“Our fire is raging, and the water buckets are empty”
You going to want to see this.
Seems some of us have a lot of time on our hands. In the case of Tim Kane, over at growthology.org, this idle time provided him the opportunity to create what he believes is a graphical illustration of exactly how ineffective Washington’s economic polices are at containing the present catastrophe.
According to Kane, the Depression Index can be thought of as a measure of Washington’s capacity to employ its policy tools to fight an economic downturn.
I developed the measure to help get a grip on how bad the macroeconomic situation in the U.S. actually is, having made this same point among colleagues: “This recession is fundamentally worse and different than anything since the Great Depression for one reason (and maybe more). The only comparable spikes in unemployment in modern history happened when the central bank caused interest rates to rise, episodes in 1974 and 1980-82. This time, the Fed is pushing rates in the opposite extreme, with the same outcome.” I decide to quantify my argument, but extended the logic to consider the other policy tool, counter-cyclical fiscal policy (deficit spending and lower taxes). It is also often used to fight recessions, but this tool has also been stretched to the extreme as well.
Kane tell us how the index works:
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.
Kane wants to be pretty clear about what it all means:
What the index tells me, at least, is simply that policy capacity is overstretched. I tend to be dismissive of actual “depression” talk, but this index honestly makes me recognize that the macro economy is in an extraordinarily abnormal situation, and normal analytical tools, models, forecasts may not be worth very much.