Economic policy-makers and analysts paid close attention in mid-August as Federal Reserve officials gathered in Jackson Hole for their annual symposium. Immediately after Chair Ben Bernanke delivered cautiously optimistic remarks about the state of the economy and the Fed's ability to improve it (at some undefined later date), a panel took the stage to present a research paper with some bad news: We're nowhere near finished with this recession. In fact, most countries that face a recession dominated by a financial crisis have never recovered to pre-crisis levels, even decades later.
I called Vincent Reinhart, a former director of the Fed's monetary-policy division who co-authored the article with his wife, Carmen, an economics professor at the University of Maryland, to tell him their research freaked me out.
"Yeah, well, you should be," Reinhart told me. "And I hope Federal Reserve officials are worried, too."
The Reinharts found that economic growth lags for years after a financial crisis ends. Advanced economies in particular feel the effect on their labor markets, with each that has faced a post-World War II financial crisis seeing higher unemployment after the crisis than before. This, in turn, suggests that what the United States faces is not a "cyclical" crisis but rather a long-term shock to the economy, something different from what we've experienced since World War II in the United States.
Christina Romer, the recently departed chair of the president's Council of Economic Advisers, made a similar point in her valedictory speech.
"This is not my father's recession," she said. "Precisely what has made it so terrifying and so difficult to cure is that we have been in largely uncharted territory. An all-out financial meltdown in the world's largest economy and the center of the world's financial system is something the world has experienced only once in the past century -- in the 1930s."
The Reinharts don't pin down the macroeconomic causes of this phenomenon in their paper (they lack the data to draw broader conclusions) and instead focus on the need for banks and homes to de-leverage -- get rid of debt -- and write down assets that have dropped in value in order to spur a return to lending and, in turn, drive growth.
There are several possible causes of macroeconomic sluggishness. One problem is that policy-makers simply don't figure out how to spur sufficient demand, through spending and tax cuts, after a crisis. Call this the "we need a World War" theory -- only massive, world-shaking government initiatives can solve the demand problem.
Another, troubling theory is that of "hysteresis" -- economies adapt to present realities. Our economy has been running below potential for some time now; according to the Fed, we're still only using about 75 percent of our economic capacity while unemployment remains high. Micro-economic evidence suggests that young people entering the job market during a recession face lower wages for the rest of their lives, and the long-term unemployed lose skills. Broadly, this same phenomenon translates into lower demand for goods and services and results in lower supply, perhaps permanently. Call this Paul Krugman's "new normal" theory -- the economy is changing because of this crisis, and not for the better.
The most worrying theory, though, is that before the financial crisis, our unemployment level was unnaturally low. By this measure, our unsustainable economic practices drove unemployment below its "natural" -- non-inflationary -- state. The natural resting point of unemployment is probably not 9.6 percent -- demand is still weak -- but by this telling, it's higher than the traditionally accepted 5 percent. Call this the "old normal" theory -- we've never really had the strong labor market we thought was there.
Some view this research with fatalism; economist Kenneth Rogoff, who co-authored with Carmen Reinhart a 2009 history of financial crises, This Time Is Different, recently wrote that "Americans will have to be patient for many years as the financial sector regains its health and the economy climbs slowly out of its hole." While the reality of the deep, and potentially non-cycle, effects of the crisis need to be faced honestly, there is no excuse for passivity. Indeed, the political problems of Democrats in Congress can be traced in part to their expectation of a cyclical recovery while deeply entrenched problems festered.
The paper does not suggest that our economic problems stem from tax rates that are too high or from having too much spending; in fact, more fiscal stimulus in moderate to large amounts is needed, and Vincent Reinhart, like his American Enterprise Institute colleague John Makin, believes a monetary policy more concerned with fears of deflation rather than the potential costs of inflation is needed. Regardless of our need for new ideas to cope with this long shock, the Reinharts believe that medium- and short-term stimulus, balanced with credible plans to address long-term deficits, can help rebuild employment. And yet these steps remain seemingly impossible thanks to political fracture, not inability to act, leaving the U.S. anything but the exceptional nation.
"So far we've been pretty typical. And there's no reason to believe we will stop being typical," Carmen told me.
No reason, indeed, unless policy-makers recognize that our jobs crisis won't end of its own accord.
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