Are We at the Start of a Recession?

On Thursday morning, April 28, the Bureau of Economic Analysis (BEA) released its “advance” estimate for the change in real GDP during the first quarter of 2022. As shown in the first line of the following table, somewhat surprisingly, the estimate showed that real GDP had declined by 1.4 percent during the first quarter. The Federal Reserve Bank of Atlanta’s “GDP Now” forecast had indicated that real GDP would increase by 0.4 percent in the first quarter. Earlier in April, the Wall Street Journal’s panel of academic, business, and financial economists had forecast an increase of 1.2 percent. (A subscription may be required to access the forecast data from the Wall Street Journal’s panel.)

Do the data on real GDP from the first quarter of 2022 mean that U.S. economy may already be in recession? Not necessarily, for several reasons:

First, as we note in the Apply the Concept, “Trying to Hit a Moving Target: Making Policy with ‘Real-Time’ Data,” in Macroeconomics, Chapter 15, Section 15.3 (Economics, Chapter 25, Section 25.3): “The GDP data the BEA provides are frequently revised, and the revisions can be large enough that the actual state of the economy can be different for what it at first appears to be.”

Second, even though business writers often define a recession as being at least two consecutive quarters of declining real GDP, the National Bureau of Economic Research has a broader definition: “A recession is a significant decline in activity across the economy, lasting more than a few months, visible in industrial production, employment, real income, and wholesale-retail trade.” Particularly given the volatile movements in real GDP during and after the pandemic, it’s possible that even if real GDP declines during the second quarter of 2022, the NBER might not decide to label the period as being a recession.

Third, and most importantly, there are indications in the underlying data that the U.S. economy performed better during the first quarter of 2022 than the estimate of declining real GDP would indicate. In a blog post in January discussing the BEA’s advance estimate of real GDP during the fourth quarter of 2021, we noted that the majority of the 6.9 percent increase in real GDP that quarter was attributable to inventory accumulation. The earlier table indicates that the same was true during the first quarter of 2022: 60 percent of the decline in real GDP during the quarter was the result of a 0.84 decline in inventory investment.

We don’t know whether the decline in inventories indicates that firms had trouble meeting demand for goods from current inventories or whether they decided to reverse some of the increases in inventories from the previous quarter. With supply chain disruptions continuing as China grapples with another wave of Covid-19, firms may be having difficulty gauging how easily they can replace goods sold from their current inventories. Note the corresponding point that the decline in sales of domestic product (line 2 in the table) was smaller than the decline in real GDP.

The table below shows changes in the components of real GDP. Note the very large decline exports and in purchases of goods and services by the federal government. (Recall from Macroeconomics, Chapter 16, Section 16.1, the distinction between government purchases of goods and services and total government expenditures, which include transfer payments.) The decline in federal defense spending was particularly large. It seems likely from media reports that the escalation of Russia’s invasion of Ukraine will lead Congress and President Biden to increase defense spending.

Notice also that increases in the non-government components of aggregate demand remained fairly strong: personal consumption expenditures increased 2.7 percent, gross private domestic investment increased 2.3 percent, and imports surged by 17.7 percent. These data indicate that private demand in the U.S. economy remains strong.

So, should we conclude that the economy will shrug off the decline in real GDP during the first quarter and expand during the remainder of the year? Unfortunately, there are still clouds on the horizon. First, there are the difficult to predict effects of continuing supply chain problems and of the war in Ukraine. Second, the Federal Reserve has begun tightening monetary policy. Whether Fed Chair Jerome Powell will be able to bring about a soft landing, slowing inflation significantly while not causing a large jump in unemployment, remains the great unknown of economic policy. Finally, if high inflation rates persist, households and firms may respond in ways that are difficult to predict and, may, in particular decide to reduce their spending from the current strong levels.

In short, the macroeconomic forecast is cloudy!

Source: The BEA’s web site can be found here.

Glenn on Economic Growth and Its Social Consequences

Adam Smith bronze statue on Royal Mile Market square in front of Saint Gilles Cathedral in Edinburgh, Scotland.

Growth matters. A lot. A slightly higher rate of economic growth, sustained over time, can make the difference between a big increase in living standards and relative stagnation. Whether we can still generate strong and steady growth is a “$64,000 question” for the economy — the question. Nobel Prize–winning economist Robert Lucas famously observed that once economists think of long-term growth, it is hard to think of anything else. A pro-growth policy agenda is a good idea because growth is a good idea.

But a deeper question remains: Is public support for growth guaranteed? Oren Cass of American Compass refers to growth and economists’ fealty to economic participation for all as “economic piety.” This critique resonates for a simple reason: Forces that propel growth invariably leave a wake of economic disruption for people in many places and political disruption for the nation. A serious discussion of pro-growth policy must account for that disruption.

A conventional pro-growth policy agenda can be enhanced by support for openness to markets, ideas, and new ways of doing things, and for the ability of firms to adapt to change. Such an enhanced agenda would center on infrastructure broadly defined, development and dissemination of better management practices, and reduced barriers to competition.

Yet the political process, and even many a conservative, is openly skeptical of such an agenda. This skepticism is rooted not in disagreement over the future of scientific advances or of organizational adaptation — but in a concern that growth’s benefits be shared broadly. Addressing this skepticism head-on is essential for rebuilding social support for growth and for countering well-meaning but potentially harmful policies.

The system that needs defending is a mature and successful one. Adam Smith, the great proponent of the “invisible hand” (not the visible hand of a state-directed economy), saw openness and competition as worth the candle. His 1776 publication of The Wealth of Nations came before what we would recognize today as industrial capitalism, though technological change and globalization were features of economic debates in the aftermath of Smith’s ideas.

Smith’s radical insight is central to economic policy today: National prosperity (the “wealth of a nation”) is represented by consumption of goods and services by its people — i.e., their living standards. The goal of the economy in Smith’s telling was to make the economic pie as large as possible. His advocacy of free markets and competition rested on their ability to boost consumption possibilities.

Two centuries later, Nobel laureates Kenneth Arrow and Gérard Debreu added the jargon and mathematics of contemporary economics to formalize Smith’s intuition. While individuals and firms act independently, competitive markets lead to an efficient allocation of resources and a maximized economic pie. Friedrich Hayek, another Nobel laureate, hailed the virtue of a decentralized competitive price system in maximizing economic activity.

Smith’s radicalism draws from his attack on mercantilism—the economic orthodoxy of the day—which stressed a zero-sum view of trade and state intervention to promote and protect certain firms and industries. (Sound familiar?) His second radical insight was that the “nation” did not mean the sovereign and the well-connected. In Smith’s view, individuals as consumers—all people—were kings. Finally, channeling the sympathetic concern espoused in his earlier classic, The Theory of Moral Sentiments, Smith championed mass participation in the productive economy as a precondition for human flourishing.

It is fair to say that Smith lacked a theory of per capita growth in the economy over time; indeed, he wrote before the massive increase in living standards attendant upon the Industrial Revolution. After 1800, per capita income in the United Kingdom — and the United States — witnessed a 30-fold increase. There have also been major improvements in the quality of goods and services that such a statistic doesn’t quite capture. And, of course, many of today’s offerings — from smartphones to computers to air-conditioning — were not available even in 1900, let alone 1800.

That lacuna in Smith’s theory partly reflects technical difficulties in modeling growth. Higher output can come from growth in inputs such as labor and capital, but what determines their growth? Today’s economists highlight population growth and society’s willingness to work, save, and invest. Still more important is growth in productivity, or the efficiency with which inputs are used to produce goods and services.

Smith’s pin-factory example — in which output rose with the specialization of tasks — links how things are done with the level of productivity. But what factors determine productivity growth over time? Today’s economic analysis focuses on technology and the process of generating ideas. Since economic growth is still crucial for people seemingly marginalized by capitalism, it’s worth asking whether the economic foundations expressed in The Wealth of Nations are still relevant today. Where does growth come from now? And do those sources still require openness and competition?

The short answer is that they do, but to see why, we need to focus on the ideas of two prominent economists after 1800: Edmund Phelps and Deirdre Nansen McCloskey.

Phelps, a Nobel laureate, has done much to connect growth to Smith’s foundational ideas. He starts with Smith’s emphasis on a great many individuals (not the state or privileged firms) searching for new and better ways of doing things. This relentless search produces innovative ideas, processes, and goods that drive growth — but only if the political economy allows openness. Smith’s messy, “bottom up” version of the market therefore puts mass innovation at the heart of economic growth. Phelps’s argument reflects how Smithian societies committed to openness are best able to prosper and promote growth.

This argument has two important applications. The first is to debunk the sometimes fashionable view of secular productivity decline — that we have run short of new things to discover and exploit. The second is to give an answer to economies struggling with growth in a period of structural changes from technology and globalization. Slowdowns in innovation are likely not due to scientific barrenness but to walls against openness and change — that is, fears of disruption.

Phelps’s concern with economic dynamism draws him to Smith’s arguments against mercantilist tinkering in the economy. Like Smith, he worries about the hidden costs of tinkering with competition by blocking change from the outside and by enabling rent-seeking on the inside. These “corporatist” policies — fashionable among some conservatives at present — inevitably embolden vested interests and cronyism, slowing change and growth. Even seemingly small interventions can subtly diminish innovation, a point to which I’ll return.

Yet such a critique must acknowledge the political consequences of disruption. Dynamism is messy. It creates growth in the aggregate, but with many individual losers as well as individual gainers.

McCloskey, an economic historian, has similarly identified the continuous, large-scale, voluntary, and unfocused search for betterment as the source of new ideas that can produce economic growth. She sees this “innovism” as primarily a cultural force, preferring the term to the more familiar “capitalism,” and connects innovism to economic liberalism. Echoing Smith, she emphasizes how an open economy allows individuals—from the moderately to the spectacularly talented—to “have a go.” This economic liberalism allows competition to enshrine liberty and mass flourishing.

In McCloskey’s telling, growth depends on a liberal tolerance and openness to change, which encourage many people to be alert to opportunity. Sustaining that tolerance as structural shifts bring economic misfortune to many individuals, however, requires more than devotion to Smith.

Therein lies the current economic-policy rub. Economists’ theories of growth bring to mind a coin: Sunny descriptions of growth and dynamism are “heads,” and hand-wringing over disruption is “tails.” As I observed earlier, growth is messy. It can push some individuals, firms, and even industries off well-worn and comfortable paths.

But Smith offers more in defense of growth than paeans to laissez-faire. Though he is sometimes caricatured as being anti-government in all cases, Smith was principally opposed to mercantilist privileges for specific businesses and industries and to the governmentalization of social affairs. He wanted government to provide what economists today call “public goods,” such as national defense, the criminal-justice system, and enforcement of property rights and contracts the institutional underpinnings of commerce and trade. He also favored support for infrastructure to keep commerce flowing freely.

But Smith went further: To prepare workers and enrich their lives, he called for government to provide universal education, and he drew a connection between education and liberty as well as work in a free society. But boosting participation in today’s economy—participation that provides support for growth—will require a bit more.

Not surprisingly, political reaction to economic disruption brings about — pardon the econ-speak—a “demand” for and “supply” of policy actions. Job losses, firm failures, and diminished industry fortunes bring about a demand for help, for adaptation. The political process responds with a supply of ideas in one of two forms: walls or bridges. Walls are protections against disruption or change. Bridges, ways to get somewhere or back, prepare individuals for the changed economy and help those whose economic participation has been disrupted reenter the workforce.

Proposals for walls are familiar. They can be physical, of course, but they needn’t be. Conservative populists advocate limits on trade and technology, in order to advance industrial policy. Some progressives advocate universal basic income. All these policies would diminish the prospects for economic advances.

The most prominent sort of wall today is what I call “modern corporatism.” It assumes that Smith was wrong: The “wealth of a nation” lies not in consumption or living standards (and so ultimately in growth) but in jobs, good jobs, even particular good jobs, with good manufacturing jobs the very paradigm. The sort of tinkering with the market that drew Smith’s ire may actually be a necessary way of recentering economic policy on jobs, so the theory goes. Opportunities for work, and for the dignity it can bring, are surely important.

A gentle industrial policy devised by social scientists who are worried about jobs is not the answer. It results in state tinkering for special interests, precisely the kind of thing that prompted Smith’s criticism of mercantilism. Moreover, as University of Chicago economist Luigi Zingales argues in A Capitalism for the People, it risks a vicious cycle: A little bit of tinkering becomes a lot of tinkering—and anyone who cannot justify special privileges is left out, calling into question social support for growth. Nevertheless, industrial policy has caught the attention of elected officials on the right, from Donald Trump to Josh Hawley to Marco Rubio. While national security and the border can be exceptions as concerns, advice from Milton Friedman to the party of Ronald Reagan this is not.

That said, economists’ invocation of Smith as a proponent of let-’er-rip laissez-faire is neither faithful to Smith nor particularly helpful to individuals and communities buffeted by disruption. With today’s rapid and long-lasting technological change and globalization, “having a go” requires support for acquiring new skills when they are needed.

That is why we need more bridges. Bridges take us somewhere and bring us back. The journey to somewhere is about preparation for new opportunities. The journey back is about reconnecting to the productive economy when economic forces beyond our control have knocked us away.

Economic bridges have three features. The first is that they help people overcome a specific challenge on their way to economic flourishing — they don’t provide that outcome directly. The second is that wider society builds the bridge, through private organizations, governments, or public–private partnerships, as globalization and technological change have introduced significant risks that individuals by themselves cannot avoid. The third feature is that they avoid restraints on openness to changes in markets and ideas.

We once did better, much better. During the Civil War, President Abraham Lincoln worked with Congress to pass the Morrill Act, directing resources to the development of land-grant colleges around the country, extending higher education to citizens of modest means, and enabling workers to develop skills for new industries, particularly in manufacturing. As World War II drew to a close, President Franklin D. Roosevelt and Congress came together to enact the G.I. Bill, helping to educate returning troops for a changing economy.

Supporting economic growth and undergirding broad participation in the economy require similarly bold ideas. To begin, community colleges are the logical workhorses of skill development and retraining, and their presence in regional economies makes them attractive partners for employers. Yet community colleges have seen their state-level public support wither. The Biden administration calls for free tuition, which would boost demand but provide no support for community college to offer a practical education and an emphasis on completion. Amy Ganz, Austan Goolsbee, Melissa Kearney, and I proposed an alternative approach based on the land-grant-college model. We proposed a supply-side program of federal grants to strengthen community colleges — contingent on improved degree-completion rates and labor-market outcomes. To further encourage training, the federal government could offer a tax credit to compensate firms for the risk of losing trained workers. It could also increase the earned-income tax credit for workers with or without children.

New ideas are also needed to promote workers’ reentry into the workforce. Personal reemployment accounts, for example, would support dislocated workers and offer them a reemployment bonus if they found a new job within a certain period of time. The “personal” refers to individuals’ choosing from a range of training and support services. Another idea is to beef up support for place-based assistance to areas with stubbornly high rates of long-term nonemployment. Such support could be integrated with an increase in the earned-income tax credit and the supply-side investment in community colleges. Building on the decentralized approach in the land-grant colleges and grants to community colleges, expanded place-based aid would be delivered via flexible block grants encouraging business and employment.

Broad public support required for growth and dynamism requires both bridge-building and a political language that frames it. Growth, opportunity, and participation are good, and we do not need a new economics. But phrases like “transition cost” and “inevitable economic forces” must give way to bridges of preparation and reconnection.

‘Why did nobody see it coming?” a quizzical Queen of England questioned a quorum of economists at the London School of Economics about the global financial crisis as it emerged in late 2008. How could major disruptive forces build up over time and yet escape the attention of experts and leaders?

Of the disruptive structural changes accompanying economic dynamism, one might ask a similar question. Growth matters. But that growth is one side of a coin whose flip side is disruption is known, certainly to economists. Why has our political discourse not emphasized this basic point?

Why did we not see fatigue with change coming among the people who most had to bear its ill effects?

However foolishly, we did not. Some so-called conservatives today have responded by saying that we should limit change. Surely a better response is that we should seek ever more growth by allowing unfettered change, but also facilitate the establishing of ever more connections in a growing economy. That classical-liberal answer has the better place in American conservatism — and in American economic life.

— This essay is sponsored by National Review Institute. Originally published here.

Solved Problem: U.S. Treasury Bonds and the Russian Invasion of Ukraine

Supports: Macroeconomics, Chapter 10, Section 10.5, Economics Chapter 20, Section 20.5, and Essentials of Economics, Chapter 14, Section 14.2.

On March 2, 2022, as the conflict between Russia and Ukraine intensified, an article in the Wall Street Journal had the headline “Investors Pile Into Treasurys as Growth Concerns Flare.” The article noted that: “The 10-year Treasury yield just recorded its largest two-day decline since March 2020, while two-year Treasury yields plunged the most since 2008.”

a. What does it mean for investors to “pile into” Treasury bonds?

b. Why would investors piling into Treasury bonds cause their yields to fall?

c. What are “growth concerns”? What kind of growth are investors concerned about?

d. Why might growth concerns cause investors to buy Treasury bonds?

Solving the Problem

Step 1: Review the chapter material. This problem is about the effects of slowing economic growth on interest rates, so you may want to review Chapter 10, Section 10.5, “Saving, Investment and the Financial System.” You may also want to review Chapter 6, Appendix A (in Economics, Chapter 8, Appendix A), which explains the inverse relationship between bond prices and interest rates. 

Step 2: Answer part a. by explaining what the article meant by the phrase “pile into” Treasury bonds. The article is using a slang phrase that means that investors are buying a lot of Treasury bonds.

Step 3: Answer part b. by explaining why investors piling into Treasury bonds will cause the yields on the bonds to fall. As the Appendix to Chapter 6 explains, the price of a bond represents the present value of the payments that an investor will receive over the life of the bond. Lower interest rates result in a higher present value of the payments received and, therefore, higher bond prices or—which is restating the same point—higher bond prices result in lower interest rates. If investors are increasing their demand for Treasury bonds, the increased demand will cause the prices of the bonds to increase and cause the yields—or the interest rates—on the bonds to fall.

Step 4: Answer part c. by explaining the phrase “growth concerns.” In this context, the growth being discussed is economic growth—changes in real GDP.  The headline indicates that investors were concerned that the Russian invasion of Ukraine might lead to slower economic growth in the United States.

Step 5: Answer part d. by explaining why investors might purchase Treasury bonds if they were concerned about economic growth slowing. Using the model of the loanable funds markets discussed in Chapter 10, Section 10.5, we know that if economic growth slows, firms are likely to engage in fewer new investment projects, which would shift the demand curve for loanable funds to the left and result in a lower equilibrium interest rate. Investors who have purchased Treasury bonds will gain from a lower interest rate because the price of the Treasury bonds they own will increase. In addition, stock prices depend on investors’ expectations of the future profitability of firms issuing the stock. Typically, if investors believe that economic growth is likely to be slower in the future than they had previously expected, stock prices will fall, which would make Treasury bonds a more attractive investment. Finally, investors believe there is no chance that the U.S. Treasury will default on its bonds by not making the interest payments on the bonds. During an economic slowdown, investors may come to believe that the default risk on corporate bonds has increased because some corporations may run into financial problems. An increase in the default risk on corporate bonds increases the relative attractiveness of Treasury bonds as an investment.

Source: Gunjan Banerji, “Investors Pile Into Treasurys as Growth Concerns Flare,” Wall Street Journal, March 2, 2022.

New 1/25/22 Podcast – Authors Glenn Hubbard & Tony O’Brien discuss inflation, inflation, inflation.

Authors Glenn Hubbard and Tony O’Brien as they talk about the leading economic issue of early 2022 – inflation! They discuss the resurgence of inflation to levels not seen in 40 years due to a combination of miscalculations in monetary and fiscal policy. The role of Quantitative Easing (QE) – and its future – is discussed in depth. Listen today to gain insights into the economic landscape.

Glenn’s New Book Was Published Today

Link to Yale University Press’s website.

Link to Amazon page.

Link to availability at local independent bookstores in your area.

Glenn’s Article from the Atlantic: “Even My Business-School Students Have Doubts About Capitalism”

Glenn’s new book that this article is adapted from

Link to the article on the Atlantic’s site.

During a lecture in my Modern Political Economy class this fall, I explained—as I have to many students over the course of four decades in academia—that capitalism’s adaptation to globalization and technological change had produced gains for all of society. I went on to say that capitalism has been an engine of wealth creation and that corporations seeking to maximize their long-term shareholder value had made the whole economy more efficient. But several students in the crowded classroom pushed back. “Capitalism leaves many people and communities behind,” one student said. “Adam Smith’s invisible hand seems invisible because it’s not there,” declared another.

I know what you’re thinking: For undergraduates to express such ideas is hardly news. But these were M.B.A. students in a class that I teach at Columbia Business School. For me, those reactions took some getting used to. Over the years, most of my students have eagerly embraced the creative destruction that capitalism inevitably brings. Innovation and openness to new technologies and global markets have brought new goods and services, new firms, new wealth—and a lot of prosperity on average. Many master’s students come to Columbia after working in tech, finance, and other exemplars of American capitalism. If past statistics are any guide, most of our M.B.A. students will end up back in the business world in leadership roles.

The more I thought about it, the more I could see where my students were coming from. Their formative years were shaped by the turbulence after 9/11, the global financial crisis, the Great Recession, and years of debate about the unevenness of capitalism’s benefits across individuals. They are now witnessing a pandemic that caused mass unemployment and a breakdown in global supply chains. Corporate recruiters are trying to win over hesitant students by talking up their company’s “mission” or “purpose”—such as bringing people together or meeting one of society’s big needs. But these gauzy assertions that companies care about more than their own bottom line are not easing students’ discontent.

Over the past four decades, many economists—certainly including me—have championed capitalism’s openness to change, stressed the importance of economic efficiency, and urged the government to regulate the private sector with a light touch. This economic vision has yielded gains in corporate efficiency and profitability and lifted average American incomes as well. That’s why American presidents from Ronald Reagan to Barack Obama have mostly embraced it.

Yet even they have made exceptions. Early in George W. Bush’s presidency, when I chaired his Council of Economic Advisers, he summoned me and other advisers to discuss whether the federal government should place tariffs on steel imports. My recommendation against tariffs was a no-brainer for an economist. I reminded the president of the value of openness and trade; the tariffs would hurt the economy as a whole. But I lost the argument. My wife had previously joked that individuals fall into two groups—economists and real people. Real people are in charge. Bush proudly defined himself as a real person. This was the political point that he understood: Disruptive forces of technological change and globalization have left many individuals and some entire geographical areas adrift.

In the years since, the political consequences of that disruption have become all the more striking—in the form of disaffection, populism, and calls to protect individuals and industries from change. Both President Donald Trump and President Joe Biden have moved away from what had been mainstream economists’ preferred approach to trade, budget deficits, and other issues.

Economic ideas do not arise in a vacuum; they are influenced by the times in which they are conceived. The “let it rip” model, in which the private sector has the leeway to advance disruptive change, whatever the consequences, drew strong support from such economists as Friedrich Hayek and Milton Friedman, whose influential writings showed a deep antipathy to big government, which had grown enormously during World War II and the ensuing decades. Hayek and Friedman were deep thinkers and Nobel laureates who believed that a government large enough for top-down economic direction can and inevitably will limit individual liberty. Instead, they and their intellectual allies argued, government should step back and accommodate the dynamism of global markets and advancing technologies.

But that does not require society to ignore the trouble that befalls individuals as the economy changes around them. In 1776, Adam Smith, the prophet of classical liberalism, famously praised open competition in his book The Wealth of Nations. But there was more to Smith’s economic and moral thinking. An earlier treatise, The Theory of Moral Sentiments, called for “mutual sympathy”—what we today would describe as empathy. A modern version of Smith’s ideas would suggest that government should play a specific role in a capitalist society—a role centered on boosting America’s productive potential(by building and maintaining broad infrastructure to support an open economy) and on advancing opportunity (by pushing not just competition but also the ability of individual citizens and communities to compete as change occurs).

The U.S. government’s failure to play such a role is one thing some M.B.A. students cite when I press them on their misgivings about capitalism. Promoting higher average incomes alone isn’t enough. A lack of “mutual sympathy” for people whose career and community have been disrupted undermines social support for economic openness, innovation, and even the capitalist economic system itself.

The United States need not look back as far as Smith for models of what to do. Visionary leaders have taken action at major economic turning points; Abraham Lincoln’s land-grant colleges and Franklin Roosevelt’s G.I. Bill, for example, both had salutary economic and political effects. The global financial crisis and the coronavirus pandemic alike deepen the need for the U.S. government to play a more constructive role in the modern economy. In my experience, business leaders do not necessarily oppose government efforts to give individual Americans more skills and opportunities. But business groups generally are wary of expanding government too far—and of the higher tax levels that doing so would likely produce.

My students’ concern is that business leaders, like many economists, are too removed from the lives of people and communities affected by forces of change and companies’ actions. That executives would focus on general business and economic concerns is neither surprising nor bad. But some business leaders come across as proverbial “anywheres”—geographically mobile economic actors untethered to actual people and places—rather than “somewheres,” who are rooted in real communities.

This charge is not completely fair. But it raises concerns that broad social support for business may not be as firm as it once was. That is a problem if you believe, as I do, in the centrality of businesses in delivering innovation and prosperity in a capitalist system. Business leaders wanting to secure society’s continuing support for enterprise don’t need to walk away from Hayek’s and Friedman’s recounting of the benefits of openness, competition, and markets. But they do need to remember more of what Adam Smith said.

As my Columbia economics colleague Edmund Phelps, another Nobel laureate, has emphasized, the goal of the economic system Smith described is not just higher incomes on average, but mass flourishing. Raising the economy’s potential should be a much higher priority for business leaders and the organizations that represent them. The Business Roundtable and the Chamber of Commerce should strongly support federally funded basic research that shifts the scientific and technological frontier and applied-research centers that spread the benefits of those advances throughout the economy. Land-grant colleges do just that, as do agricultural-extension services and defense-research applications. Promoting more such initiatives is good for business—and will generate public support for business. After World War II, American business groups understood that the Marshall Plan to rebuild Europe would benefit the United States diplomatically and commercially. They should similarly champion high-impact investment at home now.

To address individual opportunity, companies could work with local educational institutions and commit their own funds for job-training initiatives. But the U.S. as a whole should do more to help people compete in the changing economy—by offering block grants to community colleges, creating individualized reemployment accounts to support reentry into work, and enhancing support for lower-wage, entry-level work more generally through an expanded version of the earned-income tax credit. These proposals are not cheap, but they are much less costly and more tightly focused on helping individuals adapt than the social-spending increases being championed in Biden’s Build Back Better legislation are. The steps I’m describing could be financed by a modestly higher corporate tax rate if necessary.

My M.B.A. students who doubt the benefits of capitalism see the various ways in which government policy has ensured the system’s survival. For instance, limits on monopoly power have preserved competition, they argue, and government spending during economic crises has forestalled greater catastrophe.

They also see that something is missing. These young people, who have grown up amid considerable pessimism, are looking for evidence that the system can do more than generate prosperity in the aggregate. They need proof that it can work without leaving people and communities to their fate. Businesses will—I hope—keep pushing for greater globalization and promoting openness to technological change. But if they want even M.B.A. students to go along, they’ll also need to embrace a much bolder agenda that maximizes opportunities for everyone in the economy.

Link to the Amazon listing of Glenn’s new book.

The Congressional Budget Office’s Changing Forecasts of U.S. Economic Growth

There are many macroeconomic forecasts. Some forecasts are made by private economists, including those who work for Wall Street Investment firms. Other forecasts are made by economists who work for the government. Perhaps the most widely used macroeconomic forecasts are those published by economists who work for the Congressional Budget Office (CBO). The CBO is a nonpartisan agency within the federal government that provides estimates of the economic effects of government policies as part of the process by which Congress prepares the federal budget. One important aspect of the CBO’s work is to estimate future federal government budget deficits.

To forecast the size of future deficits, the CBO needs to forecast growth in key macroeconomic variables, including GDP. Faster growth in the U.S. economy should result in faster growth in federal tax revenues and slower growth in federal government transfer payments, including payments the federal government makes under the unemployment insurance system, the Temporary Assistance for Needy Families program, and the Supplemental Nutrition Assistance Program. When revenues grow faster than expenditures, the federal budget deficit shrinks.

The CBO’s forecasts of potential GDP provide perhaps the most best known projections of the future economic growth of the U.S. economy. The CBO calculates its forecasts of potential GDP by forecasting the variables that potential GDP depends on. As we’ve seen in Macroeconomics, Chapters 10 (Economics, Chapters 20), the two key variables in determining the growth in real GDP are the growth in labor productivity—the ratio of real GDP to the quantity of labor—and the growth of the labor force.

How well has the CBO forecast future U.S. economic growth? Or, equivalently, how well has the CBO forecast potential GDP. Each year the CBO publishes forecasts of potential GDP for the following 10 years and for longer periods—typically 40 or 50 years. Claudia Sahm, an economic consultant and opinion writer and formerly an economist at the Federal Reserve and the White House, has noted that the CBO’s 10-year forecasts of potential GDP have not been good forecasts of the actual growth of real GDP. Over the past 15 years, the CBO has also carried out surprisingly large downward revisions of its forecasts of potential GDP.

The figure below is similar to one prepared by Sahm and shows the forecasts of potential GDP the CBO published in 2005, 2010, 2015, and 2020 for the following 10 years. (For Sahm’s Twitter thread discussing her figure, click HERE.) That is, in 2005, the CBO issued a forecast of potential GDP for the years 2005–2015. In 2010, the CBO issued a forecast of potential GDP for the years 2010–2020, and so on. Note that for ease of comparison, all GDP values in the figure are set equal to a value of 100 in 2005.

Each straight line on the chart represents the CBO’s forecast of potential GDP over the 10 years following the year in which the forecast was published. For example, the top blue line represents the forecasts the CBO made in 2005 of the values of potential GDP for the years 2005 to 2015. The bottom blue line shows the actual values of real GDP for the years from 2005 to 2020. Note how at each five year interval, the CBO’s forecasts of potential GDP shifted down.

We can look at a few examples of how far off the CBO’s projections were. For instance, if the economy had grown as rapidly between 2005 and 2015 as the CBO forecast it would in 2005, real GDP would have been about 15 percent higher than it actually was. In other words, the U.S. economy would have produced about $2.5 trillion more in goods and services than it actually did. Similarly, if the economy had grown as rapidly between 2010 and 2019 as the CBO forecast it would in 2010, real GDP in 2019 would have been about 7.5 percent (or about $1.5 trillion) higher than it actually was. 

Why has the CBO persistently overestimated the future growth rate of the U.S. economy? The main source of error has been the CBO’s overestimation of the growth in labor force productivity. They have also slightly overestimated the growth of the labor force. Claudia Sahm has a more basic criticism of the CBO’s approach to estimating potential GDP. She argues that if real GDP grows slowly during a period, perhaps because monetary and fiscal policies are insufficiently expansionary, the CBO will incorporate the lower actual real GDP values when it updates its forecasts of potential GDP. This approach can raise questions as to whether the CBO is actually measuring potential GDP as most economist’s define it (and as we define it in the textbook): The level real GDP attains when all firms are producing at capacity. Other economists share these concerns. For instance, Daan Struyven, Jan Hatzius, and Sid Bhushan of the Goldman Sachs investment bank, argue that the CBO’s estimate of potential GDP understates the true capacity of the U.S. economy by 3 to 4 percent.

The CBO’s substantial adjustments to its forecasts of potential GDP are another indication of how volatile the U.S. economy has been since the beginning of the 2007–2009 recession.

Sources:  Tyler Powell, Louise Sheiner, and David Wessel, “What Is Potential GDP, and Why Is It So Controversial Right Now,” brookings.edu, February 22, 2021; and Congressional Budget Office, “Budget and Economic Data,” various years. 

Coming Attractions: Hubbard and O’Brien Principles of Economics Updated

It’s customary for textbook authors to note that “much has happened in the economy” since the last edition of their book appeared. To say that much has happened since we prepared our last edition in 2019 would be a major understatement. Never in the lifetimes of today’s students and instructors have events like those of 2020 and 2021 occurred. The U.S. and world economies had experienced nothing like the Covid-19 pandemic since the influenza pandemic of 1918. In the spring of 2020, the U.S. economy suffered an unprecedented decline in the supply of goods and services as a majority of businesses in the country shut down to reduce spread of the virus. Many businesses remained closed or operated at greatly reduced capacity well into 2021. Most schools, including most colleges, switched to remote learning, which disrupted the lives of many students and their parents.

During the worst of the pandemic, total spending in the economy declined as the unemployment rate soared to levels not seen since the Great Depression of the 1930s. Reduced spending and closed businesses resulted in by far the largest decline in total production in such a short period in the history of the U.S. economy. Congress, the Trump and Biden administrations, and the Federal Reserve responded with fiscal and monetary policies that were also unprecedented.

Our updated Eighth Edition covers all of these developments as well as the policy debates they initiated. As with previous editions, we rely on extensive digital resources, including: author-created application videos and audio recordings of the chapter openers and Apply the Concept features; figure animation videos; interactive real-time data graphs animations; and Solved Problem whiteboard videos.

Glenn and Tony discuss the updated edition in this video:

Sample chapters will be available by October 15.

The full Macroeconomics text will available in early to mid December.

The full Microeconomics text will be available in mid to late December.

If you would like to view the sample chapters or are considering adopting the updated Eighth Edition for the spring semester, please contact your local Pearson representative. You can use this LINK to find and contact your representative.

New 09/03/21 Podcast – Authors Glenn Hubbard & Tony O’Brien discuss the recent jobs report, Fed comments, and financial stability!

Authors Glenn Hubbard and Tony O’Brien discuss the recent jobs report falling short of expectations. They also discuss the comments of Fed Chairman Powell’s comments at the Federal Reserve’s recent Jackson Hole conference. They also get to some of the recommendations of a Brookings Task Force, co-chaired by Glenn Hubbard, on ways to address financial stability. Use the links below to see more information about these timely topics:
Powell’s Jackson Hole speech: 

https://www.federalreserve.gov/newsevents/speech/files/powell20210827a.pdf 

The report of Glenn’s task force: 

https://www.brookings.edu/wp-content/uploads/2021/06/financial-stability_report.pdf 

The most recent economic forecasts of the FOMC: 

https://www.federalreserve.gov/monetarypolicy/files/fomcprojtabl20210616.pdf

WELCOME BACK! New 08/20/21 Podcast – Authors Glenn Hubbard & Tony O’Brien return to discuss delta variant & inflation!

Join authors Glenn Hubbard and Tony O’Brien as they return for a new academic year! The issues have evolved but the importance of these issues has not waned. We discuss the impact of closures related to the delta variant has on the economy. The discussion extends to the active fiscal and monetary policy that has reintroduced inflation as a topic facing our economy. Many students have little or no experience with inflation so it is a learning opportunity. Check back regularly where Glenn & Tony will continue to wrestle with these important economic concepts and relate them to the classroom!