stanford CA 94305 6010,rehall gmail com,Ratio of later unemployment rate to peak. Peak year Peak rate rate by number of years later,1975 8 5 0 91 0 84 0 72 0 69.
1982 9 7 0 99 0 77 0 74 0 72,1992 7 5 0 92 0 81 0 75 0 72. 2010 9 6 0 93 0 84 0 77 0 65, Table 1 Unemployment in the Four Serious Slumps since 1948. Beginning in 2008 output and employment in the United States dropped well below. its previous growth path Eight years later unemployment is back to normal but output. remains below the growth path Japan has been in a persistent slump for two decades And. many of the advanced economies of Europe are in slumps several quite deep This chapter. reviews the macroeconomics of slumps taking the American experience as a leading example. The adverse shock that launches a slump generally triggers a rapid contraction of output. and employment with a substantial jump in unemployment This phase the recession is. usually brief It ended in mid 2009 in the recent case The recovery from the trough often. lasts many years The slump is the entire period of substandard output and employment. and excess unemployment In the recent U S case the slump lasted from late 2008 until. around the end of 2014 Dating the end of a slump is challenging because some of the state. variables accounting for depressed output notably the capital stock take many years to. return to normal Output in 2014 was well below its earlier trend path. Persistent slumps did not begin with the one that originated from the financial crisis of. 2008 The Great Depression remains much the deepest and longest slump in the American. record since the beginning of national income accounting Table 1 shows that the persistence. of unemployment was about equally high in the four major slumps that occurred after. the introduction of the household unemployment survey in 1948 Normal unemployment. in the U S measured as its average over the period starting in 1948 is 6 0 percent In. all four slumps unemployment remained above normal three years following the peak of. unemployment and in only one slump the milder one associated with the recession of 1990. 91 did unemployment drop below normal four years after the peak of unemployment. Other accounts of persistent shortfalls in output and employment focusing on the fi. nancial crisis and its aftermath include Kocherlakota 2013 Christiano Eichenbaum and. Trabandt 2016 Christiano Trabandt and Walentin 2010 Benigno and Fornaro 2015. Petrosky Nadeau and Wasmer forthcoming 2015 Gertler Sala and Trigari 2008 Mian. and Sufi 2010 Reifschneider Wascher and Wilcox 2013 Hall 2013 and Hall 2014. 1 The Slump Following the 2008 Financial Crisis, This section provides the factual foundation for the chapter by describing events in the. U S economy around the time of the 2008 crisis through to 2014 I provide plots of key. macroeconomic variables with brief discussions The rest of the chapter considers the ideas. and models that seem most relevant to understanding those events. Figure 1 shows that real GDP fell dramatically right after the crisis and remained below. its prior growth path even six years after the crisis Plainly the crisis had a persistent effect. on the total output of goods and services Figure 2 shows that real consumption expenditures. behaved similarly to real GDP with no sign of regaining its earlier growth path over the. period following the 2008 crisis Figure 3 shows persistent shortfalls from the growth path of. employment Figure 4 shows that unemployment rose to a high level and returned to its long. run average of 5 8 percent at the end of 2014 six years after the crisis The unemployment. rate is the only major macroeconomic indicator that returned to normal within the six year. period considered here Figure 5 shows that the labor force shrank after the crisis relative. to the working age population and that no recovery of the labor force occurred during the. recovery Figure 6 shows that average real compensation per household which had grown. briskly through 2000 flattened before the crisis fell sharply just after the crisis and only. regained its previous level in 2014 Figure 7 shows that the business capital stock in the. sense of an index of capital services available to private businesses grew much less rapidly. than normal immediately after the crisis Its growth rate returned closer to normal but. left a considerable shortfall in capital relative to trend as of 2014 Figure 8 shows that. private business total factor productivity grew rapidly from 1989 through 2006 A dip in. productivity began in 2007 Though productivity grew at normal rates during the recovery. it did not make up for the cumulative decline just after the crisis Figure 9 shows the index. of the share of the total income generated in the U S economy that accrues to workers. including fringe benefits It tends to have a high level in recession years to fall during the. 2000 2002 2004 2006 2008 2010 2012 2014, Figure 1 Real GDP 2000 2014 Billions of 2009 Dollars. first half of the ensuing expansion then rise back to a high level at the next recession But. superimposed on that pattern is a general decline that cumulates to about 10 percent over. the period Like the general declining trend in earnings the decline in the share seems to. have started around 2000,2 Driving Forces, I use the term driving force to mean either an exogenous variable or an endogenous variable.
that is taken as an input to a macro model An example of the latter case is a rise in. the discount rate for investment and job creation triggered by a financial crisis There is. no claim that the discount increase is exogenous Rather the hypothesis is that a process. outside the model say a collapse of house prices influences the model through a higher. discount rate The same process outside the model may enter the model through more than. one driving force For example the collapse of housing prices may also affect consumption. demand by lowering borrowing opportunities of constrained households. Here I provide an informal review of the driving forces that macroeconomics has identified. to account for persistent slumps,2000 2002 2004 2006 2008 2010 2012 2014. Figure 2 Real Consumption Expenditure 2000 2014 Billions of 2009 Dollars. 2000 2002 2004 2006 2008 2010 2012 2014, Figure 3 Employment 2000 2014 Thousands of Workers. 2000 2002 2004 2006 2008 2010 2012 2014, Figure 4 Unemployment 2000 2014 Percent of Labor Force. 1989 1992 1995 1998 2001 2004 2007 2010 2013, Figure 5 Percent of Working Age Population in the Labor Force 2000 2014. 1990 1993 1996 1999 2002 2005 2008 2011, Figure 6 Average Real Earnings per Household 2009 Dollars 1990 2014.
2000 2002 2004 2006 2008 2010 2012 2014, Figure 7 Index of Capital Services 2007 1 2000 2014. 2000 2002 2004 2006 2008 2010 2012 2014, Figure 8 Index of Total Factor Productivity 2007 1 2000 2014. 1989 1992 1995 1998 2001 2004 2007 2010 2013,Figure 9 Labor share. 2 1 Labor force participation, A discovery in recent U S experience has been the importance of a major decline in labor. force participation In past slumps participation remained close to unchanged the economy. has not had a consistent tendency for the labor force to shrink when job finding became more. difficult As of 2015 the U S labor market had returned to normal tightness as measured. by job finding and job filling rates yet a large decline in participation starting around 2000. has not reversed The decline in participation is an important contributor to the divergent. behavior of output and employment on the one hand and labor market tightness on the. other hand Judged by the latter the slump triggered by the financial crisis of 2008 is over. yet output and employment are far below the paths expected just prior to the crisis. Movements in participation not directly tied to labor market tightness need to be added. to the list of phenomena associated with episodic slumps Even if a major shock did not. cause a subsequent decline in participation if a decline happens to occur during a slump. the shortfall in employment and output will be negatively affected. Elsby Hobijn and S ahin 2013 is a recent investigation of the decline in participation. Autor 2011 describes the disability benefits that may be a contributor to that decline. 2 2 The capital wedge, A key fact in understanding the slump following the financial crisis is the stability of business.
earnings Figure 10 shows the earnings of private business the operating surplus from the. NIPAs revenue less non capital costs as a ratio to the value of capital plant equipment. software and other intangibles from the Fixed Assets account of the NIPAs Earnings fell. in 2007 from their normal level of just over 20 percent but recovered most of the way by. 2010 when output and employment remained at seriously depressed levels. A basic question is why investment fell so much despite the continuing profitability of. business activities Macroeconomics has gravitated toward an analysis of wedges as ways. of describing what seem to be failures of incentives The capital wedge is the difference. between the measured return to investment and the financial cost of investment I take the. latter to be the risk free real interest rate The risk premium is one component of the wedge. between the return to business capital and the risk free interest rate Other components are. taxes financial frictions and liquidity premiums To measure the total wedge I calculate. the annual return to capital and subtract the one year safe interest rate from it Later I. 2000 2002 2004 2006 2008 2010 2012 2014, Figure 10 Business Earnings as a Ratio to the Value of Capital. decompose the total wedge into one component interpreted as an extra discount on risky. capital earnings not explained by finance theory and a second interpreted as an extra. premium on safe returns not explained by finance theory. The calculation of the return to capital uses the following thought experiment A firm. purchases one extra unit of investment It incurs a marginal adjustment cost to install the. investment as capital During the year the firm earns incremental gross profit from the. extra unit At the end of the year the firm owns the depreciated remainder of the one extra. unit of installed capital Installed capital has a shadow value measured by Tobin s q. Installation incurs a marginal cost at the beginning of the period of kt kt 1 1 Thus. the shadow value of a unit of installed capital at the beginning of the year is. units of capital From its investment of a unit of capital at the beginning of year t together. with the marginal installation cost with a total cost of qt pk t the firm s nominal return. ratio is the gross profit per unit of capital t kt plus the depreciated value of the capital in. year t 1 all divided by its original investment,1 rk t 1 t qt 1 pk t 1 2. qt pk t kt, Gross profit includes pre tax accounting profit interest payments and accounting depreci. ation In principle some of proprietors income is also a return to capital non corporate. business owns significant amounts of capital but attempts to impute capital income to the. sector result in an obvious shortfall in labor compensation measured as a residual The. reported revenue of the non corporate business sector is insufficient to justify its observed. use of human and other capital Note that business capital as measured in the NIPAs now. includes a wide variety of intangible components in addition to plant and equipment. The implied wedge between the return to capital and the risk free real interest rate rf t. is the difference between the nominal rate of return to capital and the one year safe nominal. interest rate,rk t rf t 3, This calculation is on the same conceptual footing as the investment wedge in Chari Kehoe. and McGrattan 2007 stated as an interest spread Note that the wedge is in real units the. rate of inflation drops out in the subtraction, Figure 11 shows the values of the business capital wedge for two values of the adjustment.
cost parameter calculated from equation 3 combining plant equipment and intellectual. property On the left is taken as zero and on the right as 2 The former value accords with. the evidence in Hall 2004 and the latter with the consensus of other research on capital. adjustment costs The value 2 corresponds to a quarterly parameter of 8. The two versions agree about the qualitative movements of the wedge since 1990 but. differ substantially in volatility The wedge was roughly steady or falling somewhat during. the slow recovery from the recession of 1990 rose to a high level in the recession of 2001. declined in the recovery and then rose to its highest level after the crisis The two calculations. agree that the wedge remained at a high level of about 18 percent per year through 2013. Hall 2011a discusses the surprising power of the financial wedge over general economic. activity The adverse effect of the wedge on capital formation cuts market activity in much. the same way as taxes on consumption or work effort. One branch of the recent literature on the propagation of financial collapse into a corre. sponding collapse of output and employment emphasizes agency frictions in businesses and. financial intermediaries The simplest model in the case of an intermediary completely. dominant in this literature though not obviously descriptive of the actual U S economy. grants the intermediary the opportunity to abscond with the investors assets Absconding. 1990 1993 1996 1999 2002 2005 2008 2011 1990 1993 1996 1999 2002 2005 2008 2011. Figure 11 The Capital Wedge for Two Values of the Adjustment Cost. takes place if the intermediary s continuation value falls short of the value of absconding. taken to be some fraction of the amount stolen from the investors If the intermediary s. equity falls on account of a crisis for example if mortgage backed securities suffer a large. capital loss the investors need to restore the intermediary s incentive to perform by grant. ing a larger spread between the lending rate the intermediary earns and the funding rate it. pays to the investors Hence spreads rise after a financial crisis This view is consistent with. the actual behavior of the spread between the return to capital and the risk free rate. The same type of agency friction can occur between a non financial business and its. outside investors Depletion of the equity in the business will threaten the investors capital. They need to raise the rents earned by the business to increase the continuation values of. the insiders and again spreads will rise, Gertler and Kiyotaki 2011 cover this topic thoroughly in a recent volume of the Hand. book of Monetary Economics Brunnermeier Eisenbach and Sannikov 2012 is another. recent survey Key contributions to the literature include Bernanke Gertler and Gilchrist. 1999 Kiyotaki and Moore 2012 Gertler and Karadi 2011 Brunnermeier and Sannikov. 2014 and Gertler and Kiyotaki 2011 See also Krishnamurthy and Vissing Jorgensen. 2013 He and Krishnamurthy 2015 Adrian Colla and Shin 2012 and Korinek and. Simsek 2014, 1960 1965 1970 1975 1980 1985 1990 1995 2000 2005 2010. Figure 12 The S P Risk Premium 1960 through 2012,2 3 Discounts and confidence. A second branch of the literature linking financial collapse to rising spreads considers widen. ing risk premiums in crises and ensuing slumps Cochrane 2011 discusses the high volatility. of the risk premium in the stock market measured as the discount rate less the risk free rate. Lustig and Verdelhan 2012 document the tendency for discounts to rise in slumps. A basic property of the stock market is that when the level of the stock market is low. relative to a benchmark such as dividends discounts are higher see Campbell and Shiller. 1988 Normalized consumption is another reliable predictor of returns Figure 12 shows. the equity premium for the S P stock price index from a regression of annual returns on. those two variables see Hall 2015 for further discussion and details of its construction. The risk premium spiked in 2009 Notice that it is not nearly as persistent as the slump. itself the premium was back to normal well before unemployment fell back to normal and. long before investment recovered, Macroeconomics and finance are currently debating the explanation for the high volatility. of discounts In principle high discounts arise when the marginal utility of future consump. tion is high Generating this outcome in a model is a challenge Marginal utility would need. to be highly sensitive to consumption to generate observed large movements in discounts. 2001 2003 2005 2007 2009 2011 2013, Figure 13 Growth Rate of Real Consumption of Nondurable Goods per Person.
from the modest expected declines in consumption that occur even in severe contractions. Contractions in consumption appear to be almost completely surprises If a model implied. that occasional drops in consumption occurred as surprises and consumption then grew. faster than normal to regain its previous growth path the discount rate would fall after a. crisis because marginal utility would be lower in the future. Figure 13 shows the history of the growth of real consumption of nondurable goods per. person from 2001 through 2014 The largest decline was in 2009 at 2 5 percent about. 3 5 percent below its normal growth With a coefficient of marginal utility with respect. to consumption of 2 elasticity of intertemporal substitution of 0 5 the effect on marginal. utility would be a substantial 7 percent But this applies to a fully foreseen decline The. process for consumption change is close to white noise so the hypothesis of a large negative. expected change seems untenable, Bianchi Ilut and Schneider 2012 propose a mechanism to overcome the problem that. expected increases in marginal utility are inconsistent with the observed behavior of con. sumption They disconnect discounts from rational expectations of changes in marginal. utility by invoking ambiguity aversion Investors form discounts based on their perceptions. of a bad case realization of marginal utility During periods when investors have unusually.

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