Why America’s economy is no longer in the short run

27th September 2012

"I think there is good reason to think that the short run is over-it is short, after all."

"My first bit of evidence is corporate profits. They are at an all time high, around two-and-a-half times higher in nominal terms than they were during the late 1990s, our last real boom…If you think that unemployment is high because demand is low and therefore business isn't profitable, you are empirically mistaken. Business is very profitable, but it has learned to get by without as much labor. "

Indeed, The Economist's Ryan Avent says there are situations where a shortfall in demand should translate into low corporate profits-in particular, when sales fall rapidly before firms have had time to cut back on its operating expenses, including labour. However, "that need not always be the case," he writes. "Firms could be enjoying high profits simply because revenues have stabilised while costs are low, perhaps because low expectations for future nominal spending growth have discouraged investment."

But how is it that these profits can persist? Here, Avent thinks it's useful to think about the externality (the side effect or consequence of an industrial or commercial activity that affects other parties without this being reflected in the cost) of the demand shortfall:

"Larry Ball, Greg Mankiw, and David Romer have a discussion of it in a paper on New Keynesianism….When confronting a demand shortfall, they write, a firm may be indifferent as to whether it responds by adjusting prices or quantities, but there is a negative spillover effect when the choice is made across many firms to cut quantities."

Bryan Caplan, also picking up on Durado's point that corporate profits are at record highs, asks confusingly, "What is Dourado arguing?"

"If spending on output rises back towards (or all the way to) the trend of the Great Moderation, all that would happen is that profits would rise while production would remain on its current low growth path?   For profits to rise with no added growth in output, firms would need to respond to the added sales solely by raising their prices (more quickly.) If profits are to rise, their costs can't rise as quickly, which could occur because their debt service costs don't rise.  And, of course, wages might stay on their current growth path too."

Moreover, he says, increased productivity doesn't require reduced employment:

"If firms have figured out ways to produce a given level of output with less labor, this just suggests that real demand needs to increase even more."

Update: Here is Eli Dourado's point by point response to his critics. He argues that none of his critics seem willing to make any sort of broadly falsifiable claim about how long the short run lasts.

Update 2: There's more economic cat fighting as Ryan Avent responds to Dourado's response: "I have to say I find his dismissal of much of the criticism unduly breezy," Avent writes.


More on Mindful Money:

New Statesman fails macroeconomics 101

How will QE3 effect ‘too big to fail’ banks?

Is the US set to jump off a fiscal cliff?

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The Financialist

28 thoughts on “Why America’s economy is no longer in the short run”

  1. anteos says:

    great article as always Shaun.

    I’d read about the imputed rent con trick a while ago, and it astounded me. Its almost 10% of GDP now. Is it true that it constantly goes up, even when we had the HPC in 2009?


    1. Anonymous says:

      Agreed. I’d love to see a graph with:

      pre-calculation imputed rent
      post-calculation imputed rent

      Yet again this calculation locks the UK into the perverse situation where rent goes up, people have less money and we are told it’s growth.

      We have to break the cycle of more expensive living costs being a “good thing”.

      1. forbin says:

        no no no , today’s methods mean an increase in tax , be it VAT or income tax , will increase GDP !

        its all good! the headline rate goes up and the politicos and all break their arms patting themselves on their backs…….

        Today Mini Tru announced an increase in the chocolate allowance from 4 ounces to 2 !

        1984 here we come…..


        1. Anonymous says:

          How do you work that out? Tax rises dampen demand and are usually neutral to negative in terms of GDP… Aren’t they?

          1. forbin says:

            its the logic they use – if a rise in rents produces GDP growth then surely a rise in taxes will do the same

            …. and everyone else has got it wrong……. ( I was trying to make a joke πŸ˜‰ )


      2. Anonymous says:

        Higher rent is a good thing for the landowners and BTL brigade.

        1. Anonymous says:

          Yes, I really don’t think the UK ever fully removed the shackles of feudal days. It’s pretty sad that the population unflinchingly accept it all.

          The only time they become animated is when stepping on the heads of the young via perceived house price gains. If some are born to rule, I’m sorry to say that Brits are born to be ruled.

          1. Anonymous says:

            Oil wealth has made many Brits “comfortably numb” over the past 30 years.

            British workers are fairly productive and Britain has some world class products to sell. With courageous politicians making tough decisions – only modest reductions in the standard of living are needed, but sadly our current leaders are unwilling to level with us and face the music – it’s easier to pretend there is no problem while leading us down the path to debt penury.

          2. Anonymous says:

            I disagree. Politcians of all sides know that if they say no to the electorate they will not be in office to enact their policies.

            The electorate are always ok with cutting *something* so long as it doesn’t effect *them*. Brits are numbskulls rather than comforably numb!

            The only ones I have any sympathy for are the young. Soaked in advertising after generations have failed to stop the proliferation of corporations sending signals 24*7, mired in debt and told that it will all add up once they get a degree. Nothing could be further from the truth. They are being farmed.

    2. Anonymous says:

      Hi Anteos

      There was no dip in this series in 2009 in fact I have just scanned the whole data set back to 1963 and it looks as though there has never been a dip! Curiouser and curiouser….

  2. Joe says:

    It sounds like GDP should be presented as a range, say -0.2 to +0.8, which is then maybe refined over time to 0.0 to +0.6? If we said 0.3 plus or minus 0.5% then the media would just report the 0.3, but if presented as a range, I find it unlikely that they’d take the effort to try and reduce it to one number.

    1. Anonymous says:

      Hi Joe

      That would be vastly better system which would be more accurate and realistic. It would of course be a lot less media friendly and less open to spinning by politicians (and some economists..) but I think it would make the wider public aware of the uncertainty and doubt.

  3. pavlaki says:

    Having run a region where fairly accurate figures were submitted from a number of factories and sales organisations I still believed that our final consolidated figures were accurate ‘within a range’. I have therefore always taken countries GDP figures as an indicator and not a precise measure of growth as there is just no way that an entire country could be accurate to a decimal place! The interesting thing is that Britain’s figures are almost always revised up whilst the Eurozones are revised down. Psychology at work or spin?

    1. forbin says:

      I think Shaun is pointing out we’re changing to international standards

      so in future we’ll be like the others – rounding down

      theres also the hidden critique that we’re abandoning best in class to go for middle of the road reporting or maybe worse .

      I for one would like for once for our figures and reporting to be setting the standards , instead we go for cheap – well what else can we call it ?


      PS: yes we can call it below accurate …. πŸ˜‰

      PPS: yes I have always thought we report an absolute figure when all such accounting has bands of range – ie 0.0 +- 10%

  4. Mike from Enfield says:

    My brain is still reeling a little after reading that but, if I’ve got this right, my patriotic duty would be to:

    1. completely abandon any future house maintenance unless I could be certain that it would generate a larger increase in un-realised rental income

    2. spend all my disposable income on booze, fags & petrol (all of which are highly taxed)

    …as both would raise GDP and, by extension, well-being!

    1. Anonymous says:

      Hi Mike

      Actually how much house maintenance you do is irrelevant unless you are part of the survey undertaken.

      “Previous estimates of maintenance and repairs by owner-occupiers were based on a historic percentage. From Blue Book 2013, estimates are more precise. They are now based on expenditure
      patterns for the relevant quarter, taken from ONS’s Living Costs and Food (LCF) survey.”

      To be fair to the ONS at least they are trying to get this right but the old “historic percentage” system seems a bit like sticking a finger in the air.

      1. Russell says:

        I would just ask B and Q to keep some anonymised records on certain maintenance products….

  5. david says:

    Link to that news story I mentioned last night.

    1. Anonymous says:

      Hi David and thanks

      For those wondering about this then the issue at hand is why has this new story not come to wider prominence?

      “Riots in the northwestern region of Xinjiang have left 27 people dead,”

  6. Robert S says:


    I used to think highly of the ONS, but your articles and their quotes, have turned my opinions 180 degrees. They are either employ total fools and/or are highly polticised and I can’t believe a thing that they say. Admittedly I never read their reports, so I don’t know if they say this, but when a polling firm issues polling data, they always give a margin of error. So where you quote them, “GDP growth between Q4 2011 and Q1 2012 has been revised from a fall of 0.1% to flat…”, I’m sorry but I do not believe that for a minute as it’s well within a margin of error. And how dare they state, “…thereby removing the phenomenon of two consecutive quarts of negative growth.”, when they’re statisticians and should not be making such provocative statements.

    I apologise for such harsh words, but when things stoke my fire I feel compelled to write. And keep up the excellent anaylsis, please!


    1. Anonymous says:

      Hi Robert

      I do have some sympathy for the ONS over the subject of the “double-dip” as I would imagine that the pressure from the government on this point would have been immense.

  7. Rods says:

    Hi Shaun,

    Another good blog.

    Another area where the new up is really down!

    Manipulation by Governments to get the statistical results and sound bites they want, is these days the norm and seems to be getting worse.

    Unfortunately, for the politicians, reality will intervene at some point, like it did in the USSR. I think the only real measure at the moment is the size of the Government’s annual deficit, although last year they tried to make the new down as up, again manipulation and spin over reality.

    1. Anonymous says:

      Osbourne is as bad as Brown. I see him as a man bailing out buckets of reality from his sinking ship with a spoon.

  8. JW says:

    Hi Shaun

    As we have discussed before, ‘official’ statistics have now been manipulated, smoothed and weather corrected to such an extent that they are now just used to convey any ‘message’ desired by our ‘masters’.

    Our feeling of wellbeing is best measured by our psychological condition. Do we feel our jobs are secure? Do we think our children’s future are secure? Do we think our ‘wealth’ is secure? Do we think our health is secure? Do the uncertainties in our society make these easier or harder questions to answer?

    Also our society depends on electricity to work. Today its announced the probability of black-outs by 2015/6 has increased to 25%. As this depends on the completely impossible energy demand reductions forecast by NGC being attained, its more likely there is a 50% chance. To try to alleviate this the govt is talking about reintroducing incentives for large industry to reduce load last seen in the days of the ‘Bulk Supply Tariff’. I am vividly reminded of the 1970s.

    The Emperor has no clothes!

    1. Anonymous says:

      Hi JW

      I am old enough to remember my family stockpiling candles etc. in the three day week era of the 1970s when there were power cuts. If we end up back in the same situation it will be entirely due to the negligence of the UK’ s political class which has balked at doing anything about this. I recall discussing a decade ago that we needed to plan replacements for maturing power stations but the decisions were delayed or not taken. Over this period all 3 parties have been in power in some form.

      Instead we have had expensive vanity projects involving wind power. I have nothing against wind power but it requires a back up for when it does not blow so will only ever be a partial answer that is currently very expensive.

      One thought for you though finally we have found a silver lining in the cloud of the credit crunch! As without it UK energy demand would be higher and perhaps blackouts might have come with this springs cold snap.

      1. JW says:

        No Shaun, wind and solar power are completely useless expensive ‘cons’ on the population. We should never be retiring perfectly useable coal and gas-fired stations. The economic problems have had little effect on demand.

        Some things are beyond the control of politicians, this isn’t, its absolute sheer incompetence.

        1. Anonymous says:

          Here is a story of solar power in Bulgaria that might make you laugh.

          A solar power generator was recently found to be daily selling 32 times his hourly maximum generating capacity. Investigations found he was buying electricity from the grid and selling it back as “green electricity” with a big mark up.

  9. Anonymous says:

    Hello, Shaun. Thank you for your summary of the UK National Accounts. I used to work on the Canadian System of National Accounts. As far as I know, it is the general practice to make GDP(E)=GDP(I). Statistics Canada and the US Bureau of Economic Analysis does so too.

    The US BEA doesn’t calculate GDP(P) and Statistics Canada calculates it at basic prices, while GDP(E) and GDP(I) are at market prices. Conceptually the estimates shouldn’t match and they don’t if only for this reason. So it does seem debatable at least whether the ONS should make volume GDP(E) and volume GDP(I) estimates match.

    Since Statistics Canada went to chain Fisher estimates there is also a quite unnecessary source of difference between the volume GDP(E) and volume GDP(P) estimates due to the former being calculated with quarterly links and the latter with annual links. This seems to have been avoided by the ONS, where, as I understand it, both volume GDP(E) and volume GDP(P) estimates are calculated using the chain Laspeyres formula with annual links.

    That being said, considerable efforts are made to ensure that volume GDP(P) and volume GDP(E) estimates tell pretty much the same story. The GDP(E) estimates have always been the headline estimates for volume GDP in Canada, whether they deserve to be or not.

    Any Canadian user of the SNA data who doesn’t believe in reconciliation of the volume estimates could calculate the official volume GDP(E) estimates excluding the statistical discrepancy if they wanted using the old constant price series, which were additive. The chain Fisher estimates are non-additive, so this is no longer possible, and StatCan does not publish an aggregate for GDP(E) excluding the statistical discrepancy as it might have done. This would allow someone who was interested to also calculate a volume GDP(I) estimate excluding the statistical discrepancy. It really is a shame. Not every user likes things simple, and it is useful to be reminded, as you have done, that the National Accounts are actually fairly complicated.

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