Thursday, June 30, 2011

The Lucas Critique

One of the most powerful ideas in economics is the Lucas Critique. The notion is that statistical relationships estimated in historical data do not necessarily represent causal relationships manipulable by policymakers. It applied in particular force to the Phillips Curve, a connection that some researchers found between unemployment and inflation. According to this critique; simply observing that unemployment and inflation tend to move opposite one another does not mean that central bankers can push inflation higher at will and gain lower employment.

This was a powerful critique at the time, and has yet to penetrate a lot of economic talk. Here, for instance, is Christina Romer, former Chair of the CEA:
The real division is not about the acceptable level of inflation, but about its causes, and the dispute is limiting the Fed’s aid to the economic recovery. The debate is between what I would describe as empiricists and theorists.

Empiricists, as the name suggests, put most weight on the evidence. Empirical analysis shows that the main determinants of inflation are past inflation and unemployment. Inflation rises when unemployment is below normal and falls when it is above normal.
It seems that Romer is accepting not only the empirical Phillips Curve relationship, but also its causal ability to be used by central bankers. Not only is this her own opinion, but the view that ought to be held by "empiricists" who are rigorous in the way they face data, as opposed to those woolley-headed theorists.

Yet even the empirical relationship between unemployment and inflation has broken down in the past few decades. And even if one such relationship did exist, that would not necessarily provide a guide for monetary policy. I do agree that more monetary easing would be worthwhile, but this is a bad way argument in its favor.

On the other side, you have other individuals arguing against monetary easing on the grounds that higher structural unemployment makes monetary easing futile. Scott Sumner neatly addresses that argument:
For similar reasons there is no hard and fast distinction between cyclical and structural unemployment. For instance, if structural unemployment in American has risen closer to European levels, it may be partly due to the decision to extend unemployment insurance from 26 weeks to 99 weeks, and to increase the minimum wage by over 40% right before the recession. Does that mean that demand stimulus cannot lower unemployment? No, because the maximum length of unemployment insurance is itself an endogenous variable. If stimulus were to sharply boost aggregate demand it is quite likely that Congress would return the UI limit to 26 weeks, as it has during previous recoveries. For similar reasons, the real minimum wage would decline with more rapid growth in demand. Aggregate supply and demand are hopelessly entangled, a problem that many economists haven’t fully recognised.
Once again, some relationship we observe today ("there is more structural unemployment now") doesn't provide an unambiguous guide on what to do in the future.

Finally, here’s a recent example from India’s Economist Prime Minister, Manmohan Singh:
We are committed to a growth rate of 9 to 10 % per annum. Our savings rate is about 34 to 35 % of our GDP with an investment rate of 36 to 37 %. And with a capital output ratio of 4:1 we can manage to have a growth rate of 9%.
On the face of it, this is a reasonable statement. Savings do translate into investment closely enough (give or take foreign direct investment, cash stuffed under the mattress, etc.), and accumulated capital in the form of investment aids in future output growth. And, at any point in time, one can compute the ratio between capital and output as a ratio. That’s all true enough.

What’s disturbing is the manner in which Manmohan Singh apparently relies on the crutch of capital/output as a solid parameter to be manipulable by policy. This has been a consistent factor in his economic thinking for quite some time, and goes back to the assumptions of early Indian planners that the accumulation of capital alone would suffice for growth.

Well that wasn’t necessarily true in Nehru’s time and it's not true now. For instance, note as Yasheng Huang does that China is far less effective than India at translating savings into growth (the country also saves more in general). So this is not some fixed parameter set by immutable laws. Instead the capital/output ratio is highly responsive to the general policy environment and incentives faced by economic actors. In China, presumably what you have going on is a lower degree of allocative efficiency. Yet one might equally have concerns in the Indian context about the role of policy; with microeconomic problems of labor quality, health, land acquisition, general governance, labor laws, taxation, and so on and so forth. It is exactly in order to evade the government’s abysmal failure to tackle these existing and tangible problems that Manmohan Singh suggests that the problem of growth can be reduced to an arithmetic question of savings and investment. Yet that relationship may not hold up in the absence of additional reforms to improve governance and tackle the various other binding constraints that hold back growth. (oh, to be sure he mentions other steps to make sure this will happen; but if his proposals haven't taken off in the last seven years why would they take effect now?).

Let me put it this way — Tim Pawlenty recently received a lot of flack for suggesting that his economic policy would simply demand 5% growth for a decade. What if he had said instead; “I will push savings up to 20%; then since there is a 4:1 relationship between investment and growth we can expect 5% growth.” I think most people would find the idea a little nuts. Many misadventures in development economics have included failures where simply pumping in more capital didn't necessarily get you more growth in an arithmetic fashion. The root problem is that any current relationship between savings and growth doesn’t represent a causal relationship manipulable by policymakers. That’s the Lucas Critique in action.

Wednesday, June 29, 2011

Mortgage Modification and Strategic Behavior

I have a co-authored paper with Chris Mayer, Ed Morrison, and Tomasz Piskorski that is live on NBER:
We investigate whether homeowners respond strategically to news of mortgage modification programs. We exploit plausibly exogenous variation in modification policy induced by U.S. state government lawsuits against Countrywide Financial Corporation, which agreed to offer modifications to seriously delinquent borrowers with subprime mortgages throughout the country. Using a difference-in-difference framework, we find that Countrywide’s relative delinquency rate increased thirteen percent per month immediately after the program’s announcement. The borrowers whose estimated default rates increased the most in response to the program were those who appear to have been the least likely to default otherwise, including those with substantial liquidity available through credit cards and relatively low combined loan-to-value ratios. These results suggest that strategic behavior should be an important consideration in designing mortgage modification programs.
Adam Levitin has weighed in here, and David Henderson has done so here.

Monday, June 27, 2011

The Value of Marginal Education

There’s an ongoing debate at EconLog, Marginal Revolution, the New York Times and elsewhere over the value of additional education. No one doubts that education appears to be a valuable investment for students who pursue it. But it valuable for the marginal individual? Do we need public policy to steer more students through high school, College, and degrees beyond? Given the centrality of cognitive ability and human capital to economic output and general wellbeing, this has to rank as one of the more important economic questions out there.

Tyler Cowen refers us to some studies:
How much do returns to education differ across different natural experiment methods? To test this, we estimate the rate of return to schooling in Australia using two different instruments for schooling: month of birth and changes in compulsory schooling laws. With annual pre-tax income as our measure of income, we find that the na─▒ve ordinary least squares (OLS) returns to an additional year of schooling is 13%. The month of birth IV approach gives an 8% rate of return to schooling, while using changes in compulsory schooling laws as an IV produces a 12% rate of return. We then compare our results with a third natural experiment: studies of Australian twins that have been conducted by other researchers. While these studies have tended to estimate a lower return to education than ours, we believe that this is primarily due to the better measurement of income and schooling in our data set. Australian twins studies are consistent with our findings insofar as they find little evidence of ability bias in the OLS rate of return to schooling. Together, the estimates suggest that between one-tenth and two-fifths of the OLS return to schooling is due to ability bias. The rate of return to education in Australia, corrected for ability bias, is around 10%, which is similar to the rate in Britain, Canada, the Netherlands, Norway and the United States.
These are all basically examples of an Instrumental Variable (IV) approach. Let’s take these one at a time. First, we have the month of birth evidence. Yet this is the classic example of a weak instrument, an issue which is well discussed elsewhere. The month or quarter of birth has a very weak impact on final educational outcomes, and parents with children born in different months are not identical either.

Next, there is the compulsory schooling evidence, that Arnold Kling actually takes on as well, though only in the US context. He observes that the variation across states in terms of when a student can legally graduate doesn’t seem to predict their actual graduation habits. This is basically also a weak instrument; at least in the case of the US.

Finally, we have the twins evidence. The idea here is to observe one twin going to College and compare her with her sister twin who did not go to College. The assumption is that these two individuals shared identical environmental background factors, and so any resulting differences can be causally attributed to the College attendance of one twin. While this is a clever trick, it requires you to believe that twins are interchangeable humans. What if a family can only afford to send one twin to College, and so they send their more able child? What about all sorts of cognitive and non-cognitive differences that come up between children growing up in the same house? What about the possibility of twin interactions? Though interesting and suggestive, I don’t believe this evidence to be causally definitive.

It’s easy enough to knock holes in any body of literature, even one (as here) which does purport to establish identification. So here’s some evidence that points in the other direction.

1. Cognitive abilities have limited scope for educational intervention in developed economies beyond age ~5.

The evidence of this actually comes from James Heckman. He argues that we simply do not have access to any educational treatment that can reliably boost IQ over an extended period of time. Even the lauded Head Start/Perry Preschool programs can't do that. And if spending tens of thousands of dollars per pupil on a pilot program can’t produce results, it’s difficult to imagine what would.

An education proponent could now say something like, “Fine, but cognitive skills aren’t everything. Heckman supports Head Start — because it boosts noncognitive skills like impulse control.” Suppose I even grant that point — though I note that these noncognitive skills are something like a black box. There’s defined entirely as a residual of what can’t be a cognitive skill, and are inferred largely on the basis of lower crime rates among treated populations.

But think about what that would mean. Everything we do in schools — the teaching, the homework, etc. — has limited value when it comes to actually improving mental functions. Rather, it may or may not be effective in domesticating children to functioning in a modern post-industrial economy. At the very least, that would suggest that education ought radically change its focus away from cognitive tasks towards those aspects of behavior modification. Maybe we’d get the same results as school from a program forcing children to dig holes every day and fill them back up. Also note that Heckman’s results on the payoffs of education based on these noncognitive skills is rapidly declining in age. Are Head Start, prenatal care, or child nutrition policies worthwhile? Very likely. What about pushing unprepared children to attend College? Less clear.

2. Other estimates of the marginal return to education are low.

Heckman has another paper with coauthors where he attempts more rigorously to estimate the marginal impact of more education — in particular, of more College. Even the Instrumental Variable estimates discussed above may be biased — as they measure the impact on individuals induced to have the treatment (ie, more education). This need not be the same population as those induced to have more education in response to some arbitrary policy change.

Instead, Heckman creates an estimate designed to get exactly at the impact of more College on outcomes. The basic logic of his approach is to find individuals who had a low ex ante likelihood of attending College, but who went anyway. These are a proxy of the individuals targeted by, say, a program to induce more people to attend College.

He argues:
For a sample of white males from the NLSY, we establish that marginal expansions in college attendance attract students with lower returns than those enjoyed by persons currently attending college. The contrast between what conventional IV measures and the marginal return to a policy can be stark. For example, while the conventional IV estimate is 0.0951, the estimated marginal return to a policy that expands each individual’s probability of attending college by the same proportion is only 0.0148. This policy induces students who should not attend college to attend it. Too many people go to college. [Emphasis added]
Note in particular that his estimates are consistent with high “IV” estimates — based on a set of instruments that he was able to use here. So even if the “identified” estimates based on the IV literature are correct, they do not necessarily serve as useful diagnostics on whether College expansion programs are worthwhile.

I’ll acknowledge that there’s substantial uncertainty about this question and much that we don’t know. I’m not particularly on one “side” in this debate. But this is such a difficult question to answer because people who seek more education would likely have done well anyway.

What I can say is that the most effective policy interventions here have little to do with simply broadening the access to education. All sorts of early child intervention techniques seem to yield positive results. A number of charter school/school choice/voucher experiments have resulted in institutional improvements in the quality of education while lowering the cost.

Sunday, June 26, 2011

Right-Wing Keynesianism

There's an idea going around to offer a one-time tax holiday to multinational firms to encourage them to repatriate income. The US, somewhat absurdly, charges multinational firms domestic tax rates on income earned in other countries. This encourages companies to re-invest foreign profits overseas rather than repatriate that income domestically -- unless they receive a special tax break to do so.

The clear solution to this problem would be to move over to a territoriality-based tax system in which all taxes are levied depending on the tax rates prevailing in the country where the business is taking place. This would simplify the tax code; remove absurd barriers to capital returning home; and generally move to a globally harmonized system of corporate taxation.

A one-off exemption is a second-best attempt to deal with this problem. This poses a number of different problems -- in particular, businesses come to see these one-off exemptions as inevitable, and so stop repatriating profits in all other periods. This ends up "heightening the contradictions" in the corporate tax system, as it were, and ensures that exemptions become regularized.

The other chief complaint is that repatriated corporate profits don't go to productive purposes. This is the claim from Howard Gleckman at the Tax Policy center, who draws on research in the field. The paper he references finds that repatriated profits were largely dispersed to shareholders.

Here's the thing though -- those shareholders then went and did something with that money. Perhaps they reinvested in company shares; maybe they went and bought a yacht. In the case of your left-wing Keynesianism, you issue a bond for a dollar and then spend that dollar on some sector of the economy. That may not logically preclude an economic expansion, but you can see what the difficulty is. But in the case of this right-wing Keynesian policy; you do have a genuine influx of foreign cash into the economy. Perhaps corporations aren't the ones spending the money. But someone sure gets that money and spends it. To be sure, there is a parallel problem that a large enough capital influx will adjust exchange rates however.

In general; I'm increasingly skeptical of tests like the one in the paper I mentioned, where you have a specific experiment applied to some subgroup of the population and you try to learn about the response. Even if you get the identification right (and that paper spends a lot of time arguing that they have some); it's just difficult to extrapolate from there to think about what that might mean for an economy as a whole.

That makes me think this right-wing Keynesianism may be underrated. Moving to a better tax system is a win; and shifting cash domestically in the short-run may be a win too.

Saturday, June 25, 2011

Asset Prices, the Business Cycle, and Unemployment

A few months ago, I blogged about research done by Roger Farmer and Naryana Kocherlakota on understanding unemployment; and in particular relating trends in unemployment to asset markets and investor confidence.

The key issue is that it's difficult to understand why unemployment remains so high so far after the financial crisis. A real business cycle approach would look for real shocks to production; in particular idiosyncratic shocks to technology. Yet it appears that this recession involves a number of nominal and financial-sector related frictions difficult to rationalize using that model.

Another approach relies on New Keynesian thinking. In this view, prices are “sticky” as it is costly to adjust prices in the short-run in response to a moderate shock. This induces a friction in in economic activity, especially in the market for labor, that can be fixed through macroeconomic stabilization in the form of monetary or fiscal stimulus. However, if you look at scanner data, retail prices are actually fairly flexible. On top of that, the economy faced such a substantial shock, and we are sufficiently far out in the future, that surely price-setters have had the chance to adjust prices by now.

In short: the particular frictions and shocks underlying traditional macroeconomic models seem to be of limited relevance in explaining this recession. As a result, I’ve been trying to read up on alternate models — relying, for instance, on financial market frictions, household balance sheets, etc. Roger Farmer, in a new paper, offers up another such model that relies on old-style Keynesian thinking.

The basic logic comes out in this graph:

This shows asset prices and unemployment being closely linked throughout the business cycle; which isn’t a trivial fact. The logic is that asset prices follow bubbles and crashes due to self-fulfilling optimism and pessimism from investors. These booms and crashes result in larger social consequences in the form of higher unemployment through search frictions in the labor market.

In this model — as in some sense as in Keynes original work — investors do have rational expectations. They expect a bubble; and a bubble happens. They expect an economy that performs poorly over an extended period of time; and that too materializes.

Nevertheless, the paper still relies heavily on psychological assumptions about investor behavior. Investor confidence drives both asset prices, as well as willingness to hire. This response is, as I suggested in my last post, asymmetrical, as it is harder to hire than it is to fire.

I find this paper interesting as it brings the problem of unemployment into the domain of asset pricing. While Farmer emphasizes the psychological basis of bubbles and busts, someone like John Cochrane would emphasize how ultimately discount rates — the rates at which we value future income relative to current income — determine the values of current financial assets (which are just claims to future cash flows).

In Cochrane’s world — asset prices fluctuate in conjunction with macroeconomic outcomes. Is the economy looking bad? Do you anticipate losing your job, your business, or other such negative shock? If so, you wish to hold less risky assets. Yet we can’t all rebalance away from risk, as there are only so many stocks and bonds and so forth. Instead, the price of stocks and bonds fall in order to compensate us for bearing this sort of risk in a time of economic uncertainty.

Yet Farmer would point out that the process also works in reverse. High discount rates — equivalently, “pessimism” — felt by the owners of capital manifest themselves in an unwillingness to hire, particularly if there are frictions in the labor search process.

I suspect that tying Farmer’s model into a more "rational" model of asset prices that emphasizes the links between financial markets and real markets would amplify the multiple equilibrium nature of unemployment. This was the key feature of Keynes of course, and it’s interesting to see Farmer resuscitate this idea. And with unemployment at 9% or what have you it doesn’t seem implausible to think that numerous economic possibilities are open to us, depending on the nature of economic equilibria we end up at.

Sunday, June 12, 2011

Gurgaon is the Cyberpunk Utopia

The New York Times has a dystopian article on the burgeoning Indian city of Gurgaon. Alex Tabarrok rebuts with partial defense of the city, and I want to go much, much further.

To understand Gurgaon, you need to place in context with two failed modernist models for which it serves as a foil — Le Corbusier's Chandigarh, and Lutyens' Delhi.

Chandigarh is on the opposite side of the state of Haryana from Gurgaon, and is in many ways its complete antithesis. As it happens, there is also where I was born. The city was conceived by Jawaharlal Nehru as a future Administrative capital that would embody his rationalist, secular, modernist vision for an independent India. The city was largely designed by Le Corbusier, who had an overlapping modernist vision, and was fortunately unable to inflict this dream on too many other countries. Here is James Scott on the city in his Seeing Like a State:
Whereas road crossings in India had typically served as public
gathering places, Le Corbusier shifted the scale and arranged the zoning in order to prevent animated street scenes from developing. Notes one recent observer: "On the ground, the scale is so large and the width between meeting streets so great that one sees nothing but vast stretches of concrete paving with a few lone figures here and there. The small-scale street trader, the hawker or the rehris (barrows) have been banned from the city center, so that even where sources of interest and activity could be included, if only to reduce the concreted barrenness and authority of the chowk, these are not utilized."
As he goes on to detail, Le Corbusier built the sort of city Times readers might prefer to read about at a distance -- one with large boulevards and carefully planned and segregated townships. Yet this city is sterile, non-diverse, and in a certain sense unlivable.

Luytens' Delhi, too, was a forceful stamp of an alien vision on India. Designed as the center of the British Raj, it was rapidly appropriated as the center of the bureaucratic, license raj India.

Gurgaon came into existence, in a concrete and visceral sense, as the rejection of these modernist aspirations. Though near Delhi (and connected by a privatized highway), it is in the state of Haryana — and so did not suffer from the regulatory and tax impediments of the national capital. Its growth has taken place in reverse proportion to the stultifying effects of India's regulatory regime, which was partially dismantled starting in 1991.

Unlike the commercially and socially bleak Chandigarh, Gurgaon rapidly became a dynamic hub, home to both large industrial plants as well a torrent of service industries in fields ranging from IT to financial services to real estate. The local mall culture, though sneered at by the mandarins of Luytens' Delhi, reflects the consumerist aspirations of a new generation, while the nightlife is booming as well. Both Chandigarh and Gurgaon rank among the top three richest cities in India; yet Chandigarh derives much of its wealth from the income of bureaucrats. Gurgaon’s wealth is all privately generated.

Despite these substantial achievements, many people — even in India — react to Gurgaon with disdain. On paper or in a photo, Gurgaon is a messy place. This sense of disorder manifests itself most literally in the realm of unorganized and intermingled uses of property. When seen in a picture by those conditioned to "see like a state," this appears haphazard and disturbing. Surely, some state entity must come in and clean that up, and return us to an orderly world of happily segregated functions. Yet the form of such economically integrated units, though perhaps not visually appealing to an eye conditioned by Leviathan, are in fact most conducive to the functions of economic and social fulfillment, and are partially why immigrants flock to the city. There is a hidden internal logic here. Jane Jacobs would have hated Chandigarh, and perhaps come to love, or at least appreciate, Gurgaon.

Gurgaon tends to be lowly ranked on indices of where people would like to live based on “objective” criteria; yet regularly tops surveys of where people actually say they want to live. Surely the collective decisions of 1.5 million people count for more than the editorial decisions of magazines or the fleeting judgments of parachuting foreign journalists. Rather than asking Gurgaon to conform to your aesthetics; shift your aesthetics to accommodate Gurgaon.

Yet Gurgaon will handle just fine the concerns of well-intentioned leftist bloggers. It is wealthy and powerful enough to constitute a power center of its own, and various other public goods will come into the city soon enough through political pressure (the Delhi metro, for instance, is being extended there). Somehow, the city seems to have given everybody access to electricity, which is a challenge in other parts of India where the state is marginally more present.

More at risk are politically vulnerable slums. Like unplanned Gurgaon, the state sees these entities as blemishes on the earth to be destroyed. Dharavi for instance is a well-known slum in the heart of Mumbai, and is routinely at risk of destruction in resettlement plans.

What city planners rarely realize is that such slums, just as much as Gurgaon, reflect exciting engines of opportunity and capitalism. New York for instance has long been home to large centers of industry — the meatpacking district for instance. The advantages of density and transportation offer huge advantages for a number of industries; and indeed Dharavi is something of the commercial hub of Mumbai, home to thousands of business, tens of thousands of factories, while being the recycling center of the city. India has actually struggled to translate booming economic growth into employment gains — unlike in China, onerous labor laws have limited large-scale manufacturing employment. However, areas like Gurgaon and Dharavi, in their own ways, are the employment hotspots of the country.

They are also inclusive of newcomers. Millions of Indians hope to transition from a life of subsistence farming to something better. Yet regulatory restrictions on urban land, paired with city slicker xenophobia about foreign migrants, make this difficult. Only in Dharavi are there cheap enough rents and an inclusive enough attitude to absorb migrants, many of whom sojourn through the place over time to something a little nicer. Various redevelopment plans in motion would completely destroy this social fabric. Even if families receive comparable housing plots, the networked system of small industrial plants would be completely destroyed, and a valuable form of commercial growth would disappear. For more on this, see this Tedx talk by Matias Echanove and Rahul Srivastava. They point to pictures like this:

The left half of the picture is Dharavi; the right half is Tokyo. The reason they seem to blend right in is that well-situated historical cities like Tokyo tend to build organically up from their underlying source, rather than relying solely on state initiatives to place things in nice grids or dismantle everything in favor of high rises.

Areas like Dharavi and Gurgaon also represent one of India’s few strong areas of economic comparative advantages relative to China, a country with an economy three times as large. China's mega cities are actually relatively smaller than one might expect for a country of its level of development and urbanization — a legacy of controlled migration into urban areas. By contrast, India’s greater Delhi — including the capital region plus satellite cities like Gurgaon — has over 22 million people. This mass density and agglomeration of individuals facilitates a far greater degree of specialization and interaction, something that economics from Adam Smith on down have placed at the heart of economic growth.

To be sure, Gurgaon and Dharavi have real prolbems. But too frequently, urban developers use these problems as excuses to implement overweaning solutions that destroy local social capital, networks of economic activity, and the decentralized tricks that people come up with to solve local solutions. More Chandigarhs, Brasilias, or project housing aren't the way to handle urban problems. Just let these cities be and they'll surprise you.

Unemployment and Recalculation

There are two ways to think about current deep and persistent rates of unemployment. One point of view is that these merely reflect the poor rate of economic growth, and ought be remedied by stimulus either fiscal or monetary. Another point of view is that high unemployment reflects the degree of economic restructuring that needs to happen to cover the malinvestment of the housing boom; and so easy fixes are not available for the labor market. The first set of views are held by a number of people across the right and left; with the preference for fiscal/monetary stimulus varying by ideology. The second set of views are held by a motley of individuals, from Austrians to Raghuram Rajan, to Minnesota Fed President Narayana Kocherlakota, to Arnold Kling and his idea of PSST (patterns of sustainable specialization and trade).

One point of evidence in favor of the “structural” view is the pattern of hiring and firing — in which many jobs across a range of dying industries are disappearing. According to that school of thought, this indicates that those industries are experiencing a reallocative shock.

Ricardo Caballero comments on this in an interview with the Minnesota Fed:

Q: And should we be concerned about jobless recovery in the United States? Do you think there might now be a higher level of structural unemployment?

This was a time when the important work of Steve Davis and John Haltiwanger in documenting the nature of the process of job creation and destruction in U.S. manufacturing led to an explosion of research trying to explain this process.

One of the key features of their findings was that recessions come with sharp spikes in job destruction. Somehow, other researchers jumped to the conclusion that this spike meant that job reallocation was strongly countercyclical. That is, that reallocation increased during recessions: a sort of Schumpeterian cleansing. Many theories were written about this phenomenon.

Mohamad and I made the rather obvious observation that a spike in destruction in itself does not mean that reallocation increases during recessions, since this would also require that creation increases. Steve and John had already documented that job creation actually falls at impact. We explored whether the initial spike in destruction translated into abnormally high creation during the recovery phase of the cycle, which would be a dynamic version of the countercyclical reallocation story. Not only did we not find this increase in creation during the recovery, but we found that job creation was actually below normal levels. That is, cumulative restructuring is procyclical, not countercyclical.

We then went on to show that a model where financial constraints tighten as a result of the recession could explain such patterns. I think this is the connection with the current recovery. This was a recession which severely damaged the financial sector; hence, it is not surprising that hiring is so muted.

I don’t think this view is inconsistent with the idea that the economy does face long-term structural challenges in adapting to new social and technological changes. However, I’d say it tackles the idea that such reallocative challenges are an argument for weaker stimulative efforts. Rather, this seems to say that proper economic recovery goes hand in hand with reallocation. No need to view AD/PSST as opposed from the policy point of view.