Man Without Qualities

Thursday, August 28, 2003

Schrodinger's Raccoons and the Search for Economic Reality

Tom Maguire has found one - a Schrodinger's Raccoon!

Here is what that particular Schrodinger's Raccoon (aka Herr Doktorprofessor Krugman) had to intone about the Search for Economic Reality a few years ago (link thanks to astute MWQ reader):

[T]he whole "New Economy" doctrine ... is based on a misunderstanding of the relationship between measurement and reality...[!] The New Economy doctrine, sometimes called the New Economic Paradigm, may be summarized as the view that globalization and information technology have led to a surge in the productivity of U.S. workers. This, in turn, has produced a sharp increase in the rate of growth that the U.S. economy can achieve without running up against capacity limits. ...

The conventional view that the economy has a "speed limit" of around 2-percent to 2.5-percent growth does not come out of thin air. It is based on the real-life observation that when the output of the U.S. economy--as measured by real gross domestic product--is growing rapidly, the unemployment rate falls; when the output is growing slowly or is shrinking, the unemployment rate rises. Over the last 20 years, the break point--the growth rate at which unemployment neither rises nor falls--has been between 2 percent and 2.5 percent. And this break point does not seem to have changed much in recent years: Since mid-1994, GDP has grown at about a 2.7-percent annual rate, while unemployment has fallen at a steady rate, implying that the no-change-in-unemployment growth rate is closer to 2 percent than to 3 percent. (Click here to see a chart that illustrates the break point.)...

[W]hile the economy can grow faster than 2-point-whatever percent for a while if it starts from a high rate of unemployment (like the 7.5-percent unemployment rate that prevailed in late 1992), in the long run, that growth rate cannot remain higher than the rate that keeps unemployment constant. And that is where the infamous "speed limit" comes from.

Well, we're nowhere near a 7.5% unemployment rate now - the national rate is just 6.2% and even California's rate is only 6.6%. So we're right up against that "speed limit" that's based on 20 years of real-life observation of the U.S. economy right now? But - as I noted in a recent post - here's what the same Raccoon pulled from the can behind the Princeton economics department just a few days ago:

Just to stabilize the labor market in its present dismal state would probably take growth of at least 3.5 percent; it would take much more than that to return the economy to anything resembling full employment. ... The best guess is that growth in the second half of the year will be faster than in the first half, possibly high enough to create some jobs, but not high enough to make jobs easier to find. In other words, in terms of what matters most, the economy will continue to deteriorate.

So as I did in that prior post, again I ask: Is 5% "much bigger" than 3.5%?

UPDATE: Others, including David Kelly, an economic adviser for Putnam Investments, do not share any of than Herr Doktorprofessor's apparently diverse opinions:

This week, analysts revised up its number for economic growth to 3.1 percent in the second quarter of this year. That number happens to be the break-even point on unemployment. Growth above that level creates jobs, below that level loses jobs. "We should begin to see a lift off in job growth in the next few months if we keep up this pace of economic growth," Kelly said. If the economy were to grow at 4 percent or so over the next year, as some analysts believe it will, that could create 1.5 million new jobs, not quite half the number lost since Bush took office, and enough for him to claim his economic growth package is paying off.

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