Why Has the US Economy Recovered So Consistently from Every Recession in the Past 70 Years?
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The US economy’s consistent recovery from recessions over the past 70 years is marked by a stable annual reduction in the unemployment rate, typically around one tenth of the current level of unemployment.
Robert Hall and Marianna Kudlyak, "Why Has the US Economy Recovered So Consistently from Every Recession in the Past 70 Years?" Federal Reserve Bank Of San Francisco, June 2021, https://www.frbsf.org/economic-research/files/wp2020-20.pdf
In terms of the LFP issue Ben noted, “…Variations in labor-force growth. The DMP model of Mortensen and Pissarides (1994) has a constant labor force. Extensions to endogenous participation may involve positive or negative co-movements of participation and unemployment. Figure 31 shows that participation rate grew during the years up to 1990 when the rising rate for women was a key factor for overall participation (to achieve a basic adjustment for demographic influences, the data refer to ages 25 through 54).In the recovery from the 2020 recession, participation was essentially unchanged. In the recovery from the 2007-09 recession, participation declined…”
To them this implies there are structural headwinds to increasing employment rapidly, they hypothesis (but don’t quantify) that it is a combination of negative feedback from unemployment to tightness, vacancy costs, recruiting process and externalities, composition effects, scarring effects, the separation rate act to bend employment recoveries into parallel paths, “…If employers find it potentially profitable, they will exert the same effort to lay on new workers if the unemployment rate is 10 percent or 4 percent—vacancy creation is infinitely elastic. Contagion may arise from the congestion that occurs in the recruiting process when employers are flooded with applicants. Or contagion may involve changes in the equilibrium search and recruiting strategies of job-seekers and employers that impede matching and lower the efficiency of the matching process. These modifications of the DMP model lower the elasticity of vacancy creation and slow down the rate of recovery of unemployment…We noted that part of the high level of unemployment soon after a crisis reflects a change in the composition of unemployment toward individuals with naturally lower job-finding rates. This is a source of lower matching efficiency, a decline in one of the DMP model’s driving forces. A related phenomenon is the lower incidence of on-the-job search when unemployment is high. Again, this is a source of lower matching efficiency….”
They establish that"...A remarkable fact about the historical US business cycle is that, after unemployment reached its peak in a recession, and a recovery begins, the annual reduction in the unemployment rate is stable at around one tenth of the current level of unemployment... Hall and Kudlyak (2020a), we study US business-cycle recoveries over the past 70 years. We focus on the unemployment rate. Our key results are (1) the recovery process takes place reliably, regardless of the nature of the shock that causes the preceding economic contraction, and (2) the recovery process is similar in all of the ten past recoveries—unemployment falls by about 0.1 log points per year. Figure 1 displays the log of the unemployment rate during the 10 recoveries since 1948, with the recession spells of sharply rising unemployment left blank. Throughout the paper we exclude the recovery from the pandemic recession that started in 2020. The key fact about recoveries is apparent in the figure: Unemployment declines smoothly but slowly throughout most recoveries most of the time, at close to the same proportional rate. In the log plot, the recoveries appear as impressively close to straight lines…”
Their takeaway, “…Why has the US economy recovered so consistently from every recession in the past 70 years? Our answer:Recoveries are endogenous—there is a natural force causing job-seekers to match with available jobs and to lower unemployment. The bulge of unemployment created by a crisis at the beginning of a recovery creates a negative feedback to labor market tightness, endogenously slowing the recovery…”
Ed Comment:“I thought I RSVP’ed to this when you sent it to me awhile back. I may have composed it in my head but then ran out of time to put it on paper, which I will do now. Their work may be sloppy, but I think it’s important because it refutes Keynesian economics, which has no natural recovery mechanism. Ben, you say recovery can be accelerated, but from what recovery baseline/model? Is there one? If so, what does it predict and why? My sense is there isn’t one. My own view is the following: The economy naturally expands to the private sector’s willingness and capacity to bear risk. Shocks largely reveal flawed allocations (of risk), often unidentified risk such as risks of terrorism, withdraw/liquidity risk, pandemic risk, etc. Equity (which underwrites risk) is destroyed in the process. Less equity causes less risk-taking. Risk-taking can grow as the economy better accesses the risk (i.e. comes to expect less risk than it initially expected). Risk-taking also grows as the economy creates or accumulates more equity. In part, the latter occurs naturally but often requires (is accelerated by) finding new resources allocations to replace old ones that now have lower/subpar expected risk-adjusted returns. Resources satisfying debt-fueled subprime consumption must be reallocated to other endeavors—restaurant work at lower wages than the counterfactual, which spurs increased demand, for example. Reallocations require experimentation by risk-taking entrepreneurs at a time when risk-taking constrains growth in recessions. Increased risk-taking also requires the risk-reducing good ideas of creative smart people, who are perennially in short supply. The pullback is exacerbated by my rodent in a hole (the private sector) who gradually travels further and further from its den in search of food when it encounters no risk, but then retreats to the den when it encounters risk before it gradually expands its search again from a more conservative range. The rodent may be systematically mistaken in its assessment of risk. Nevertheless, the underlying pattern of its behavior should be logically predictable. From my perspective, these are more logical explanations for both animal spirts and the predictable recovery pattern that Keynesian economics does not predict. I don’t believe the government can accelerate the recovery in practice. It merely misallocates resources at a time when the economy needs to search for new/more optimal allocations. That slows the reallocation of resources. It’s akin to cars in a traffic jam waiting to cross a bridge. You can get out of the line and drive the car faster. But the only thing that matters is whether you cross the bridge sooner. Theoretically, analysts could find the/a more optimal long-term allocation. But in practice, only random mutation and survival of the fittest can find them systematically.”
Ben Comment 2/2:I think the baseline depends very much on which model you believe in. Even in a fully Keynesian model the economy will *eventually* recover. In a real business cycle (RBC) model, government spending slows recovery. In a new Keynesian model it can speed recovery but we’re also talking about fully specified macro models so most of these will be solved numerically - so I wouldn’t take any of them as gospel in terms of how quickly the economy recovers after a shock.
Ben Comment 1/2:One thing worth highlighting, I think, is that they totally ignore changes in the labor market participation rate. I think this probably matters and discouraged workers (those no longer looking for a job) are not counted as unemployed.As the unemployed (active job seekers) find work, they are replaced by the non participants who start looking for jobs again. In my mind, the pull of a good labor market is likely as strong a reason for the job-finding rate to be higher than the declines in the unemployment rate. I’m not sure why they skip over this but it seems important when thinking about why the unemployment rate is change - there’s a numerator effect and a denominator effect. We have to tease ouch which one actually matters. Their conclusions about the effectiveness of policy are weird. Of course the economy has a “strong” self-correcting element. I don’t think anyone ever says “recovery is impossible without intervention.” Intervention is always about dampening the lows and speeding the recovery process - Koo’s debt overhang work gives a situation in which recovery will eventually happen but policy makes it faster and alleviates suffering among the populace. One of the quotes you pulled out discusses the composition of job seekers during a recession. As the recession goes on, lower match-propensity workers are left in the pool as higher match-propensity workers find matches. That’s sort of tautological. How does one become a high match-propensity worker? By finding jobs more quickly. I’m not really sure I see any reason this should be true. Bad luck could make you a low match-propensity worker as much as any sort of skill or productivity level (remember the Demings paper? The super talented are the worst hit!). I don’t know. DMP is a old model with a lot of flaws and there have been a lot of improvements on it since. I’m not really sure why Hall used this model as the basis of his analysis instead of something like Shimer’s model. It seems to me like he found a cool relic in the data (the similarities in recovery speeds) and wrote a paper around it without being particularly thoughtful.
We though you would want to take a closer look this research from Robert Hall and Marianna Kudlyak that finds that economic recoveries in the US largely mirror each other (note we looked at an earlier version of this last year at the start of the pandemic), "...we reach an important conclusion: the unemployment paths of the original job-losers are neither as high to begin with nor as persistent as the path of elevated unemployment in the wake of the crisis...."Note they exclude labor market correction associated with the pandemic from their evidence.