Tuesday, October 06, 2009

Defining away recession

Back in December, I predicted that the recession would last all year.

I should have thought more deeply about what economists mean when they talk about "recession." The standard definition is "two down quarters of GDP."

I didn't think about the definition of GDP. According to wikipedia:
The most common approach to measuring and quantifying GDP is the expenditure method:
GDP = private consumption + gross investment + government spending + (exports − imports)
Raise government spending, you raise GDP (by definition, assuming you're not crowding out private investment), and voila-- the recession is over! It's simple!

The government has been spending lots and lots of money, and yet unemployment continues to rise. I think it's time to either redefine "recession" or come up with a more relevant measure of how the economy's doing; the current definition make it way too easy for governments to game the numbers and declare "Mission Accomplished, Economy Back On Track."


Anonymous said...

I agree 100%. It is similar to how they re-define inflation to make the numbers look lower than what is real (conveniently keeping social security reimbursements from rising).

Matthew Cornell said...

The idea of consumption and growth being fundamental measures says something not often talked about: Ours is a sick model. Taking a cue from the AI program in The Matrix, what other organism is based on growth and consumption? Cancer! I'd love to hear your thoughts on this...

I'm looking forward to watching Michael Moore's "Capitalism: A Love Story" to see his take on it.

Gavin Andresen said...

A lot of really good things are strongly correlated with GDP growth: a cleaner environment, higher literacy, less violent crime, etc. I agree with the criticisms of attempts to create other measures of progress-- they either end up being very subjective or end up being GDP multiplied by a constant.

I do wish people would think more about what they do with their wealth; the ads for multi-thousand-dollar watches and dresses in the New York Times magazine should embarrass anybody who reads it. But I don't think that coming up with a "better" definition of growth would have any effect on people's behavior.

And I hope Michael Moore appreciates the irony in making an anti-capitalist movie; it's the capitalist system that has made him rich and allowed his movies to be seen by millions of people. If he gets a few people to donate money to a good cause instead of buying a third big-screen TV (for the guest room), then I'll be happy.

But I'm cynical, so I expect he'll instead get people to support counter-productive policies like import tariffs and quotas or price controls.

Paul G. Silva said...

I wonder why a recession is not defined by unemployment. That seems to be the only metric that has true political power after all...

Gavin Andresen said...

Darn good question, Paul!

I think it's because the first macro economists didn't have a good handle on what causes unemployment, so their equations didn't mention employment.

As far as I can tell, they're STILL debating why unemployment happens (why doesn't the price of labor automatically rise or fall to match the supply of people looking for work?)...

Paul G. Silva said...

My just-informed-enough-to-be-dangerous thought on why unemployment lags is:
1. Most employment requires specific skills. When you get laid off, you may very well need to retrain - that takes time.
2. Humans are very reluctant to decrease their personal income - not simply because they are used to having a certain income level, but because doing so is often interpreted as "*I* am worth *less* as a human being.

Of course, what the hell do I know. If the answer were that simple, someone would have thought of it decades ago - so the truth is clearly more complex.

Gavin Andresen said...

No, you're absolutely right Paul-- sticky wages and the transaction costs of finding a new job are the two explanations you get from economists.

But there's STILL a lot of debate about HOW sticky wages are, and a lot of economists who seem to ignore retraining costs.

For example, Arnold Kling criticizes Paul Krugman (and others) for pretending that we all work for the "GDP factory" and that the government can simply create "GDP factory jobs" to cure unemployment.

Paul G. Silva said...

I love Arnold! His ideas will never get made into law, but at least he knows it and has a great attitude about it :).

Have you heard of any alternate definitions of GDP or of economic growth that you find attractive? Has anyone tried GDP*=GDP-Government spending

Gavin Andresen said...

I guess it all depends on what you're trying to DO with the numbers. If you're comparing countries, then subtracting government spending wouldn't make sense, because countries vary so much in what their governments do.

Oh, by the way, you can see GDP broken out into its components at:

I like to think that if we got the micro-level policies right (free trade, more open borders, eliminate licensing and other barriers to competition, etc) then the macro would just take care of itself, but maybe I'm naive.

I do think a lot of macro-economics is the modern day equivalent of arguing over the number of angels that can dance on the head of a pin.

Paul G. Silva said...

Thanks for the link - I LOVE DATA! :)

AS for Macro-econ, I feel much the same. That said, there does seem to be some real knowledge gained. The Great Moderation implies (but does not prove) that the Milton-inspired reforms of macro econ had some important effects.

But most of it feels like village chieftens noticing slight correlation with how the tea leaves are arranged and then committing billions of people to follow the path of those leaves :(.

Is it realistic to hope for anything else? Humans feel a NEED to have their government DO SOMETHING when things Go Wrong. And even in non-democracies, leaders with power are under the delusion that they can Make Things Better...

I sometimes enjoy trying to imagine what Government will look like in 2k years. Just as we look at Rome with respect for all they did... NONE OF US WOULD WANT TO LIVE THERE. It would rate as a 3rd world nation in terms of its government compared to today's standards...

But if I knew what the future held, I'd have a better job :).