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Home Publications Blogs Beat the Press Gregory Mankiw's Pop Quiz on the Economy

Gregory Mankiw's Pop Quiz on the Economy

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Saturday, 07 May 2011 13:08

In his weekly column in the NYT, Gregory Mankiw gave a three question quiz for economists. His questions are:

1) How long will it take for the economy’s wounds to heal?

2) How long will inflation expectations remain anchored?

3) How long will the bond market trust the United States?

Let's start with questions 2 and 3, because these are easier. 

The answer to question number 2 seems obvious -- as long as there is no inflation. Why should people expect inflation when they are not seeing any? There is no evidence of generalized cost pressure in the economy as all indexes of wages are showing the rate of wage growth remaining pretty much constant. Commodity prices did rise, but this was mostly just a return to pre-recession levels, and it is not clear that these prices are even sticking at their higher level. This question is sort of like asking in the middle of a drought in the desert, when will people expect rain? Presumably when they see clouds on the horizon and not until then.

The answer to question 3 largely follows the answer to question 2. After all, the real threat to those holding U.S. government bonds is inflation, not insolvency, unlike the euro zone countries that Mankiw refers to in his piece. The United States can always print more dollars to meet its obligations. Greece cannot do the same with euros.

The idea being pushed by many in policy circles that at some point the bond markets will lose faith in the ability of the U.S. government to pay its debts is absurd on its face. This would be like saying that if I issued iou's, that were payable in my iou's, that the markets would be worried about my ability to meet my commitments.

Ultimately there can be an issue of inflation, where the markets would worry that the United States might print so much money as to seriously reduce the value of its currency, but this just brings us back to question #2. With inflation nowhere on the horizon, it is difficult to see why the bond markets would have this concern any time in the near future.

Okay, on to question #1. This is obviously a trick question, since it depends on what policies the country pursues. If the deficit hawks get full control over the levers of government and we start cutting spending rapidly, then it will take many many years before the economy recovers.

Similarly, if inflation hawks at the Fed can force increases in interest rates, like their counterparts at the European Central Bank, then recovery can take a very long time.

On the other hand, if we could get another big jolt of stimulus, a more aggressive monetary policy, or a big fall in the dollar to boost net exports, then we could see the economy recover fairly quickly. However, this is a political question, not an economic one, so Mankiw is being tricky by slipping it into his econ quiz.

Mankiw's gets in a cheap shot against the Obama administration in framing this question. He tells readers:

"When President Obama took office in 2009, his economic team projected a quick recovery from the recession the nation was experiencing. The administration’s first official forecast said economic growth, computed from fourth quarter to fourth quarter, would average 3.5 percent in 2010 and 4.4 percent in 2011. Unemployment was supposed to fall to 7.7 percent by the end of 2010 and to 6.8 percent by the end of 2011.

"The reality has turned out not nearly as rosy. Growth was only 2.8 percent last year, and the first quarter of this year came in at a meager rate of 1.8 percent. Unemployment, meanwhile, lingers well above 8 percent, and according to Ben S. Bernanke, the Federal Reserve chairman, is expected to keep doing so throughout this year.

"Economists will long debate whether President Obama’s policies are to blame or the patient was just sicker than his economists realized."

Actually, the forecasts were not so much wrong about the pace of the recovery as they were about the severity of the downturn. The first forecast from the Obama team assumed that in the absence of any stimulus the unemployment rate would peak at around 9.0 percent in the first quarter of 2010. Instead, with the economy losing more than 600,000 jobs a month at the time President Obama took office, the unemployment rate soared to 9.3 percent by the second quarter of 2009, just as the stimulus package was first having an impact.

One needs only to compare the projections to the actual data at the time when the Obama program first went into effect to know that there is no doubt that the "patient was just sicker than the economists realized." It is difficult to understand how honest economists could debate this proposition.

Nor is it easy to understand the purpose of the comparison to the growth following the 1981-82 recession:

"But there is no doubt that the pace of this recovery will come nowhere close to matching the one achieved after the last deep recession, when President Ronald Reagan presided over a fall in the unemployment rate from 10.8 percent in December 1982 to 7.3 percent two years later."

The recession of the early 1980s was a classic Fed-induced recession. The recession came about because the Fed pushed interest rates through the roof. The answer was easy: lower interest rates. When the Fed did lower rates, there was enormous pent-up demand for houses and cars, which sent the economy soaring. The last recession was not started by high interest rates and there is no pent-up demand for housing (maybe to some extent cars) to tap. Is it really surprising that we can't follow the same path to recovery this time?

Comments (11)Add Comment
A Chicken In Every Pot Hawk
written by Union Member, May 07, 2011 7:24
Deficit Hawks and Inflation Hawks are on everywhere in Washington and Wall Street yet Hawks for Prosperity are scares. If it is universally accepted that 70% of the economy is driven by consumer spending, why is there so much resistence and opposition to policies that would put money in the hands of consumers to spend, or paychecks for the unemployed to spend.
Perhaps you wouldn't want the economy to benefit too many people, that might lead to prosperity.
What you said.
written by Ozymandius, May 08, 2011 3:10
"It is difficult to understand how honest economists could debate this proposition." I don't know why Mankiw offends me so much; maybe it's because he has a reputation for being a very smart, very good economist but is constantly publishing tripe like this.
...
written by William Peterson, May 08, 2011 6:13
I think you are a bit optimistic about Q2. In the first place, bond investors outside the US are currently worried about political gridlock: a failure to raise the debt ceiling in time (or a solution which was an obvious fudge) would scare them badly. Secondly, the proposition that a country which can borrow in its own currency can finance any deficit, however large, by creating new IOUs only works if investors are prepared to hold an extremely high (and increasing) proportion of their total wealth in the form of those IOUs. Simple arguments about diversification of risk suggest this is unlikely.
...
written by Kokuanani, May 08, 2011 10:04
If Mankiw is so interested in finding answers to these quesions, why doesn't he turn ON the comment section accompanying his article in the NYT?

He might even get some thoughts from folks other than "economists." Or do those count?
I have a quiz for Mankiw
written by masaccio, May 08, 2011 1:08
1. Your theories and the models you built from them failed utterly. What have you done to correct for your disastrous failures?

2. You are rich, and you don't bear any of the pain from the mess you and your failed economist buddies created. What have you done to alleviate the misery you caused?

3. How did you develop the chutzpah necessary to keep talking in public?
...
written by Fed Up, May 08, 2011 6:01
"On the other hand, if we could get another big jolt of stimulus, a more aggressive monetary policy, or a big fall in the dollar to boost net exports, then we could see the economy recover fairly quickly."

Most of that depends on more debt. Why do you believe the solution to too much private debt is more private debt or more gov't debt? Can you get the idea that too much debt is the problem whether private or gov't? Do you believe real aggregate demand is unlimited so that real aggregate supply shocks don't occur?

"That was a classic Fed induced recession. The recession came about because the Fed pushed interest rates through the roof. The answer was easy: lower interest rates. When the Fed did lower rates, there was enormous pent-up demand for houses and cars, which sent the economy soaring."

Were people tricked into debt because of certain price and wage expectations? What is going on if more and more lower and middle class debt is not producing price inflation?
...
written by Fed Up, May 08, 2011 6:08
From NYT article: "AFTER more than a quarter-century as a professional economist, I have a confession to make: There is a lot I don’t know about the economy. Indeed, the area of economics where I have devoted most of my energy and attention — the ups and downs of the business cycle — is where I find myself most often confronting important questions without obvious answers."

Typical clueless, spoiled, rich, and overpaid economist. Either doesn't understand medium of exchange (the difference between currency with no bond attached and the demand deposits from debt), has the dumb idea that real aggregate demand is unlimited so however fast the supply side grows is how fast real GDP will grow, or some combination.
...
written by Gordon, May 08, 2011 7:02
Dean Baker,

You write:
"Ultimately there can be an issue of inflation, where the markets would worry that the United States might print so much money as to seriously reduce the value of its currency, but this just brings us back to question #2. With inflation nowhere on the horizon, it is difficult to see why the bond markets would have this concern any time in the near future."

Isn't the flaw in your logic your focus on the "near future"?

I don't know how you personally define "near future", but isn't someone who is considering buying a bond concerned about inflation occurring at any point during the life of the bond (even if the later the better)? So couldn't the bond market demand higher interest rates for long-term Treasury bonds even if they don't expect much inflation in the "near future" but do see a significant risk of high inflation several years from now (due to "printing money")?
...
written by paine, May 08, 2011 8:36
now we need cash sales not credit sales
to hell with enlightened shylock macro

the liquidity trap is really a credit ration freeze

who ever believed corporations were motivated by borrowing rates ??
its all usury here
instead of adding to job class debt burdens
try more and bigger
payroll tax holidays
and sales tax holidays
all on uncle's tab

shower the consumer markets
with uncle green pixie dust

pay the employed's own share of health premiums
and medicare premiums



re index the social security payments system
and send thru the step up outlays now

lots of ways to get cash to household first spenders

credit flow macro is for cheese cakers
Union member, Fed up, and Paine.
written by Ralph Musgrave, May 09, 2011 6:18
.
“Union member” above asks why stimulus money is not channelled into the pockets of ordinary consumers. Reason is the same as the reason Marie Antoinette told French peasants to eat cake: the rich don’t give a sh*t about the less well off. Plus ca change….

“Fed up” claims that more deficit means more debt. That is total nonsense. As Keynes, Milton Friedman, Warren Mosler and numerous other economists have pointed out ad nausiam, deficit can perfectly well accumulate as extra monetary base.

Paine is quite right to say we need more cash sales, not credit sales. I.e. Paine is saying the same as “Union member”.


Friedman and Keynes (not a good mix)
written by Matias Vernengo, May 10, 2011 1:59
Ralph, Friedman might have known that deficits could be financed by printing money, but he thought that was always inflationary (the market had a tendency to the natural rate of unemployment). Friedman, and the teaching of some of his stuff (by Mankiw amoing others) is part of the problem.

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About Beat the Press

Dean Baker is co-director of the Center for Economic and Policy Research in Washington, D.C. He is the author of several books, his latest being The End of Loser Liberalism: Making Markets Progressive. Read more about Dean.

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