- If we go back to the
previous Great Recession, then one of the things that
many of us think we see there is the fact that the
nature of that recession, the fact that it was bound
up with a financial crisis, it really sort of broke the
model of demand formation, which prior to the Great
Recession, had depended to a substantial extent,
on household borrowing. And that behavior has been very different since the Great Recession. And it looks like then for
any sort of potential output that the economy might have
been capable of producing since 2009, the ability
then to generate the demand to meet that potential has been impaired. My name is Mark Setterfield, and I am Professor of Economics at the New School for Social Research. I do macroeconomics, and part of my interest in
macroeconomics is in hysteresis. Hysteresis is essentially,
a type of path dependence, which really just says that events today, can have lasting effects
on outcomes in the future. And specifically, what hysteresis claims is that even temporary effects today, can have permanent effects
potentially, on future outcomes. There are a couple of
qualifications to that. First of all, not every
temporary effect matters. It tends to be the more extreme
effects that are important. So for example, if I'm
walking home this evening and I trip over my shoelace,
that's unfortunate, but it probably won't
change the route that I take to go home next week. Whereas, if I'm walking home
and I'm attacked, for example, then that would really
give me pause for thought and it might change my behavior
permanently thereafter. The other thing I think, that is important is that hysteresis is not fatalistic. So when we say that the
future effects are permanent, we don't mean that there's nothing that can be done about them. And in fact, very often,
subsequent interventions can undo any of the hysteresis
effects that we find. So the question becomes, what does hysteresis have
to do with economics? And if we're looking at the whole economy, an obvious example of a
temporary event is a recession. So then well, recessions we
know can be milder or deeper. For example, the recent COVID-19 recession was particularly deep,
even deeper in fact, if we look at the rising unemployment and the drop in output, than
the previous Great Recession. So then the question becomes, can an event like the COVID-19 recession permanently scar the US economy? Do we see any evidence
since the recovery began, of adverse hysteresis effects that could permanently affect the level of activity in the US economy? So since we're looking
at aggregate activity, I think, a good place to start
is by reminding ourselves of what I think, Robert Solow once said, which is that "economists
are a bit like parrots because all they keep saying is supply and demand, supply and demand." But it turns out that's,
you know, a good place to start here, because
if we're interested in aggregate activity, we could do worse than think in terms of
aggregate supply conditions and aggregate demand conditions. And look at each in turn and see if in fact, there is evidence
of adverse hysteresis effects. So if we start with aggregate demand, one of the things that
we know that happened during the COVID-19
recession was that households dramatically increase their savings rates. And that's not surprising because of course, many
households were fearful of what would come next. Would there be another surge? Would they lose their job? Would their business be the
next to sort of close down as a result of the lockdowns? So what households were doing was holding on to liquid assets and avoiding commitment
to current expenditures on goods and services. So then the question becomes,
the pandemic goes away, but does that type of behavior go away? Or do households, for
example, remain fearful of the pandemic? Will it come back? Will that interrupt their income? So should they continue to avoid spending? Or alternatively, are
they, just as a result of the pandemic now,
suddenly more aware of and averse to the
uncertainty of the future? If we look at the evidence, it seems not. I mean, what we've seen over
the last couple of years is that households have
dissaved very aggressively, they've reentered credit markets. So if we think of that type of behavior as what we've seen in the last few years, it really doesn't add up
to any sort of evidence that in the longer term we're gonna find a permanent scarring effect
on aggregate demand formation. So I did say that the parrot economist says supply and demand, and okay, so we look at the demand
side, that's one thing. But what about the supply side? Well, if we think of the US economy, it's capital abundant,
it's potential to produce is going to be limited,
if anything, by labor. So what we really might
want to go looking for is any evidence that there's going to be a sort of permanent effect
of the COVID recession on the total capacity of the
US economy to employ people. And well, we can break that
down into three components. We can look at the employment rate, the labor force participation rate, and the total population. So let's start with the employment rate. What we're thinking about
here, is the possibility that the COVID recession
has somehow damaged the labor market so that
we can't get back to the type of employment rate that we saw before the COVID recession and that might have persisted in the absence of the pandemic. But if we look at the
unemployment figures, in fact, unemployment, by any measure, whether it's the narrow
headline unemployment rate or even the broader U-6 rate, that includes discouraged workers and involuntary part-time workers; those measures of unemployment have dropped like a
stone since the beginning of the recovery, much faster in fact, than they dropped, following
the Great Recession or even the previous dot com recession. So that doesn't look like evidence of sort of permanent structural
damage to the labor market. So then we go on to labor
force participation, and I think, here, one of the things that macro economists were wary of was that a lot of the unemployment during the COVID recession
actually affected women. And the question was, would those women who became unemployed
and then dropped out of the labor force as many did, would they come back into the labor force? Why might they not? Well, women are, because of the gendered structure of work in the home, disproportionately involved in childcare. So one possibility is that they might have stayed out of the labor
force for fear of bringing, you know, COVID-19 home
and affecting children. Another possibility
was that if we think of many of the women who lost jobs in low-paid service sector industries, would it change the sort of calculus of their labor supply behavior? Why go to work in a low-paid occupation and then struggle to find childcare, which is costly and difficult? Maybe it would, you know,
fundamentally affect the labor force participation
of women for that reason. Well, again, if we look at the evidence, it doesn't seem to have
worked out that way. Labor force participation
has come back more slowly over the last two to three years, than the employment rate has recovered. But if we look more carefully at who seems to be hanging back, who hasn't come back into the labor force, the sort of representative
suspect, as it were, is older, white, and male. And I think, the reason for that is fairly easy to explain, right? Older white men, those are the folks who disproportionately
own wealth in the economy. And because they're older,
they're closer to retirement. So what this looks
like, is a certain group of the population bringing
forward retirement decisions. So if you think about it, that's bunching retirement decisions that would otherwise have been spread out over a longer period of time. That really is a temporary effect. It might persist for a while, but it's not going to affect
labor force participation, relative to some sort
of counterfactual trend, where we would've been in the absence of the COVID
recession, in the longer term. So then the only other place to look on the supply side then,
is total population. And of course here, we face the tragedy of the pandemic itself, right? The actual deaths from
COVID, which of course, disproportionately affected older members of the population who weren't working. But of course, it also
affected a lot of people of working age. And we did see during the pandemic, a so-called excess mortality
among people of working age. The other thing of course, is
that immigration was affected. COVID was a communicable disease, so you couldn't really
have businesses as usual in terms of immigration,
because of the fear of people coming into the country and bringing COVID-19 with them. Since the end of the COVID recession, what we seem to see is
the US population growth has kind of reverted to trend. But that in itself, won't make up for all of the sort of lost population, as it were, due to excess mortality. And of course, also the immigration policy during the pandemic. So then for any given labor
force participation rate and any given employment rate, if we've got this kind of lost population, then what that adds up to is more or less permanently missing workers, compared to where we would've been in the absence of the recession. And at the moment, that
seems like that might add up to a permanent effect. But here, we have to remember what we mean by permanent, right? We only really mean permanent if we sit around and do nothing. And since part of the
problem I've just identified is immigration, well then of course, the obvious thing to
do would be to think of acting on immigration policy and making up for lost population, if that is going to be
some kind of constraint on the supply side, by
admitting more immigrants, just as we admitted fewer for health reasons during the pandemic. I've talked about demand and supply because certainly, from
a Keynesian perspective, we can't just look at supply and assume that demand
will automatically adjust to fully utilize all of the resources that are capable of
producing what we would call, potential output, as a
result of the availability of sort of capital and labor on the supply side of the economy. And that's why I singled out
initially, demand formation as a potential source
of hysteresis effects. Because of course, if we
go back to the previous Great Recession, then one of the things that many of us think
we see there is the fact that the nature of that recession, the fact that it was bound
up with a financial crisis, it really sort of broke the
model of demand formation, which prior to the Great Recession, had depended to a substantial extent, on household borrowing. And that behavior has been very different since the Great Recession. And it looks like then for
any sort of potential output that the economy might have
been capable of producing since 2009, the ability
then to generate the demand to meet that potential has been impaired. And well, quite famously,
what we know is that there has been this kind of steady process of revising downwards, the
sense of potential output in the US economy since 2009, which eventually, of course, inevitably makes actual and potential output look very close to each other and seems to solve the problem. But what that suggests
is something more like a hysteresis effect, that
you had a big recession, you broke, in that case, the
demand formation process. And then the supply side
has somehow adjusted so that we end up with, you know, by 2019, lower unemployment rates, but not in the way that we would've had the same lower unemployment rates in the absence of the Great Recession. Now, this time, however,
with the COVID recession, it looks a little different, you know, so that problem of demand
formation doesn't seem to be, well, even really persistent,
much less permanent. As I was saying, using
households as an example, households really have dissaved with almost giddy abandon
since the end of the recession. They've reentered credit markets. So it doesn't look, in that sense then, as if there's going to be
anything that would cause the type of under
utilization of resources, a more or less sort of permanent gap between potential output and actual output that might once again, start
dragging the potential output down to the actual level. And again, that is a very
Keynesian perspective because the focus there
is on how much demand can you generate, so how
much of the potential output on the supply side can
you actually buy up? What is going to be
your unemployment rate, your capacity utilization rate? How many of the available resources are you actually going to utilize? That's an emphasis that
I think, is specific to a more Keynesian perspective. I think the conclusions
that we can draw then about the question we started with, have there been, or is there evidence of adverse hysteresis effects arising from the COVID-19 recession?
