Quantifying the Lasting Harm to the U.S. Economy from the Financial Crisis

Quantifying the Lasting Harm to the U.S. Economy from the Financial Crisis Robert E. Hall Hoover Institution and Department of Economics Stanford University Lessons from the Financial Crisis and the Great Recession for Economic Modelling Jerusalem 20 June 2014 1

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Components of the Shortfall of Output, 2007 through 2013 Percentage points Output 13.3 Productivity 3.5 Capital 3.9 Population 1.3 Labor-force participation 2.4 Employment rate 2.2 Hours per week 0.8 Labor quality -0.3 Business fraction -0.5 3

Productivity Focus on total factor productivity 4

Productivity Focus on total factor productivity Combine utilization with TFP generally 4

Productivity Focus on total factor productivity Combine utilization with TFP generally Avoid duplication of Fernald s paper at the Macro Annual conference 4

Productivity Shortfall is not generally the result of low factor utilization 5

Productivity Shortfall is not generally the result of low factor utilization Fernald concludes that the shortfall arises from a return to normal, low TFP growth rates from the growth spurt 5

Productivity Shortfall is not generally the result of low factor utilization Fernald concludes that the shortfall arises from a return to normal, low TFP growth rates from the growth spurt The shortfall of 3.5 percentage points is not statistically surprising the standard deviation of 6-year changes is 4.4 percent 5

Investment Driven by demand for output and the discount rate applicable to the future marginal product of capital 6

Investment Driven by demand for output and the discount rate applicable to the future marginal product of capital Output demand fell and discounts rose, despite falling interest rates 6

Capital wedge ( ) kt q t = κ 1 + 1 k t 1 7

Capital wedge ( ) kt q t = κ 1 + 1 k t 1 1 + r k,t = 1 [ ] πt + (1 δ t )q t+1 p k,t+1 q t p k,t k t 7

Capital wedge ( ) kt q t = κ 1 + 1 k t 1 1 + r k,t = 1 [ ] πt + (1 δ t )q t+1 p k,t+1 q t p k,t k t g t = r k,t r f,t 7

The Capital Wedge for Two Values of the Adjustment Cost κ 20 18 16 14 12 10 8 6 4 2 0 1990 1993 1996 1999 2002 2005 2008 2011 20 18 16 14 12 10 8 6 4 2 0 1990 1993 1996 1999 2002 2005 2008 2011 8

The Capital Wedge for Two Values of the Adjustment Cost κ 20 18 16 14 12 10 8 6 4 2 0 1990 1993 1996 1999 2002 2005 2008 2011 20 18 16 14 12 10 8 6 4 2 0 1990 1993 1996 1999 2002 2005 2008 2011 κ = 0 κ = 2 8

The S&P Risk Premium, 1960 through 2012 30 25 20 15 10 5 0 5 1960 1965 1970 1975 1980 1985 1990 1995 2000 2005 2010 9

Plant and equipment investment 1200 1200 1000 1000 800 800 600 600 400 400 200 200 0 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 0 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 10

Plant and equipment investment 1200 1200 1000 1000 800 800 600 600 400 400 200 200 0 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 0 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 Plant Equipment 10

IP and housing 1200 1200 1000 1000 800 800 600 600 400 400 200 200 0 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 0 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 11

IP and housing 1200 1200 1000 1000 800 800 600 600 400 400 200 200 0 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 0 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 IP Housing 11

Capital/Output Ratio, with 1990-2007 Trend and CBO-Based Forecast 1.25 1.20 1.15 1.10 1.05 Trend, 1990 2007 1.00 0.95 CBO based forecast 0.90 1990 1993 1996 1999 2002 2005 2008 2011 2014 2017 2020 2023 12

Unemployment and labor-market tightness Think of unemployment as an aspect of labor supply unemployment is a negative factor for employment 13

Unemployment and labor-market tightness Think of unemployment as an aspect of labor supply unemployment is a negative factor for employment DMP says unemployment depends on tightness job-finding is faster in a tighter market and entry rates to unemployment are also somewhat lower 13

Unemployment and labor-market tightness Think of unemployment as an aspect of labor supply unemployment is a negative factor for employment DMP says unemployment depends on tightness job-finding is faster in a tighter market and entry rates to unemployment are also somewhat lower Look at tightness from the perspectives of employers, employed individuals, and jobseekers 13

Unemployment and labor-market tightness Think of unemployment as an aspect of labor supply unemployment is a negative factor for employment DMP says unemployment depends on tightness job-finding is faster in a tighter market and entry rates to unemployment are also somewhat lower Look at tightness from the perspectives of employers, employed individuals, and jobseekers Study role of UI benefits 13

Average Time to Fill a Job Vacancy, JOLTS, 2001 through 2012 Months 1.0 0.9 0.8 0.7 0.6 0.5 0.4 0.3 0.2 0.1 0.0 2000 2002 2004 2006 2008 2010 14

Average Weekly Hours of Work, Current Population Survey, 1948 through 2013 42 41 40 39 38 37 36 35 1948 1953 1958 1963 1968 1973 1978 1983 1988 1993 1998 2003 2008 2013 15

Job-Finding Rate among the Unemployed, 1990 through 2013 35 30 25 20 15 10 5 0 1990 1993 1996 1999 2002 2005 2008 2011 16

Indexes of the Job-Finding Rate by Duration of Unemployment 2.5 2.5 2.0 2.0 1.5 1.5 1.0 1.0 0.5 0.5 0.0 1948 1953 1958 1963 1968 1973 1978 1983 1988 1993 1998 2003 2008 2013 0.0 1967 1972 1977 1982 1987 1992 1997 2002 2007 2012 17

Indexes of the Job-Finding Rate by Duration of Unemployment 2.5 2.5 2.0 2.0 1.5 1.5 1.0 1.0 0.5 0.5 0.0 1948 1953 1958 1963 1968 1973 1978 1983 1988 1993 1998 2003 2008 2013 0.0 1967 1972 1977 1982 1987 1992 1997 2002 2007 2012 Low duration High duration 17

Unemployment Exit Rates and Change in Composition of Unemployment, 2007-2009 Source Normal exit rate, percent per month Change in percent of unemployment, 2007 to 2009 Layoff 64.7-2.2 Permanent loss 41.4 17.7 Temp job 51.1-0.9 Quit 55.7-5.0 New entrant 49.2-1.6 Reentrant 48.7-8.0 18

Matching Efficiency for Unemployed Jobseekers 0.40 0.35 0.30 0.25 0.20 0.15 0.10 0.05 0.00 2001 2003 2005 2007 2009 2011 2013 19

Overall matching efficiency (from Hall and Schulhofer-Wohl (2013)) 1.75 1.50 1.25 1.00 0.75 0.50 0.25 fixed component weights fixed distribution of observables 0.00 2001 2003 2005 2007 2009 2011 20

Inflows to unemployment from lost jobs 50 45 40 Percent of unemployment 35 30 25 20 15 10 5 0 Permanent job loss Layoff 1994 1997 2000 2003 2006 2009 2012 21

Other inflows to unemployment 50 50 45 45 Percent of unemployment 40 35 30 25 20 15 10 Reentrant Quit Percent of unemployment 40 35 30 25 20 15 10 Temp job ended 5 5 New entrant 0 1994 1997 2000 2003 2006 2009 2012 0 1994 1997 2000 2003 2006 2009 2012 22

Chodorow-Reich and Karabarbounis (2013) 12 10 UI, before adjustment Percent of trend productivity 8 6 4 UI, after adjustment 2 Other benefits 0 1990 1992 1994 1996 1998 2000 2002 2004 2006 2008 2010 2012 23

High unemployment following the crisis By far the most important factor is the shift among inflows to unemployment toward jobseekers with low normal job-finding rates 24

High unemployment following the crisis By far the most important factor is the shift among inflows to unemployment toward jobseekers with low normal job-finding rates These are losers of permanent jobs and workers on layoff, waiting for possible recall 24

High unemployment following the crisis By far the most important factor is the shift among inflows to unemployment toward jobseekers with low normal job-finding rates These are losers of permanent jobs and workers on layoff, waiting for possible recall Decline in inflows from quits and reentry, with high normal job-finding rates 24

High unemployment following the crisis By far the most important factor is the shift among inflows to unemployment toward jobseekers with low normal job-finding rates These are losers of permanent jobs and workers on layoff, waiting for possible recall Decline in inflows from quits and reentry, with high normal job-finding rates No much evidence that UI benefits extensions had more than a modest role 24

Standard and Fixed-Weight Measures of Labor-Force Participation, 1990 through 2013 75 85 70 Overall labor force participation rate (left scale) 80 65 75 3.0 percentage points 60 55 Fixed weight average of labor force participation rates by sex and age (right scale) 70 65 1.9 percentage points 50 1990 1993 1996 1999 2002 2005 2008 2011 60 25

Contributions of Sex-Age Groups to Participation Shortfall, 2007 through 2013 Age Men Women Sum 16-19 0.06 0.17 0.23 20-24 0.18 0.05 0.24 25-34 0.20 0.11 0.31 35-44 0.04 0.13 0.17 45-54 0.19 0.35 0.53 55+ 0.27 0.43 0.70 All 0.95 1.24 2.19 26

Conventional and Extended Measures of the Labor Force 70 68 66 Percent of population 64 62 60 58 56 Standard measure Add marginally attached Add discouraged 54 52 50 1994 1997 2000 2003 2006 2009 2012 27

Increments to the Labor-Force Participation Rate from Inclusion of Marginal and Discouraged Individuals Year Marginal Discouraged Both 2008 0.05 0.02 0.08 2009 0.30 0.16 0.46 2010 0.41 0.32 0.73 2011 0.43 0.24 0.67 2012 0.39 0.20 0.60 2013 0.32 0.18 0.50 28

Five Quantiles of the Distributions of Real Weekly Earnings, 2000 through 2012 8.0 7.5 7.5 90th 7.0 90th 7.0 75th 75th 50th 6.5 50th 6.5 25th 6.0 25th 6.0 10th 10th 5.5 5.5 5.0 2000 2002 2004 2006 2008 2010 2012 5.0 2000 2002 2004 2006 2008 2010 2012 29

Joint Distribution of Market and Reservation Wages 3 2 Participate 1 Market wage 0 1 2 3 Do not participate 4 4 3 2 1 0 1 2 3 Reservation wage 30

Participation Reductions from 11-percent Tax on Low-Wage Workers Compared to Actual Declines in Participation Participation rate, percent of population Men Women Base parameters 72.9 59.2 With tax 70.1 57.2 Decline, based on model 2.8 1.9 Actual, 2007 73.2 59.3 Actual, 2012 70.2 57.7 Actual decline 3.0 1.6 31

Number of Recipients of Social Security Disability Benefits Aged 18 through 64, in Millions 14 12 10 Millions of people 8 6 4 2 0 1996 1998 2000 2002 2004 2006 2008 2010 2012 32

Medicaid Recipients 80 70 60 Millions of beneficiaries 50 40 30 20 10 0 1990 1993 1996 1999 2002 2005 2008 2011 33

Beneficiaries Receiving Food Stamps 60 50 Millions of beneficiaries 40 30 20 10 0 1990 1993 1996 1999 2002 2005 2008 2011 34

Summary of Sources of Decline in the Labor-Force Participation Rate, Percentage Points of Population Total decline in participation relative to trend 3.0 Sex-age mix effect 1.1 Marginal and discouraged individuals 0.5 Increase in disability benefit recipients over trend 0.4 Residual (rising primary wages, rising tax rates) 1.0 Sum of components 3.0 35

Effects of Boost to Product Demand Comnponent Contribution to shortfall Immediately Within a few years Ultimately Productivity 3.5 No No Possibly Capital 3.9 No A little Yes Unemployment 2.2 Partly Mostly Yes Participation 2.4 Partly Partly Partly 36