TR Monitor

The next decade: “scars” or technological advances

GUNDUZ FINDIKCIOGLU CHIEF ECONOMIST

ARE WE ON THE FASTɓTRACK towards something, and if so, what? The IMF talked about post-pandemic economic “scars” for an entire year. Everyone thinks labor has been displaced, supply chains broken, energy and other input costs have gone up, and so on. Food prices are on the rise and the FA• posted that real food prices are almost on par with the early 1970s – the first oil shock. That is the second highest in the whole global food price index series. Inflation is soaring although which inflation is arguably imprecise. Everyone is about to become a “Fed watcher”, as was the case in 2013. But technological improvement, the enlightened economy, the gifts of Athena, and TFP (total factor productivity) growth can be entirely different matters to such an extent that the period between 1929 and 1941 – yes the Great Depression - was possibly the most technologically-advanced decade. Let’s look into this a bit more. How did a deep recession become the seedbed of a technological jumpstart?

REAL BUSINESS CYCLES ̜RBC̝

RBC theorists follow in Lucas’ footsteps by arguing that the central purpose of a theory of the economic cycle is not to explain the origin of a particular business cycle, but rather to make the artificial, modelled economy reproduce the actual behavior of a real-world economy. Indeed, if any economic cycle starts with an exogenous shock, studying the specific characteristic

of this shock serves little purpose for the task of elaborating a general theory of the business cycle. It is much more important to understand the regularities that will ensue after the shock occurs. RBC theoreticians build models in the Solow-Ramsey tradition, modified to allow for stochastic shocks that hit the economy at random. Any stochastic shock of this nature is called an “impulse mechanism” of the business cycle. The typical impulse mechanism considered in standard RBC models is a technological shock, represented as an autoregressive stochastic shock on total factor productivity (TFP). TFP is a parameter of the production function, which embodies a broad concept of efficiency in combining inputs to obtain outputs.

COLE AND OHANIAN

The RBC interpretation of the U.S. Great Depression stems from the work of two leading authors, Harold Cole and Lee •hanian. Cole and •hanian’s early work is mainly negating, consisting of showing that earlier explanations are unsatisfactory. In their 1999 paper, the authors start by describing the behavior of the main de-trended macroeconomic aggregates from 1929-1939. They tried to single out, among the many different explanations in the literature, the models which best fit these data. Cole and •hanian (1999) found that stochastic shocks to the growth rate of the TFP could explain roughly 40% of the 1929-1932 drop in output. An interesting point, highlighted later by •hanian (2002), is that the drop in measured TFP during the Great Depression, although not sufficient to reproduce in the model the magnitude of the decline in output, was still relatively high when compared with the drops in measured TFP that normally accompanied recessions in the post-World War II period. This feature means that the behavior of TFP during the 1930s was peculiar, in that some of the specific reasons had still to be discovered.

TECHNOLOGICAL INNOVATIONS PEAKED

The post- Great Depression boom accompanied by spectacular technological advances was attributed to wartime expenditures. Accordingly, there were huge military and other public expenditures which sparked technological innovations, which in turn spilled over to civilian sectors in the 1950s. This is the view of Ken Arrow, for instance. But there are alternatives to this narrative. Although Cole & •hanian’s 1999 measurement is kind of problematic because

1937 was chosen as the base year, the RBC approach told us one crucial thing: shocks to technological innovations matter. Alexander Field (2003, 2006) showed how technology was developing behind the scenes. •n the scene there were bankruptcies, unemployment, and personal tragedies. Behind all these, petrochemicals, synthetic rubber, aeronautics, electrical devices, electronics, electricity generation, civil engineering, transportation and communication were all experiencing revolutionary changes. This view is backed by Alexopoulos & Cohen (2009). They rely on new sources that could represent technical advances and claim that there is a relationship between technological innovations and the great Depression. In particular, the upturn – after 1934 - was predicated on technological innovations that had been occurring since the late 1920s. The overall TFP growth between 1929 and 1941 was the highest in the entire 20th century.

SHOCKS, PAST AND PRESENT

Let’s consider 1929 as a vehicle of what I will try to say about today. Traditionally economists tended to consider the Great Depression as starting with the stock market crash of 1929 and ending with the election of Roosevelt in the 1933. Had the Great Depression been a normal business cycle, it should have ended much earlier than it actually did. •nce the effects of the negative TFP shock were exhausted, the economy should have recovered its steady-state growth path. In Cole and •hanian’s (1999) simulations, output should have recovered its trend level by 1936, if the measured shocks to TFP in the 1930s had been the sole “impulse mechanism” for the economic cycle. The TFP was back to its trend level in that year. However de-trended data show that in 1939 output was still a good 25% below its trend level.

WAS THE 1929 STOCK EXCHANGE CRASH EXOGENOUS JUST AS COVID IS TODAY?

There may in fact be a very important link between the stock market crash and the acceleration of the decline in real output in late 1929 and throughout much of 1930. That link is that the stock market crash caused consumers to become temporarily uncertain about future income. As a result, they chose to delay current spending on durable goods as they waited for further information about the likely course of economic activity. This decline in spending then drove down aggregate income through a standard Keynesian mechanism or, conceivably, through effects on the real interest rate and the supply of labor. Also, as Bernanke showed two decades ago, even a temporary increase in uncertainty can cause an immediate drop in investment spending. The explanation for the fall in real output in the year following the Great Crash is particularly useful because 1930 is arguably the most puzzling year.

MONETARY POLICY ERRORS PROLONGED THE RECESSION BACK THEN

There are monetary explanations for both the mild downturn in the summer of 1929 – see Hamilton [1987] - and for the severe collapse in late 1931 - see Friedman and Schwartz [1963]. Hamilton, for example, notes that the fact “that short term risk-free rates fell like a rock after 1929 reinforces the view that something besides high interest rates was leading the economy ever deeper into depression in 1930” (Hamilton, 1987: 168). Sometimes, recessions are recessions because they are what they are, not because rates were high or the public sector didn’t spend enough beforehand, etc. What starts with a spark, as a stock market collapse or as a CDS rise, can trigger long-lasting real sector developments if the economy itself is structurally weak already, and/or fragile. The monetary policy upturn in 1936 proved to be wrong. It was too early to raise interest rates. The Fed knew this and acted accordingly after 2008. It is likely to act in the same vein in 2022 as well.

SCARS OR SIGNS OF TECHNOLOGICAL CHANGE?

This is an early example of what the IMF has lately called “scarring ”. In other words, “scarring ” took a decade back then. Now it is expected to last three years. The observation that the recovery failed to happen in the mid1930s led Cole and •hanian to argue that the Great Depression was not only the result of a temporary shock that caused a fluctuation around the trend-growth path, but that it was probably the outcome of a mixture of a temporary shock with some other permanent shocks that caused the growth path itself to shift downward.

ANALYSIS

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2021-09-27T07:00:00.0000000Z

2021-09-27T07:00:00.0000000Z

https://trmonitor.pressreader.com/article/281973200804607

NASIL BIR EKONOMI MEDYA HABER BASIN A.S. (Turkey)