How badly has the U.S. economy performed under President Barack Obama? Ronald Reagan posed the political version of this question in his presidential debate against Jimmy Carter in 1980, when he asked: "Are you better off than you were four years ago?" It is, naturally, the question Mitt Romney asks now.
At first glance, the answer is: just a little better off. In the second quarter of 2012, real gross domestic product was 5.2 per cent higher than in the fourth quarter of 2008, the last full quarter before Mr Obama took office. The seasonally adjusted unemployment rate of 7.8 per cent in September was the same as in January, 2009. Yet, since he took office when the economy was in the throes of a huge financial crisis, analysts must ask whether this performance is decent in the circumstances, as supporters argue, or disappointing, as opponents insist.
John Taylor, professor at Stanford University, a highly regarded macroeconomist, has no doubt of the answer. In a recent blog, he argues that strong growth normally follows U.S. financial crises, the exception to this rule being the current recovery. Moreover, he argues, bad policy is to blame. True, Prof. Taylor is a member of Mr. Romney's economic team. Yet the question remains: Is he right? The answer is: no. But it is important to ask why.
The first question is whether Prof. Taylor is comparing like with like. Against him is widespread agreement that the aftermaths of systemic financial crises are worse than those of more normal downturns. The seminal research of Carmen Reinhart and Kenneth Rogoff in their classic book, This Time is Different, has shaped this consensus. It is also supported by the work of the economic historian Alan Taylor, of the University of Virginia, included in a recent paper entitled The Great Leveraging .
Prof. Reinhart and Prof. Rogoff distinguish a "systemic financial crisis" as one characterized by a real estate bubble and high levels of debt. Neither of these preceded the recessions of 1973 and 1981. Both the precursors and results of the recent crisis were quite different from the downturns in the mid-1970s, early 1980s and early 1990s. This is true of real house prices, inflation, interest rates and debt .
The second question is whether speed of recovery is a good measure of success. The answer is: no. To understand this, focus on the systemic financial crises that began in 1893, 1907, 1929 and 2007, respectively. What marks out the recent recession is not the weakness of the recovery, but that of the contraction. The main reason the recovery seems weak was that the contraction was so mild, given the scale of the financial crisis. That was a huge policy success.
In their response to Prof. Bordo and Mr. Haubrich, Prof. Reinhart and Prof. Rogoff also note that the economic contraction after the recent crisis was smaller than after prior systemic crises. Moreover, five years on, real GDP per head, relative to the baseline, is higher than in the average of prior systemic crises. That is what matters. A stronger recovery from a steeper plunge is hardly a better outcome than a slower recovery from a milder plunge.
The third question is whether it makes sense to focus on U.S. experience alone. Prof. Bordo has complained that Prof. Reinhart and Prof. Rogoff lump together countries "with diverse institutions, financial structures and economic policies". But it beggars belief that the U.S. of the late 19th or early 20th centuries, with the gold standard, no deposit insurance, no central bank before 1913 and minimal federal spending is more similar to today's U.S. than Japan or Sweden in the 1990s or Spain and the UK today. Prof. Reinhart and Prof. Rogoff are surely right to reject this appeal to American exceptionalism. Beyond that, limiting the analysis to U.S. experience also limits the range of comparisons, thereby forcing the researchers to include many U.S. recessions that are of borderline relevance, at best, to the needed focus on systemic crises.
The international comparisons made by Prof. Reinhart and Prof. Rogoff turn out to be quite revealing. The performance of the U.S. in this crisis has been markedly better than the average of the other high-income countries that were hit by the recent wave of systemic banking crises . Again, the analysis supports the view that systemic financial crises do cause deeper and longer-lasting recessions. Using a database of more than 200 recessions over 140 years in 14 high-income countries, Prof. Taylor argues that the combination of a credit boom with a financial crisis imposes "abnormally severe downward pressures on growth, prices and capital formation for sustained periods."
In sum, we have no reason to regard the performance of the U.S. economy under President Obama as poor, given the conditions he inherited. But this does not mean that recovery could not have been far stronger. Policy was insufficiently supportive of a stronger recovery. That is partly because the administration underestimated the forces for contraction. It is still more because of the opposition of the Republicans to any stimulus. In an economy afflicted by the implosion of a huge credit boom, the forces for contraction were bound to be both strong and enduring. With interest rates at zero, the effectiveness of monetary policy was limited. Given this, the American Recovery and Reinvestment Act, which amounted to an average of a little under 2 per cent of GDP in the years it was effective, was plainly too small.
The great achievement of policy was to limit the severity of the post-crisis recession. This is largely due to the Federal Reserve and the decision to prevent a financial collapse in the autumn of 2008. But it is also due to sensible, albeit limited, action by the administration. Moreover, by historical and international comparisons, the U.S. economy has performed quite well. Focusing on the recovery, without looking at the contraction, is clearly misleading. Finally, to the extent that the recovery was not stronger, the obstructionism of Republicans in Congress has to bear a sizable part of the blame. But the big question is: What comes next? Who has the policies to ensure a strong and sustained U.S. recovery? I intend to examine that question next week.