Reflections on Christina Romer’s Testimony
University of Wisconsin professor Menzie Chinn filed this guest blog post.
In her testimony before the Joint Economic Committee yesterday, Christina Romer, chair of the Council of Economic Advisers, presented an explication of the progress of the financial crisis and the economic downturn, the anticipated effects of the measures undertaken and planned, and the outlook going forward. On most points, we’re in agreement, so I’ll highlight only some key issues of interest.
I would characterize her description of the economic outlook as guardedly optimistic. We can’t say much more because Romer – in line with historical practice – did not provide specific forecast numbers associated with her testimony. She did indicate that the CEA forecast is in line with the Blue Chip forecast, of -2.1 percent annualized growth in the second quarter and a leveling off in the second half of the year. What specifically “in line” means is up for some debate; in early March, I observed that, given the dispersion in private-sector forecasts, the CEA’s short-term outlook seemed well within the consensus range.
I think Romer is right to be guardedly optimistic with regard to this near-term outlook, despite the fact that the past quarter's annualized GDP growth rate of -6.1 percent was toward the bottom of the range of forecasts. In addition to the factors she identified, including housing starts and consumer confidence, I would look to the point Jim Hamilton highlighted, namely that inventory disinvestment accounted for -2.8 percentage points of the growth rate. To the extent that inventories are now at quite low levels, production is more likely to ramp up next quarter. In addition, the rebound of consumption growth suggests that there will be some demand to sustain continued increases in production.
Is (Was) There a Credit Crunch?
The testimony devotes some attention to describing the unfolding of the crisis. It’s a narrative I largely agree with. One notable passage contains this retrospective glance:
Last fall, there was some debate about whether credit was actually all that important. Some pundits suggested that we should just let the financial system fend for itself because it really didn’t matter. The horrific falls in employment and production over the last five months have largely ended that debate. Shuttered factories across the country simply scream that Main Street and Wall Street do indeed intersect.
As one who heard a surprising number of academic macroeconomists dismiss the importance of the freeze in the credit markets, I think this quote calls for some economists to reassess the usefulness of their theoretical framework for assessing this downturn. It should also signal that, going forward, in determining who we pay attention to, we should look to their previous record of statements.
While I agree with the view there is some cause for optimism, especially after the passage of the American Recovery and Reinvestment Act, I do believe that there are two major risks to the outlook. The first concerns the effectiveness of interventions aimed at restoring the solvency of the banking sector and spurring the resumption of lending. In light of the increase in the International Monetary Fund’s estimate of financial institution losses ($2.7 trillion vs. a January estimate of $2.2 trillion for assets and loans originating in the United States), it is not at all clear that the US government has sufficient resources to recapitalize the system and thereby restart lending.
Romer’s testimony clearly indicates an understanding of the perils confronting us:
…Japan’s experience in the 1990s shows the costs of skimping on bank rescue. Until banks are cleansed of highly uncertain assets and robustly capitalized they will be hesitant to lend, and lending is what we need them to do.
So far, we can’t be sure that the appropriate steps to avoid this path will be taken, given the popular resistance to further resource transfers. Certainly, the incipient rebound in financial sector bonuses, and bank management resistance to additional regulation, seems likely to make it harder to build a constituency for the difficult choices that will probably have to be made in the near future.
As Romer pointed out, there is a synergistic aspect to the measures undertaken: Stimulus without repair of the financial system will, on its own, be insufficient to pull the economy out of recession. Similarly, repair of the financial system will be much more difficult if asset prices continue their decline. On the first point, we have little experience with measuring the effectiveness of fiscal policy in conditions of severe financial distress. The range of estimates that the Congressional Budget Office uses in generating its high-low forecasts pertains to the results obtained over periods when the financial system was operating in a normal or near-normal manner. As one can see from the CBO’s assessment of the effects of the ARRA, this range of impacts is quite large:
Figure 1: From the CBO, Estimated Macroeconomic Impact of the American Recovery and Reinvestment Act of 2009, March 2, 2009.
In times of financial-sector stress, households and firms may opt to rebuild balance sheets instead of increase consumption and investment, thereby short-circuiting the Keynesian multiplier process. A recent IMF analysis suggests that two years after output reaches a peak, output will be 3 percent lower on average in a recession occurring in conjunction with a financial crisis, compared with a recession in the absence of a financial crisis. (I will note as an aside that if one believes this effect is operative, then government purchases of goods and services are then a relatively more effective mode of stimulus than tax cuts, unless those tax cuts are directed to highly liquidity constrained households – see here.)
The second major concern is the international economic outlook. The IMF’s most recent estimates project world output growth this year (q4/q4) to be -0.6%. World trade is predicted to shrink by 11%.
The contractionary impact on the United States was highlighted in yesterday’s advance GDP release. Annualized real export growth was an estimated -30%, following a -24% rate in the last quarter of 2008. The trade deficit continued its precipitous decline mostly because imports continued their even more rapid decline; non-oil-goods imports were down by an estimated 39% (on an annualized basis) in the first quarter.
Figure 2: Year-over-year growth rate of GDP (blue, left scale), in exports (red, right scale), goods imports ex.-oil (green, right scale). NBER defined recession dates shaded gray. Source: BEA, GDP advance release of 29 April 2009, NBER, and author’s calculations.
We have not witnessed declines of this magnitude for more than 30 years.
It’s clear that we have some challenging times ahead of us. In my view, the administration’s made the first right steps. But in some respects, the biggest challenges lay ahead.
-- Menzie D. Chinn is professor of public affairs and economics at the University of Wisconsin. He is a research associate at the National Bureau of Economic Research and is co-blogger with James Hamilton of Econbrowser.
May 1, 2009; 6:15 AM ET
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