Hurricanes and GDP at the Zero Bound

A blog about business and economics.
Oct. 29 2012 4:35 PM

Hurricanes and GDP at the Zero Bound

On the question of hurricanes and short-term macroeconomic indicators, here's how I would put it. Right now the American economy is in a recession. Recessions shouldn't happen. The planned saving behavior of firms and households ought to be balanced by the planned investment behavior of firms and households, creating a situation in which roughly all available resources are employed.

When that fails to happen—a recession—it's an indication that the interest rate is too high. A lower interest rate would, at the margin, decrease desire to save and increase desire to invest and bring the system closer to equilibrium. Cut the interest rate low enough and you've restored balance, creating a situation in which roughly all available resources are employed.

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But suppose that interest rates are zero. What happens then?

Well, then you've got a recession. The recession could be cured by unorthodox monetary policy or by fiscal policy measures, but it hasn't been. So you're left hoping that the marginal product of capital will increase, thus bringing savings and investment back into equilibrium. An exciting new technological discovery could make that happen. And so could a hurricane. If there are already a bunch of perfectly good cranes in town, then nobody wants to invest in new cranes, and the crane factory sits idle. But if a hurricane wrecks a bunch of cranes, then the marginal value of a new hurricane goes up, and people want to invest in new cranes.

Now before everyone starts screaming "broken windows fallacy," take note: This is a terrible solution to unemployment. By reducing society's stock of capital goods and consumer durables, the hurricane spurs new production into being. But it's also making us poorer.

The point I want to make about this isn't that hurricanes are "good for the economy." The important point is that suffering through a downturn without adequate fiscal and monetary stimulus amounts to rebalancing the economy through a slow-motion hurricane. We will, eventually, return to full employment. But we're getting there by allowing the per capita stock of capital goods (as it happens, mostly houses) and durables to deteriorate year after year. Eventually this will lead us to a rebalancing, but it's a form of rebalancing via impoverishment. Stimulus is much better.

Matthew Yglesias is the executive editor of Vox and author of The Rent Is Too Damn High.

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