The Long Slump Robert E. Hall∗ Hoover Institution and Department of Economics, Stanford University National Bureau of Economic Research
[email protected]; website: Google “Bob Hall”
December 3, 2010
Abstract In a market-clearing economy, declines in demand from one sector do not cause large declines in aggregate output because other sectors expand. The key price mediating the response is the interest rate. A decline in the rate stimulates all categories of spending. But in a low-inflation economy, the room for a decline in the rate is small, because of the notorious lower bound of zero. I build a general-equilibrium model that focuses on the behavior of an economy when the nominal interest rate is pinned at zero. Equally important is that the real rate is pinned at a rate above the market-clearing rate because inflation responds only weakly to the presence of slack. I concentrate on three closely related sources of declines in demand: the buildup of excess stocks of housing and consumer durables, the corresponding expansion of debt that financed the buildup, and financial frictions that resulted from the decline in real-estate prices. The model characterizes rationing of customers in the output market when the interest rate is pinned at zero and connects the rationing to the labor market. It provides a coherent rationale for the common-sense notion that the reason that employers don’t hire all available workers during a slump is that they don’t have enough customers. I demonstrate the empirical relevance of the three driving forces.
∗
This paper provides background for my AEA presidential address, January 8, 2011, Sheraton Denver Downtown Hotel, 4:40 pm in the Grand Ballroom. I am grateful to Steven Davis, Mark Gertler, Robert Lucas, Richard Rogerson, David Romer, and Robert Shimer for comments.
1
98 97 96
Normal
95 94 93 92 91 90 89
Slump
Slump
Slump
Slump
88 87 1979
1982
1985
1988
1991
1994
1997
2000
2003
2006
2009
Figure 1: U.S. Unemployment Rate, 1980 through 2010
1
Introduction
At the beginning of 2011, the U.S. and many other economies are in slumps—employment is low and output is well below its growth track. The worst slump in U.S. history was the Great Depression, in which the economy contracted from 1929 to 1933 and failed to return to normal until the buildup for World War II. The slump that began with the recession at the end of 2007 will last for most of a decade, according to current forecasts. Figure 1 shows the employed fraction of the labor force aged 25 through 54 since the beginning of 1979 (the remaining fraction of the labor force is unemployed). Slumps are identified as periods when this measure of employment was less than its normal level since 1948 of 95.5 percent of the labor force. A slump begins with a contraction, usually fairly brief, at least in comparison to the extended period of slow growth that follows the contraction. Relative to the vocabulary of peaks and troughs, a slump lasts from the time when employment falls below its normal level during the contraction to the time when employment regains its normal level during an expansion. Thus a slump spans the trough date. Usually most of the slump occurs after the trough, during the period of inadequate but positive growth. Everybody but business-cycle
2
specialists uses the term recession to describe a slump. All departures from full employment seem hard to explain by standard economic principles. Whenever unemployment is above normal, job-seekers line up outside any employer who is hiring. By standard principles, employers ought to be able to make mutually beneficial deals with the unemployed. As they do so, unemployment should return to normal. The process shouldn’t
