Why Macro Isn’t Macro

The obsession today besides Gangnam Style and kimchi hotdogs is figuring out why the US economy does not operate on all cylinders. Many of us have been moaning about too much stimulus from the Fed and the government. Others defend stimulus as if it came down from a mountain on a stone tablet. It occurred to me that there is another way to explain why monetary and fiscal stimuli are at once ineffective, impotent, and wasteful. No I am not talking about any of my relatives.

The problem is that macro isn’t always macro. If you apply a macro remedy to a non-macro problem then you are not heading in the right direction. Sort of like having a heart problem and the doctor takes out your liver. It doesn’t make much sense right?

So let’s dig into what macro means – macroeconomics that is. No offense to macrobiology or macrobiotics or macrophilia. Let’s use an example. Suppose we have an athletic team with 5 members who average 150 pounds (for you non-Americans that’s roughly 700 kilos). One of the team members quits and is replaced by a new team member who weighs 300 pounds. If the guy who left weighed near the average it is pretty obvious from my exciting and colorful example that the average weight of the team has now increased substantially. So the coach weighs the team and exclaims – “this team weighs too much – we must do something about it.” So the coach tells each player to lose 30 pounds. Does that make sense? If the entire reason the team weighs more is because of this one new player – why don’t you do something about that? Just fire that player and hire one that weighs 150 pounds. That sounds more logical – the coach has confused the average weight of the team with the reason the team got heavier.

This example is making me hungry. So let’s get back to macroeconomics. The economy of any country is incredibly complex. One day you buy a house the next day you buy a bottle of JD. One day you buy a roundtrip ticket to Ellettsville and the next day you buy a JD with Coke at the Uptown Cafe. One day you receive a stock dividend from the Jack Daniels Company. Aside from JD the economy produces a lot of different things. When someone asks how the economy is doing – we don’t spend hours describing the changing outputs of each and every one of these things. We usually refer instead to how much is left in your gallon bottle of JD. No – that is silly. You call up your friendly macroeconomist and say – Larry what is going on with GDP? You see, Gross Domestic Product is a measure of how much stuff (stuff is a very technical term I use in graduate macro classes to define all the crap measured in GDP) a country produces.

GDP is macro! In 2011 USA GDP totaled about $15 trillion. Imagine all that stuff piled up in front of you. If GDP increases to $16 trillion in 2012 then we will say something like – Holy Smokes Petula – our nation produced more in 2012 than 2011. Let’s celebrate with a little JD. We say this because you actually know someone named Petula and because you identify a nation’s output  as GDP. You then start imagining about all the wonderful things that we produced – more t-shirts that say dumb things, a bigger harvest of tomatoes, more automatic weapons, a bunch of cool tattoos, and on and on. You can imagine the quantities of most things we buy increasing more or less in proportion to GDP’s increase.

But the truth is that the increases and decreases are not usually so equally proportioned among the different kinds of goods and services. The truth is that in some years much of the increase is services to consumers. In another year much of the increase is computers and other equipment used by businesses. This is normal. But in some years the changes can be VERY unequal. Imagine in one year that all of the $1 trillion increase was JD. Or instead the entire increase came from Viagra. You see what I mean? Your interpretation of what is happening to national output might not be correct. If you don’t approve of Tennessee sour mash or little blue pills, then upon learning that the increase in GDP of $1 trillion was all bottles of JD or Viagra, you might be less approving. You might worry about the producers of all those other goods and services. The $1 trillion increase might not look so beneficial.

This is very much what is happening in the USA now. The situation now has to do with the less-than-spectacular performance of the national economy. I put some numbers together below to try to convince you that the performance of the national economy or the changes in GDP have been dominated by one or two parts of the overall economy. Mistaking the problem of a few sectors as a national or macro problem is like worrying in the above example that the average weight of the team is too high. Yes the weight was too high but not because each team member was too heavy. The remedy should fit the problem. If the problem with GDP is focused in a few sectors, then broad brush fiscal and monetary policies that are meant to revive the entire economy are going to be inefficient and impotent.

So let me turn to the actual numbers. These numbers are the published figures for real GDP for the USA – where real means that the impact of inflation has been removed and the numbers reflect only output or volume changes. These are standard numbers published by the Bureau of Economic Analysis at www.bea.gov

The last US recession started at the beginning of 2008 and lasted for most of two years – 2008 and 2009. Real GDP contracted at a rate of about -1.7% per year. In the two years that followed the recession the economy recovered growing at an average rate (over 2010 and 2011) of about 2.1% per year. The economy seems to be growing at a slower pace than that in 2012. So over three years of recovery let’s suppose the annual growth rate turns out to be a little less than 2%. People look at that number and compare it to past recoveries and find the current experience to be very disappointing. The slow employment growth and stubbornly high unemployment rate support this disappointment.

This disappointment leads our policymakers to want to raise the amount of stimulus. They want to spur on spending in the national economy. They lament middle class people who are unable to buy enough goods and service. They worry about teachers and police who cannot buy enough and therefore firms do not produce more. But this is a very misleading picture. What I do below is compare the growth rates of major national spending categories during the two years of the recovery (2010 and 2011) to the growth rates prevailing in the two years prior to the beginning of the recession (2006 and 2007):

           

                                    Annual Average Growth Rate

                                          2006-2007      2010-2011
Consumer Durable goods           4.8                   6.4
Consumer Non-durable goods    2.3                   2.3
Consumer Services                     2.3                   1.5

Business Equipment                    5.5                10.0

Exports                                      9.2                   8.9

Imports                                      4.3                   8.7
Federal government defense       1.9                 0.2

Federal government non-defense 1.2                2.3

State and local government         1.2                2.6                

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From the above table it is not easy to see why the macro economy is stalling. Many of these categories are growing stronger after than before the recession started. While it is true that state and local government, federal defense spending, and consumer services have not helped, take a gander at the two categories I purposely left out:

                              Annual Average Growth Rate

                              2006-2007             2010-2011

Business structures       11.8                     -6.5

Residential investment -13.0                     -2.6

These two categories of real GDP comprise the real estate part of national output. With respect to business structures we see a very strong pre-recession sector that has still not turned positive. Focusing on the demand for new houses for families we see that the problems started well before the recession. If there is a sector that appears to be the leading indicator or the cause of what was to come – it is residential investment. It was contracting at double-digit rates BEFORE the recession started – and it continues to contract.

It is true that we had a national recession in the US during 2008 and 2009. But as we look at the past 6 years and try to decide on policy in 2012 and 2013 – it seems pretty clear that we do not have a macro problem today. The recession started with real estate and it ended with real estate. And real estate continues to plague us.  Most of the other categories are growing plus or minus at about their pre-recession rates. As such this is not the time for general stimulus – a policy aimed at expanding spending in all categories of spending would be both wasteful and dangerous. Why stimulate sectors that have recovered?

If real estate is really the issue, then why don’t policymakers focus their policy energy on the real issue? Maybe I should leave it there. The current policies are tantamount to making all the players on the team lose 30 pounds. What do you think? These policymakers have access to this same data. Why do they waste our time and money on policies that won’t work? Why don’t they spend more time dealing with what actually caused our current mess?