Eli Dourado Replies to his Critics

Eli Dourado wrote some more about QE3.

The problem is that even if this story is true, we are probably, again, out of the short run. NGDP is almost 10 percent higher now than it was at the pre-crash peak. The number of people employed, even with population growth, is still below the pre-crash peak. Even assuming that insider nominal wages are totally inflexible, nominal output per worker has grown fast enough that insider real wages have probably adjusted. Furthermore, in five years, a non-trivial fraction of insiders retire or change jobs.

This inspired me to review the numbers again--calculate how far nominal GDP, real GDP, the price level (GDP deflator) and wages (production and nonsupervisory hourly,) are from the trends of the Great Moderation.    I also took a look at the changes from the previous peak.

For example, nominal GDP is $15.6 trillion.    It peaked in the second quarter of 2008 at $14.4 trillion.   Nominal GDP is 8.14 percent above its previous peak.  (I guess that is close to 10 percent, and nominal GDP is 9.19 percent greater than it was in the fourth quarter of 2007, when employment peaked and the recession officially began.)

Of course, most Market Monetarists don't focus much on where nominal GDP is now compared to the peak.   It is currently 15.2 percent below the growth path of the Great Moderation.   It would have to grow approximately 23 percent to get back to that the old trend in one year.

What about the price level?   Using the GDP deflator, the price level is now 115.   When nominal GDP peaked in 2008, it was 108.   The price level has increased 6.5 percent.    The price level has increased less than nominal GDP.  

The price level  is currently 2.4 percent below its trend growth path from the Great Moderation and would need to grow 4.27 percent to return to that trend in one year.

Real GDP is $13,546 billion.   When nominal GDP peaked in 2008, real GDP was $13,300 billion.   Real GDP has increased by 1.76 percent over the last 4 years.  Not much.

Suppose the price level is sticky, even stuck, downward, but had stopped rising when it was 108 back in 2008.  The current nominal GDP would be consistent with real expenditures and real GDP of  $14,400 billion.   If real GDP had increased to that amount, it would have risen approximately 8 percent.   That seems like quite a bit,  but it would still leave it well below trend.

Real GDP is currently 13 percent below the trend of the Great Moderation.   If it had increased 8 percent over the last 4 years, it would still be 7.61 percent below trend.   Absolutely no price increases would have fixed only slightly half of the problem after four years.   For real GDP to return to its trend for the Great Moderation, it would need to grow 17.75 percent.

What about wages?    When nominal GDP peaked in 2008, the hourly production and nonsupervisory wage was $18.   It is now $19.72.   It has increased 9.5 percent--even more than prices.   However, wages are now 2.5 percent below the trend of the Great Moderation, about the same as the GDP price deflator.   For wages to return to the trend over the next year, the increase would need to be a little more than 5 percent.

Employment?  When nominal GDP peaked in 2008, employment was 146 million.   It is now 142 million.   It  is 2.5 percent lower.  

That is pretty bad, of course,   But for most Market Monetarists, the problem isn't that it hasn't reached its previous peak (which was six months before nominal GDP peaked, though not significantly higher,) the problem is the shortfall from trend.  Employment is 9.25 percent below the growth path of the Great Moderation.   It would need to grow more than 11 percent to return to trend in a year.

Most Market Monetarists are struck by these figures--nominal GDP is 15 percent below trend, while prices and wages are about 2.5 percent below trend.   Real GDP is 13 percent below trend and employment is 9.5 percent below trend.

Given these large numbers, is comparing the current level of nominal GDP to its previous peak, and similarly for real GDP and employment, noting that real GDP has passed its previous peak by less than 2 percent while employment is 2.5 percent short--that important?  These are much smaller numbers.  Sure, it is a puzzle, but 2 and 2.5 is nothing close to 15, 13 and 9.

I calculated the ratio of nominal GDP to nominal wages.   I multiplied the hourly wage by 2000 to get an annual full time equivalent.    This ratio is 1.31 percent lower than it was when nominal GDP peaked in 2008.  The ratio is about 13 percent below trend.  

I also looked at the ratio of real GDP to employment.    That measure of productivity has increased by 4.4 percent since nominal GDP peaked in 2008.   Interestingly, it is  4.2 percent below its growth path from the Great Moderation.    To return to trend, it would need to grow 5.8 percent over the next year.

Like other Market Monetarists, I admit that it possible that potential output has fallen to a lower growth path and is now 13 percent below the trend of the Great Moderation.   The 2.5 decrease in prices and wages could have been sufficient to limit the decrease in real expenditures to the reduction in potential output.

It could be.   But I doubt it.