a key fact is that recessions are followed by rebounds. Indeed, if periods of lower-than-normal growth were not followed by periods of higher-than-normal growth, the unemployment rate would never return to normal.
However, Mankiw goes on to explain that sometimes a recession is the prelude to something worse, not just the downturn before the revival:
I don't think so. The problem is that those numbers start at the end of the recessions, and we do not know when the recession will end. In other words, if God came down and told us the exact date the current recession was going to end, my forecast subsequent to that date would be for higher than normal growth. But absent that divine intervention, there is always some chance the recession will linger (remember the Great Depression), and an optimal forecast has to give some positive probability weight to that scenario as well. The forecast should be an unconditional expectation, not an expectation conditional on a particular end date for the recession.
Arnold Kling offers an alternative and cogent summary of a tricky mathematical puzzle:
Brad DeLong sighs:
Mankiw is here arguing that the Obama administration's forecast is too high, and so forecasts future deficits that are smaller than the deficits are in fact likely to be. Mankiw is arguing that future economic growth is likely to be just average--that there will be no post-recession catch-up during which growth is faster than average.
Whether an unexpected fall in production is followed by faster than average catch-up growth depends what kind the fall in production is. A fall in production that does not also change the unemployment rate will in all likelihood be permanent. A fall in production that is accompanied by a big rise in the unemployment rate will in all likelihood be reversed. You have to do a bivariate analysis--to look at two variables, output and unemployment. You cannot do a univariate analysis and expect to get anything useful out.
Guess what kind of unexpected fall in production we are experiencing right now?
That an unemployment rate higher than normal is likely to be followed by a period when unemployment falls sharply is sure. On average, we expect half of deviations of unemployment from its average value to be erased over the next two years:
Prof. DeLong then flaunts his mastery of the medium by embedding two charts, both of which suggest that high unemployment today is followed by robust GDP growth over the next eight quarters. But wait! Mankiw responds:
There is not enough information presented for me to know whether to agree with Brad's inference. My guess is that this regression line (at least I presume it is a regression line) is completely driven by the few observations in the upper right, which are probably all from the Reagan-era boom that followed the 1982 recession. It looks like if you take out that one episode, the relationship would largely disappear. I would be curious to see the statistical significance of the regression, using the relevant serial correlation corrected standard errors (I believe that 8 lags would be needed, given the overlapping data). If I am right that what we have here is an uncorrelated cloud plus the Reagan boom, then I would not expect a high level of statistical significance for this relationship.
Far be it from me to suggest that Mankiw peeked; he may simply live and breathe these stats like others know baseball. But whatever the explanation he seems to be correct - I dredged up quarterly unemployment and GDP growth from 1960 to the present and attempted to mimic the DeLong chart with and without the Reagan years. The Reagan recovery following 1981-1982 is highlighted and does seem to drive the result:
Let's end with a chortle - isn't it nice to see Krugman and DeLong relying on the Regan-era tax cut fueled boom to justify the Obama-era recovery plan?
START HERE: With any luck this will be the relevant Excel file. Download GDPvUnemploy
I CAN HEAR KRUGMAN NOW: Who knew Krugman was such a Reagan fan? I can hear him now: "Mr. President, if ever the economy is down, I want you to tell the guys to tax one for the Gipper". OK, maybe not...