Brookings Papers of Economic Activity The disappointing recovery of output after 2009 Fernald, Hall, Stock and Watson Discussion Lucrezia Reichlin Brookings Papers of Economic Activity March 23-24, 2017

What kind of recovery? Not the “classical” recession and recovery

Key question for FHSW Why has the recovery from last recession been so slow? Establish features once variables are “cleaned” from cyclical component Do growth accounting to compare with previous recessions and establish role of TFP, labor force participation etc.

Cyclical adjustment obtained by using Okun’s law

This recovery …. QUESTIONS: Slow because change in trends or cycle? If trends, has the change occurred prior to the Great Recession? What are the drivers?

Main findings of the paper Slower output recovery mostly explained by slow TFP growth (71% of shortfall), LFPR and K/POP When adjusted by the cycle the shortfall is larger. Interpretation: the shortfall due to trend and noise (about 50-50) TFP started slowing before the crisis therefore main factors precede the Great Recession Weak investment and capital growth are not key factors for slow recovery Rule out demand driven alternative explanations of slow recovery but finds some role for fiscal policy

Alternative ways to analyze the data …. Estimate VAR 1984-2009 and compute counterfactual paths 2010-2016 conditioning on historical correlations and observed unemployment 2009-2016 RESULTS: counter-factual paths higher than actual for output

Conditionally on unemployment GDP is higher than realized

Alternative ways to analyze the data …. ➔ This is in line with FHSW: indicates that unemployment rate recovered earlier than other variables If we define the cycle via Okun’s law, the cyclically adjusted series simply reflect this fact ➔ POTENTIAL PROBLEM: Leans heavily on a stable Okun’s Law During last recovery unemployment recovered relatively fast and this lowers cyclically adjusted output FHSW may under-estimate (slow) cyclical contribution to recovery

Results on GDP change when sample starts in 1990

Other issues TFP has large irregular component not clearly interpretable Role of capital and investment not clear ➔ define alternative decomposition to address these problems

Alternative time series model Variables in level T is a random walk with drift C is a stationary process

Transformations for the decomposition in ln-levels Variable Transformations for the decomposition in ln-levels Civilian Unemployment Rate: 16 yr + (SA, %) Levels Real Gross Domestic Product (SAAR, Bil.Chn.2009$) Natural logarithms Real Private Nonresidential Fixed Investment (SAAR, Bil.Chn.2009$) Output, business sector (2012=100) Hours, business sector (2012=100) Labour productivity, business sector (2012=100) Capital input (2012=100) TFP, business sector (2012=100)

Results Output gap shows unusually slow cyclical recovery GDP trend slowed down earlier than TFP trend Slow recovery is both about the trend and the cycle The trend in TFP has large idiosyncratic component (which is what the FHSW decomposition attributes to the irregular). TFP has also a cyclical component correlated with non-residential investment

Output gap: it took a long time to go back to a possibly slowing trend

TFP and GDP trends: correlation weak

But the cyclical component of TFP is strongly correlated with and leading the cycle of non residential investment

The role of investment VAR model suggests investment weaker than path conditional on unemployment contrary to FHSW results Factor model suggests role for TFP and investment in explaining weak cyclical output

Alternative decompositions – different stories Alternative decompositions may attribute some medium term fluctuations in TFP to the cycle rather than the trend These maybe related to demand factors Alternative is structural decomposition based on VAR Blanchard-Quah identification Demand shock: neutral on TFP in the long-run Supply shock: unrestricted

TFP has a sizeable cyclical component: ¼ of variance between 2 and 10 quarters

Conclusions GDP trend slowed down before the crisis But slow-recovery also explained by cyclical component including TFP and investment TFP trend also slowed-down before the crisis but later than GDP trend – not easily interpretable TFP has persistent fluctuations possibly related to demand

My own comment There is idea that recession had a scarring effect that lowered LFPR but did not affect U3 unemployment rate in the long-run Erceg and Levin (2014) present evidence from state level data But Okun’s law method will treat whole decline as in the trend/noise components once the U3 rate has normalized