More Evidence on What Is Holding the Economy Back

Milton Friedman’s “plucking model” should be back in fashion now because it reminds us of the historical fact that throughout American history—until now—the deeper the recession, the faster the recovery. I like to bring a guitar to talks and lectures to illustrate this: Like a guitar string, when the economy is “plucked” down or pulled down, the “string” or the economy always springs back up. The more the economy is “plucked” down, the faster it springs back up. This has been true throughout recorded American history, and it holds whether or not there has been a financial crisis. Here is a link where you can find Hoover Institution Working Paper E-88-48 in which Friedman described the model. (He also envisioned a board on top of the guitar string to prevent a reverse action on the upside, which he argued was not in the data).

Of course something is now interfering with the usual economic response, because our current recovery is certainly not springing back to normal. I have argued that economic policy is holding the economy back, and I think recent research by Ellen McGrattan and Ed Prescott (on increased regulations) and by Scott Baker, Nick Bloom, and Steve Davis (on policy uncertainty) supports this view. Their work is part of a forthcoming book (Government Policy and the Delayed Economic Recovery) edited by Lee Ohanian, Ian Wright and me.

Here are two charts which show why both increased regulation and policy uncertainty are very significant. The first chart uses data from research by Susan Dudley and Melinda Warren. It takes their series on the number of “full time equivalent” federal employees in regulatory activities and subtracts out the number of Transportation Safety Administration (TSA) workers. (I interpolated the years 2002 and 2003 when TSA was expanding and moving from DOT to DHS). There has been a 25 percent increase just since 2007. And these data barely reflect the increased regulations from the health care and financial reform legislation.

The second chart shows the number of provisions in the tax code that are expiring each year. This is part of an index used by Baker, Bloom, and Davis. It shows a substantial increase in the past few years in policy uncertainty.

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About John B. Taylor 117 Articles

Affiliation: Stanford University

John B. Taylor is the Mary and Robert Raymond Professor of Economics at Stanford University and the Bowen H. and Janice Arthur McCoy Senior Fellow at the Hoover Institution. He formerly served as the director of the Stanford Institute for Economic Policy Research, where he is now a senior fellow, and he was founding director of Stanford's Introductory Economics Center.

Taylor’s academic fields of expertise are macroeconomics, monetary economics, and international economics. He is known for his research on the foundations of modern monetary theory and policy, which has been applied by central banks and financial market analysts around the world. He has an active interest in public policy. Taylor is currently a member of the California Governor's Council of Economic Advisors, where he also previously served from 1996 to 1998. In the past, he served as senior economist on the President's Council of Economic Advisers from 1976 to 1977, as a member of the President's Council of Economic Advisers from 1989 to 1991. He was also a member of the Congressional Budget Office's Panel of Economic Advisers from 1995 to 2001.

For four years from 2001 to 2005, Taylor served as Under Secretary of Treasury for International Affairs where he was responsible for U.S. policies in international finance, which includes currency markets, trade in financial services, foreign investment, international debt and development, and oversight of the International Monetary Fund and the World Bank. He was also responsible for coordinating financial policy with the G-7 countries, was chair of the working party on international macroeconomics at the OECD, and was a member of the Board of the Overseas Private Investment Corporation. His book Global Financial Warriors: The Untold Story of International Finance in the Post-9/11 World chronicles his years as head of the international division at Treasury.

Taylor was awarded the Alexander Hamilton Award for his overall leadership in international finance at the U.S. Treasury. He was also awarded the Treasury Distinguished Service Award for designing and implementing the currency reforms in Iraq, and the Medal of the Republic of Uruguay for his work in resolving the 2002 financial crisis. In 2005, he was awarded the George P. Shultz Distinguished Public Service Award. Taylor has also won many teaching awards; he was awarded the Hoagland Prize for excellence in undergraduate teaching and the Rhodes Prize for his high teaching ratings in Stanford's introductory economics course. He also received a Guggenheim Fellowship for his research, and he is a fellow of the American Academy of Arts and Sciences and the Econometric Society; he formerly served as vice president of the American Economic Association.

Before joining the Stanford faculty in 1984, Taylor held positions as professor of economics at Princeton University and Columbia University. Taylor received a B.A. in economics summa cum laude from Princeton University in 1968 and a Ph.D. in economics from Stanford University in 1973.

Visit: John Taylor's Page, Blog

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