David Altig Schools Me on Business Cycles

In a post where I praised Bruce Bartlett, I tried the following experiment at comparing long-term growth rates:

We often hear about average annual real GDP growth being around 3.5%. This was true for the period after World War II up to the end of the Carter Administration. Since then?

From 1980QIV to 1992QIV, average annual real GDP growth = 3.0%.

From 1992QIV to 2000QIV, average annual real GDP growth = 3.6%.

From 2000QIV to 2006QIV, average annual real GDP growth = 2.6%.

Notice something? During the low tax eras (Reagan-Bush41 and Bush43), we witnessed lower growth rates. During the Clinton Administration – which began with its fiscally responsible policies with a tax rate increase – we saw strong growth. Maybe part of the explanation has to do with the impact on national savings from fiscal irresponsibility justified by phony free lunch promises.

David Altig objects:

I have a bit of a problem with the evidence here. To get the gist of my objection, take the following quiz:

Which one of these time periods did not include a recession?

a. 1980QIV to 1992QIV
b. 1992QIV to 2000QIV
c. 2000QIV to 2006QIV

If you answered b, you win the gold star. And if you knew that, are you really surprised that the period from 1992 through 2000 had higher average growth than the other two periods, which did include recessions? Suppose we instead make the comparisons including only the expansion years of the Reagan-Bush41 and Bush43 administrations? Here’s what you get:
From 1983 to 1989, average annual real GDP growth = 4.3%.

From 1992 to 2000, average annual real GDP growth = 3.7%.

From 2002 to 2006, average annual real GDP growth = 2.9%.

You could just as well look at those numbers and conclude that potential GDP growth – measured cycle to cycle – is declining through time. And if you accept pgl’s characterization of irresponsible policy, followed by responsible policy, followed by irresponsble policy, you might then conclude that policy has very little to do with that trend.

David has a point here, but I have to object to how he is making it. Let me explain by talking about his and my characterization of the Reagan years. I think David and I can agree that this 1983 to 1989 period was one from the bottom of a rather deep recession to the top of the boom that subsequently followed. So part of the high growth rate observed during this period was from normal Keynesian effects of returning to full employment. Now if one thinks of the economy that Reagan inherited from Carter (1980QIV) and the one that Clinton inherited from Bush41 (1992QIV), neither was exactly at full employment. But we had similar unemployment rates as well as the beginning of tepid recoveries from mild recessions. My case for using this time frame to estimate long-term growth is that we were in similar situations in regards the business cycle at the beginning of my 12 year period and at the end of it.

So what is David’s point? The eight years of the Clinton term in office began with the economy that was below full employment and ended with the economy being very near full employment. I will concede that the observed 3.6% average annual growth rate was in part due to Keynesian effects. But to suggest that the period from 1980QIV to 1992QIV proves that the free lunch supply-siders have it right is absurd. Of course, David is not trying to make this point.