Business cycles ; Economic conditions - United States ; Econometric models ; Gross national product ; Recessions ; Labor productivity

Timothy Cogley

English

Research Papers in Economics

FRBSF WEEKLY LETTER
Number 93-02, January 8, 1993
The Recession, the Recovery, and the
Productivity Slowdown
From 1988 to 1991, real output grew at the unusu-
ally slow rate of 1.3 percent per year. In contrast,
from 1953 to 1987, real GNP grew at an average
rate of 3.0 percent per year. If the current growth
rate persists, the cumulative effect on real income
will be very large. For example, at a 3.0 percent
annual growth rate, per capita income doubles
every 23 years, while at a 1.3 percent annual
growth rate, ittakes 53 years for income to double.
Economists generally attribute the slowdown to
two factors: a short-run contraction beginning in
1990 and a long-run productivity slowdown that
began in the early 1970s.lfour problems were due
mainly to the recession, the slowdown would be
mostlytransitory. Outputgrowth would eventually
return to normal as the economy recovered from
recession. In this case, the main problem for
policymakers would be to increase the pace of
recovery without increasing inflation. On the
other hand, if the primary problem is a long-term
productivity slowdown, then slow growth may be
the norm. In this case, short-term monetary or
fiscal stimuli are not likely to be helpful.
This Weekly Letter seeks to quantify the relative
importance of long-run and short-run factors,
and it discusses some implications for policy-
makers. It concludes that the economy is oper-
ating near its long-run trend path and that its
recent sluggish performance is due primarily to
a slowdown in trend growth. This suggests that
policies aimed at stabilizing the business cycle
may be less effective than those designed to
stimulate productivity growth.
Separating secular and cyclical fluctuations
Our first task is to separate long-run trends in per
capita GNP from short-run cycles. To accomplish
this, I use a variant of the model developed by
Blanchard and Quah (1989). They identify busi-
ness cycles by studying the joint dynamics of
output growth and the unemployment rate.
Roughly speaking, their model can be inter-
preted as a dynamic version of Okun's Law. The
basic idea underlying Okun's Law is that unem-
ployment tends to be higher than normal when
actual output falls below potential output. For
example, the static version of Okun's Law states
that for each percentage point of unemployment
above the natural rate, output falls below po-
tential by roughly 2.5 percent. Thus one can
estimate the gap between actual and potential
GNP from cyclical fluctuations in the unemploy-
ment rate. Blanchard and Ouah translate this
idea into a dynamic setting~ which allows for
lags in the relation between output and employ-
ment gaps. I modify their model by substituting
per capita hours worked for the unemployment
rate. The rationale for this substitution is that
hours are a better indicator of the state of the
labor market, since firms can vary employment
by adjusting overtime as well as by hiring or fir-
ing. But the basic idea remains the same: Hours
worked tend to be lower than normal when out-
put is below potential.
To be specific, I assume that output and hours
are subject to two kinds of independent random
shocks; one kind generates permanent move-
ments in per capita GNp, while the other has
only transitory effects. I attribute permanent
movements in per capita output to technological
innovations. Since technological innovations per-
manently alter productivity, they affect potential
GNP and therefore have a permanent effect on
actual GNP. I attribute transitory movements in
outputtocyclical disturbances. This interpretation
is consistentwith business cycletheories in which
cycles represent temporary deviations from the
long-run growth path. Such theories include
Keynesian, Monetarist, and some New Classical
models. In these models, fluctuations in aggregate
demand and temporary fluctuations in aggre-
gate supply can drive the economy away from its
long-run growth path, but the economy will even-
tually recover and return to its long-run path.
A model was estimated for output growth and
employment, and the assumption that business
cycles are transitory was used to separate trends
and cycles. The results are illustrated in the fol-
lowing chart. The solid line shows real GNP per
working age person overthe period 19.s~to 1991.The behavior of real wages provides some inde-
pendent support for these estimates. In the long
run, increases in real wages are tied to increases
in labor productivity. Thus, a slowdown in pro-
FRBSF
The dotted line shows the long-run component
of GNP, which is defined as the path that output
would have followed had there been no cyclical
disturbances. The distance between the two lines
is the cyclical component of GNp, and it can be
interpreted as the path output would have fol-
lowed had there been no technological progress.
The shaded lines mark the dates of recessions, as
determined by the National Bureau of Economic
Research.
ductivity growth should be accompanied by a
slowdown in real wage growth, and this has
occurred. From 1955.Q1 to 1973.Q2, real com-
pensation per hour grew at an average rate of 2.7
percent per year, but since 1973.Q3 it has grown
by only 1.0 percent per year. The decrease in real
wage growth roughly matches the decrease in
trend output growth. While real wage growth fell
by 1.7 percentage points, trend output growth
fell by 1.5 percentage points.
The chart shows that the economy has experi-
enced two large contractions since 1954. The
first occurred in 1974-1975 as a consequence
of the first OPEC crisis, and the second occurred
in 1980-1982 as a consequence of the second
OPEC crisis and the Volcker disinflation. The
economy also has experienced two large booms,
the first at the time of the Vietnam War and the
second in the 1980s. In fact, the 1980s boom was
the longest and largest in the post-war period,
with output peaking at 6.7 percentabove trend
at the end of 1989.
The causes ofthe productivity slowdown are
not well understood. Economists have proposed
various hypotheses, including theories based on
changes in the composition of the labor force, an
increase in government regulations, slow com-
mercial adaptation of scientific discoveries, and
mismeasurement of output, but no consensus has
emerged.
How does the 1990 recession compare with
past business cycles?
Various observers have remarked that the current
recession and recovery seem to be different from
previous business cycles. To put this into per-
spective, it is useful to compare the 1990reces-
sion with earlier business cycles.
The most recent recession began in July 1990,
and it ended in March 1991. Compared with past
recessions, the initial decline in economic activ-
ity was relatively mild (see, for example, Trehan
1992). What has been disturbing is the weakness
of the subsequent recovery (see Throop 1992).
My model suggests a possible explanation,
namely, that the recovery has been weak because
the economy is operating near its long-run trend.
When the economy falls below its long-run path
it has a subsequent tendency to catch up. That
is, when output falls below trend, subsequent
output growth tends to be unusually high. The
1974-1975 and 1981-1982 recessions provide
dramatic examples. In the first quarter of 1975,
real output bottomed out at 9.4 percent below
trend. Over the next two years, output growth
averaged 4.8 percent per year, which is 70 per-
,
Per
Capita
GNP
1985 1990 1975 1965
P £" 't £"YP er ",api aun
Total and Long-Run Component
Thousands of
1992 dollars
20
19
18
17
16
15
14
13
12
LL.U1U..l.:oL...L.L.L..I.."I..L..............L..L.L.IiiiLLL..I.."I..LL.IllI..lL..L.L.l...............iLU.J 11
1955
The productivity slowdown
The chart shows that long-run growth was sub-
stantially higher in the first half of the period than
in the second. During the first half ofthe sample
(1955.Q1-1973.Q2), the average rate of trend
GNP growth was approximately 3.5 percent per
year. During the second half (1973.Q3-1991.Q4),
the average rate of trend growth fell to roughly
2.0 percent per year. The decline in long-run
growth has had a large cumulative effect. For ex-
ample, if the economy had sustained an average
growth rate of 3.5 percent through 1992, per
capita income would now be more than 20 per-
cent higher. In current dollars, this amounts to
almost $4,000 for each working age person.
Thus, to a great extent, the economy's current
malaise reflects the effects of an ongoing pro-
ductivity slowdown.cent higher than average. Similarly, after GNP
had bottomed out at 9.7 percent below trend in
the fourth quarter of 1982, output growth aver-
aged 5.5 percent per year over the next two
years, or more than twice the average growth
rate.
But recessions do not necessarily push the econ-
omy below trend. Roughly speaking, a recession
occurs when output declines for two (or more)
consecutive quarters. If the economy is well
above trend when output begins to fall, it may
end up near trend when the recession ends. In
this case, there will be no tendency to catch up.
While this scenario is somewhat unusual, it does
appear to fit the 1990 recession. According to my
model, the 1990 recession began when the econ-
omy was near the peak of the 1980s boom. Since
the fall in output was relatively mild, the economy
seems to have absorbed the recession without
falling belowtrend. Further, sinceoutputappeared
to beclose to trend when the recession ended. the
economy did not experience the "catch up" 'phe-
nomenon that followed earlier, deep recessions.
Instead, the economy seems to be experiencing
the slower trend growth that has become the norm
overthe lasttwentyyears, perhaps damped abitby
a gradual convergence to trend,
While these estimates are subject to sampling
error, it is possible to quantify the degree of un-
certainty aboutthe direction and size ofthe devia-
tion from trend. Monte Carlo simulations indicate
that there was an 86 percent chance the GNPwas
above trend at the end of 1991. Further, if GNP
was below trend at that time, it was probably only
sl ightly below. For example, the chance that the
economy was more than 2.5 percent below trend
was only 7.1 percent. Finally, the chance that the
1990 recession was as deep as the 1975 or 1982
contractions was only 2.4 percent.
Summary and implications
The recovery from the 1990 recession has been
disappointing. My model suggests that this is
due moreto slow growth in trend real GNPthan to
cyclical factors. This recession marked the end of
the large 1980s boom. The recovery has been slow
because the usual "catch up" phase did notoccur
and because trend growth has become slower.
One implication ofthis diagnosis is that growth is
likely to continue to be modest in the near term,
barring unforeseen shocks. Since the economy
seems to be near its trend path, businesspeople
and policymakers should not expect a recovery
like those following the 1975 or 1982 recessions.
A second implication concerns the nature of
unemployment. If the economy is operating near
its trend path, then unemployment must be pri-
marily structural rather than cyclical. As some
sectors expand and others shrink, workers who
lose jobs in shrinkingsectors mustfind newones in
expanding sectors. The reallocation process takes
time, since unemployed workers may have to
acquire new skills or move to new locations. For
example, many people who have lost jobs in bank-
ing, defense, or as a resultofcorporatedownsizing
expectto make career changes. There is also some
evidence that regional imbalances have been im-
portant. Cromwell and Trenholme (1992) report
that job losses in the recession were unusually
concentrated in two regions (the Northeast and
California) and that these regions have continued
to lose jobs in the recovery. If this diagnosis is
correct. the natural rate of unemolovmpnt hris
increas~d and will remain high ~ntiist;~~t~~al
reallocations are complete.
A third implication concerns the focus of policy-
makers. If our current woes are due primarily to a
long-term productivityslowdown, then short-term
monetary or fiscal policies are not likely to be
helpful. Such policies are useful mainly for sta-
bilizingthe business cycle, that is, for dampingthe
amplitude of short-term deviations from trend.
Mosteconomists believe thatthey have littleeffect
on long-term productivity growth. This suggests
that understanding the productivity slowdown
ought to be a priority for policymakers.
Timothy Cogley
Economist
References
Blanchard, Olivier, and Danny Quah. 1989. "The
Dynamic Effects of Aggregate Demand and Supply
Disturbances." American Economic Review
(September) pp. 655-673.
Cromwell, Brian, and Karen Trenholme. 1992.
"Where's the Recovery?" Federal Reserve Bank of
San Francisco Weekly Letter (November 27).
Throop, Adrian. 1992. "The Slow Recovery!' Federal
Reserve Bank of San Francisco Weekly Letter
(September 25).
Trehan, Bharat. 1992. "An Unprecedented Slow-
down?" Federal Reserve Bank of San Francisco
Weekly Letter (May 8).
Opinions expressed in this newsletter do not necessarily reflect the views of the management of the Federal Reserve Bank of
San Francisco, orofthe Board of Governors of the Federal Reserve System.
Editorial comments may be addressed to the editor or to the author.... Free copies of Federal Reserve publications can be
obtained from the Public Information Department, Federal Reserve Bank of San Francisco, P.O. Box 77Q2, San Francisco 94120.
Phone (415) 974-2246, Fax (415) 974-3341.. ~ t:r\ ·s~U1 ueaq,\as 41lM
? ~ Jaded pap,\oaJ ua pajulJd
OUt>6 'V) 'O:>SPUl!.I:1 Ul!S
lOLL xog 'O'd
O)SI)UOJj UOS
JO ~U08
aAJaSa~ IOJapaj
~uaw~Jodaa 4)JOaSa~
Index to Recent Issues of FRBSF Weekly Letter
DATE NUMBER TITLE AUTHOR
6/19
7/3
7/17
7/24
8/7
8/21
9/4
9/11
9/18
9/25
10/2
10/9
10/16
10/23
10/30
11/6
11/13
11/20
11/27
12/4
12/11
12/25
1/1
92-24
92-25
92-26
92-27
92-28
92-29
92-30
92-31
92-32
92-33
92-34
92-35
92-36
92-37
92-38
92-39
92-40
92-41
92-42
92-43
92-44
92-45
93-01
Perspective on California
Commercial Aerospace: Risks and Prospects
Low Inflation and Central Bank Independence
First Quarter Results: Good News, Bad News
Are Big U.s. Banks Big Enough?
What's Happening to Southern California?
Money, Credit, and M2
Pegging, Floating, and Price Stability: Lessons from Taiwan
Budget Rules and Monetary Union in Europe
The Slow Recovery
Ejido Reform and the NAFTA
The Dollar: Short-Run Volatility and Long-Run Adjustment
The European Currency Crisis
Southern California Banking Blues
Would a New Monetary Aggregate Improve Policy?
Interest Rate Risk and Bank Capital Standards
NAFTA and u.s. Banking
A Note of Caution on Early Bank Closure
Where's the Recovery?
Diamonds and Water: A Paradox Revisited
Sluggish Money Growth: Japan's Recent Experience
Labor MarketStructure and Monetary Policy
An Alternative Strategy for Monetary Policy
Sherwood-Call
Cromwell
Parry
Trenholme/Neuberger
Furlong
Sherwood-Call
JuddlTrehan
Moreno
Glick/Hutchison
Throop
Schmidt/Gruben
Throop
Glick/Hutchison
Zimmerman
Motley
Neuberger
Laderman/Moreno
Levonian
CromwelllTrenholme
Schmidt
Moreno/Kim
Huh
Motley/judd
The FRBSF Weekly Letter appears on an abbreviated schedule in june, july, August, and December,

974-2246, Fax (415) 974-3341.. ~ t:r\ ·s~U1 ueaq,\as 41lM ? ~ Jaded pap,\oaJ ua pajulJd OUt>6 'V) 'O:>SPUl!.I:1 Ul!S lOLL xog 'O'd O)SI)UOJj UOS JO ~U08 aAJaSa~ IOJapaj ~uaw~Jodaa 4)JOaSa~ Index to Recent Issues of FRBSF Weekly Letter

The recession, the recovery, and the productivity slowdown

Abstract

Similar works

Full text

Available Versions

Research Papers in Economics