Tuesday, May 24, 2022
Recession? Part 2: The economics of a decline
The video in the previous post includes another economist, Mark Hamrick of Bankrate, who says traditional indicators of recession, such as rising unemployment, don't seem to him to be apparent. Similarly, the IMF's Gita Gopinath suggests inflation, not recession, is the immediate pressing problem. So why do I disagree? This is a great opportunity to revisit some fundamental economic theory.
Standard business cycle models imagine a tradeoff between inflation and unemployment, with output fluctutating accordingly. Countercyclical monetary and fiscal policy are then the standard remedy. I'm skeptical of those models for a couple of reasons, but for present purposes it's sufficient to note that the inflation-unemployment tradeoff is nonsense. America's stagflation of the 1970s is sufficient rebuttal. But more importantly, the standard business cycle is not what we are facing. Standard theories posit a recession is caused by demand side problems (e.g. consumer pessimism and too little spending) or supply side problems (e.g. bad investments stemming from bad monetary policy). But that's not the nature of our current problem.
Indeed we are facing increasing inflation from monetary expansion, as Gopintha warns, and I think it will worsen. But a steep economic decline is almost assured for reasons other than business cycle. In no particular order, the American economy faces:
- Long run reduction in energy. The federal government is implementing Green New Deal proposals to eliminate fossil fuels. Fossil fuels cannot be replaced by wind and solar, because wind and solar are not sufficiently scalable and the amount of storage needed to solve the intermittency problem is not feasible. So the federal government is acting to shrink our energy supply. This will shrink the economy, and it isn't a recession-like bust.
- Disruption of supply chains from the Wuflu lockdowns. As I warned at the time, government planners have no idea what is and isn't essential; the terms are almost meaningless in economics. Small manufacturers and contractors turn down orders and jobs because of lack of materials and labor (former workers still on the dole). The restaurant industry has been wrecked. We've still not recovered from these disruptions, and they are being exacerbated by other factors, such as...
- Increased regulation. The Biden administration and federal bureaucracy has accelerated regulation, and of particular note they've been doing away with benefit-cost requirements, reducing these substantially. The decrease in regulation under President Trump was the primary reason for our unprecedented economic boom (the one the Wuflu lockdowns killed). There is no greater destroyer of entrepreneurship and small business than draconian regulation and regulators. Draconian regulators -- you know, the people who go back and forth between posititons in TBTF firms and positions in federal administrative agencies?
- Lockdowns in China's major cities have further disrupted suppy chains. China is a major source for the world's parts and pieces.
- Russia's war on Ukraine has disrupted a substantial amount of the world's gas, oil, petrochemical, and agricultural trade. This is a separate reason for why food and energy prices will rise. I emphasize that it is separate because it is a factor independent of the homegrown ones the Biden administration wants to ignore.
None of these have anything to do with traditional business cycle theory, and they aren't things you can "countercycle" your way out of. This is why I'm skeptical of applying business cycle theory to the current debacle. There's too much else going on.
Let's note one more thing. The Fed is currently concerned with inflation, and so needs a tighter monetary policy. But higher interest rates will lead to an higher debt payments, and it won't take much to explode the these to impossible levels. But a downturn will tell the Fed to pursue a loooser policy with lower rates, the inflation they (supposedly) want to curb. And you cannot stimulate your way out of reduced supply that comes from less energy, supply chain failures, increased regulatory burdens, and less food production. You cannot overcome blackouts and food shortages by handing out fiat money.
Short of highly improbable rapid reversals of policies, or other unforeseen contingencies, we are in for a real disaster, I fear.
