A Depression Index
Green shoots? Are you serious? This crash isn’t over yet, but the mainstream media is so hungry for a new storyline that it risks detaching from reality. Perhaps the stark reality of this recession can only be understood in pictures, so I created a depression index to make it clear. This index measures not just the weakness of the economy, but the weakness of macro policy capacity as well.
Economic Capacity Underutilized, Media Oblivious
When the government’s Employment Situation report was published last month, it inspired some laughable adjective pairings. David Leonhardt of the New York Times called it "Dreadful, Yet Encouraging." The front page of Washington Post practically gushed to Beltway readers that the jobs report offered the, “strongest evidence yet that the recession is moderating.” Stop. When a 0.4 point increase in the national unemployment rate is reported as the best evidence of economic improvement, it’s time to raise your eyebrows. When the May report was released last Friday, it showed the unemployment rate increasing another 0.5 points. This is not the time for the media to don rose-colored glasses.
Here’s the reality: Since World War Two, there have been 39 monthly reports in which the unemployment rate increased by 0.4 points or more. How many of those instances have occurred in this recession? Nine. Only two post-war recessions are comparable in severity, 1974 and 1980 (see chart). But this one is the worst. In a normal downturn, the rate of unemployment rises a net 2 or 3 points. The current spike of 4.5 points is matched only by the back-to-back recessions of the 1980s, this time in 17 months compared to 34 then.
A Sense of History
If it was macro pain alone that I wanted to measure, I would turn to the famous misery index, made famous during the 1976 presidential election by Jimmy Carter. He cited the misery index – simply the rate of unemployment plus the rate of inflation – of 13.6 as an indictment of Republican policies. Four years later, Ronald Reagan noticed the misery index was up to 22.0 (all this comes from the scandalously reliable Wikipedia.org), and asked during the only presidential debate of 1980, “Are you better off now than you were four years ago?” Today, the misery index seems mild by comparison. With no inflation to speak of, it measures a mere 9.4, same as the unemployment rate. But misery alone does not tell you how bad things are.
The real cause for alarm is how little capacity our policymakers have to fight the recession. Remember, in the 1980s the Federal Reserve was doing everything in its power to cause a downturn (and wrench out inflation), but today’s Fed is doing everything it can to stop one – with roughly the same result. The Fed was also raising interest rates before the 1974 recession. In contrast, Bernanke’s Fed has slashed the overnight fed funds rate from a monthly average of 5.25 in late 2006 to near zero. While the effect of monetary policy is known to lag, the rate gun is out of ammo.
The other policy tool, if you believe the hype, is fiscal stimulus. Although deficit spending has been used almost constantly since the mid-1960s at around 4 percent of GDP, it was never more than 6 percent until this year. The Obama administration's Office of Management and Budget (OMB) says the deficit will be 13.9 percent of GDP this year. Fair to assume that gun is “out of ammo,” also?
Index of Economic and Policy Capacity
To make the situation clear, I thought it would be useful to combine the three indicators of economic and policy capacity into a simple depression index. I define the depression index as equal to the monthly average fed funds rate plus the surplus(deficit) as a percentage of GDP minus the rate of unemployment.
In a stable economy, the depression index would probably hover around zero, rising during healthy times and dropping below zero when the economy is weak and/or fragile. For example, the index rose above zero during the late 1990s when unemployment was relatively low, the budget briefly went into surplus, and Fed funds rate was around 5 percent. During the last sixty years, this index only touched below 10 points on two brief occasions: one month in late 1992 and four months during the middle of 2003. The Fed funds rate was 1.0 that summer and the budget deficit was 5 percent of GDP, yielding a policy capacity of negative 4. Since the unemployment rate peaked at 6.3 percentage points that summer, the overall depression index measured negative 10.
This spring, unemployment is spiking and both policies are being exhausted to stop it. The effect is a depression index that is not only the worst on record, but twice as low as ever before. The depression index is now negative 23.1. A metaphor for the index is something that measures the heat of a fire and how much water the firefighters have to douse it. Our fire is raging, and the water buckets are empty.
Recovery is going to have to come from the private sector. Indeed, research shows that new firms create new jobs, as obvious as that may sound. What we need then is less emphasis on monetary policy and fiscal policy, and more on growth policy.
On that note, I suppose a third policy could be considered for inclusion in the depression index. Taxes. Lower tax rates are known to encourage economic growth, and tax rate cuts have been utilized throughout history to fight recessions. Then again, given the policy preferences in D.C. nowadays, I decided not to include average tax rates in the index. It would be too depressing.
Tim Kane, Ph.D., is a senior fellow at the Kauffman Foundation and coauthor of Growthology.org.