What Would a “Tight Money” Economic Recovery Look Like?

After most recessions the Fed allows above trend NGDP growth, to spur the recovery.  In the first quarter of the 1983-84 recovery NGDP rose at an 11% annual rate (7.7% real, 3.3% inflation.)  But suppose they kept money so tight that NGDP actually grew slower than trend?  What kind of recovery would we expect?

1. Contrary to what you might expect, we would expect a recovery.  Wage growth would gradually slow and unemployment would fall.  But the recovery would be far slower than normal.
2. Interest rates would stay very low, held down by both the slow NGDP growth and the low level of RGDP relative to trend.
3. During a recession highly cyclical industries such as housing and autos decline more sharply than overall GDP.  If the recovery was very slow, then over time the housing and auto industries would pickup due to growing population, and also the depreciation of cars.  You’d see RGDP growth move from services to autos and cars, but importantly the overall rate of RGDP growth would not be affected by this “rotation.”  Autos and housing growth would pick up, causing growth to slow in other sectors.  Recall that the Fed controls the overall increase in NGDP, not individual sectors of the economy.

And of course this is exactly what’s happened:

Federal Reserve Chairman Ben S. Bernanke has something to tout before Congress in hearings this week: job growth in the auto and housing industries.

Consumers rely on loans to buy cars and homes, so these segments of the economy are among the most responsive to Bernanke’s strategy of holding interest rates low and pressing on with bond purchases of $85 billion a month.

“The rate-sensitive sectors, most notably housing and autos, are kicking into a higher gear,” said Mark Zandi, chief economist for Moody’s Analytics Inc. in West Chester, Pennsylvania. “This reflects the Fed’s aggressive monetary policy and resulting rock-bottom interest rates,” along with “working off the excesses of the boom and bubble.”

Bernanke and his colleagues on the Federal Open Market Committee have pledged to continue buying bonds until the labor market improves “substantially.” Climbing employment in construction and vehicle manufacturing bolsters the case that asset purchases can help spur the improvement.

Zandi predicts total job growth this year of “close to 2 million,” about the same as last year.

“About the same as last year.”  Hmmm, doesn’t that undercut the argument that easy money is spurring a faster recovery?

For those who think housing is important, consider these data points:

January 2006:  Housing starts = 2.303,000  U = 4.7%

April 2008:  Housing starts = 1,008,000  U = 4.9%

December 2012:  Housing starts = 973,000  U = 7.8%

January 2013:  Housing starts  = 890,000   U = 7.9%

Yes, unemployment is high, but not because of housing.  It’s the NGDP, stupid.