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Vol. 7, No. 3
FEBRUARY 2012­­

EconomicLetter
Insights from the

Federal Reserve Bank of Dall as

Economic Rebounds in U.S. and Euro Zone:
Deceivingly Similar, Strikingly Different
by Anthony Landry and Carlos E.J.M. Zarazaga

While U.S. productivity
recovered most of
the ground lost during
the downturn, the
same thing didn’t occur
in the euro zone.

T

he global downturn following Lehman Brothers’ failure in
September 2008 has become known as the Great Recession for
good reason: It was the most severe global economic contraction since
the Great Depression. As the dust settles, patterns among key macroeconomic variables have emerged. Identifying them may make it possible to
understand the nature of the downturn and, thus, determine which policies
might best address its fallout.
We analyzed the trajectory of two widely watched macroeconomic
variables—real (inflation adjusted) output per working-age person (16 to
65 years old) and productivity—during the Great Recession and its aftermath. We looked at two major world economies, the United States and
the euro zone. On both sides of the Atlantic, real gross domestic product
(GDP) per capita has rebounded anemically from the Great Recession’s
trough.
This similarity, however, is deceiving because the trajectory of productivity in the two regions has differed. While U.S. productivity recovered
most of the ground lost during the downturn, the same thing didn’t occur
in the euro zone. This discrepancy is puzzling and holds important implications for the outlook in these two regions as well as for measures that
could invigorate the slow and fragile recovery.
Output Performance: Deceivingly Similar
The 2008–09 recession and its aftermath have been particularly difficult, as shown in Chart 1. The natural logarithms of real GDP per member
of the working-age population (multiplied by 100) for the U.S. and the
euro zone are represented by the solid lines, along with corresponding
prerecession trends, depicted by the dotted lines.1

The logarithmic transformation is
handy for two reasons. First, the natural logarithm of the real GDP series
grows linearly instead of exponentially.
Second, we can easily calculate the
percentage difference between any
two points by subtracting the values associated with them. Thus, it is
straightforward to establish that at the
trough of the latest U.S. recession, in
third quarter 2009, real GDP fell 12
percent relative to trend. Real GDP per
member in the working-age population was 125, and the trend value was
137. A similar calculation for the euro
zone indicates that real GDP per person in the working-age population was
approximately 7 percent below trend
in second quarter 2009.
These large declines from trend
are not the only features of the Great
Recession that the U.S. and the euro
zone share. After touching bottom,
the two economies started growing
again but at a rather dismal pace. The
rebounds have been so anemic that
real GDPs have been moving along
trajectories parallel to, but below, prerecession trends.

This suggests that something is
wrong in the U.S. and euro zone.
Several studies have documented that
usually the more severe the downturn,
the stronger the subsequent recovery.2 The fact that output per capita
in two major world economies is not
tracing a typical V-shape—but one
closer to an L-shape—deeply concerns
policymakers.
The International Monetary Fund
reported similar output performances
following most past recessions involving financial-sector crises.3 Therefore,
it is tempting to conclude that there
is nothing anomalous about the U.S.
and euro zone recoveries: They are
proceeding as expected, at the snail’s
pace typical of past similar episodes.4
This evidence is often presented as
supporting the view that financial crises are inevitably associated with slow
recoveries and, therefore, policymakers
can do little to speed the subsequent
rebound.
But viewing only the trajectory of
GDP may be misleading. It is necessary to look further. According to theory, a key determinant of the prosperity

Chart 1

U.S. and Euro Zone GDP Deceivingly Similar
100 x natural log of GDP per member of the working-age population
150
140
130

U.S.

120
110
100

Euro zone

90
80
70
’91

’92 ’93 ’94 ’95 ’96 ’97

’98 ’99 ’00 ’01 ’02 ’03

’04 ’05 ’06

’07 ’08 ’09 ’10 ’11

NOTE: Dotted lines indicate prerecession trend.
SOURCES: Organization for Economic Cooperation and Development; U.S. Bureau of Economic Analysis.

EconomicLetter 2

F edera l Re serve Bank of Dall as

of nations is the efficiency with which
they transform labor and capital inputs
into output. This dimension reveals a
striking departure between the U.S.
and euro zone recoveries.
Productivity Performance:
Strikingly Different
A key difference between rich and
poor nations is that rich ones combine
their capital and labor inputs more efficiently than poor ones do, economic
literature has shown. This efficiency is
called total factor productivity (TFP). It
seems reasonable to infer that TFP performances during the Great Recession
are as important as those of output
for understanding this contraction and
weak recovery.
We lack the data needed to assess
the recent dynamics of TFP in the
euro zone—figures, when available
on a regular basis, are published with
a long lag. One way around this is to
use labor productivity—measured as
real GDP per worker—as a proxy for
TFP. If we could use TFP, we would
measure the efficiency of the economy
by taking into account variations in
capital stock (capital input) and hours
worked (labor input). Labor productivity takes into account only variations in
employment—that is, in the number of
workers rather than hours worked.
In the case of the U.S., these two
series tend to display similar patterns
over periods of two to three years—
the time frame studied here—because
hours worked by the average household are relatively stable and investment flows are typically too small to
induce significant fluctuations in the
capital stock over short time spans. In
the euro zone, the use of labor productivity as a proxy for TFP is somewhat more problematic. A recent study
showed that hours worked per household are less stable over the business
cycle in many countries of this region
than in the U.S. 5 Still, it is reassuring that after taking into account the
potential bias introduced by this measure, the study’s authors came to the
same conclusion from their analysis

of the Great Recession downturn as
we did from our examination of the
available evidence for the subsequent
recovery. That evidence includes the
admittedly imperfect gauge of true
productivity plotted in Chart 2.
The chart shows the natural logarithms of labor productivity in the U.S.
and the euro zone—again multiplied
by 100—alongside their prerecession
trends. Euro zone labor productivity
traced the same L-shaped pattern as
real GDP did in Chart 1: Labor productivity fell sharply during the Great
Recession and never recovered relative
to its prerecession trend. This pattern
of labor productivity is consistent with
economic theory because a decline in
productivity decreases output as well.
If capital and labor inputs are combined with less efficiency than before,
the resulting output will be lower.
The behavior of U.S. labor productivity, however, is strikingly different. Labor productivity fell modestly
during the Great Recession and quickly
recovered to its prerecession trend.
The combination of an anemic recovery in real GDP with a strong rebound
in labor productivity is inconsistent
with economic intuition. If capital and
labor inputs are combined with more
efficiency, why isn’t output higher?
In fact, productivity and output
not moving in sync seems to be an
anomaly relative not only to the euro
zone, but also to past experience in
the U.S. (Chart 3). The dotted lines
in the chart display the percentage
deviations from trend of private sector
TFP (not just labor productivity measured by output per worker) around
the trough of the country’s two most
severe recessions in the last 30 years—
the Great Recession, shown in blue,
and the one that occurred in 1980–82,
depicted in orange. The solid blue and
orange lines provide the analogous
information for private-sector output per member of the working-age
population.
The chart seems to confirm that
TFP rising above trend—shown as the
horizontal line extending from “0”—

Chart 2

U.S., Euro Zone Labor Productivity Strikingly Different
100 x natural log of labor productivity
140
130

U.S.

120

110
100
Euro zone
90
80

70

’91 ’92 ’93 ’94 ’95 ’96 ’97

’98 ’99 ’00 ’01 ’02 ’03

’04 ’05 ’06

’07 ’08 ’09 ’10 ’11

NOTE: Dotted lines indicate prerecession trend.
SOURCES: Organization for Economic Cooperation and Development; U.S. Bureau of Economic Analysis.

Chart 3

U.S. Productivity and Output Not Moving in Sync As They
Did After Earlier Slump
Percent deviation from precrisis trend
6
4

Output
Total factor
productivity

2
0

Output–productivity gap
with above-trend
productivity, a rarity
after a slump

–2
–4
Total factor
productivity

–6
–8

Output

Great Recession
1980–82 downturn

–10
–12
1978
2005

1979
2006

1980
2007

1981
2008

1982
2009

1983
2010

1984
2011

SOURCE: “Fiscal Sentiment and the Weak Recovery from the Great Recession: A Quantitative Exploration,” by Finn E.
Kydland and Carlos E.J.M. Zarazaga, Federal Reserve Bank of Dallas Working Paper, forthcoming.

and output staying below it is a rarity.6
It didn’t happen in the euro zone this
time around. It didn’t happen in the
U.S. during an earlier slump of similar

F ederal Reserve Bank of Dall as

magnitude. It’s hard to make sense of
this anomalous development in the
wake of the Great Recession. The fact
that machines and workers seem to

3 EconomicLetter

EconomicLetter
be more productive in the U.S. should
induce that country’s firms to invest,
hire more workers and expand production. Instead, U.S. employment
and output lag, suggesting either TFP
measurement errors or economic friction that stymies the transmission of
productivity gains to output gains.
Nevertheless, productivity
advances in the U.S. may explain why
it has better navigated the financial
headwinds blowing from the euro
zone, where a sovereign-debt crisis is
prolonging the downturn’s upheaval.
By the same token, the weak euro
zone recovery is exactly what can be
expected given labor productivity’s
poor performance. Provided the measurement errors are not so large that
they invalidate the use of this variable
as a proxy for TFP, the low-productivity problem is one that euro zone policymakers must address to eventually
engineer a recovery strong enough to
restore output to its prerecession trend.
Meanwhile, the challenge for U.S. policymakers will be to figure out why,
despite large TFP gains, that hasn’t
happened yet in their own country.

a financial crisis or not, will permanently shift that
trend downward.
4

Mark Wynne advances this conjecture in his

analysis of the performance of GDP in the aftermath of financial crises in “The Sluggish Recovery from the Great Recession: Why There Is No
‘V’ Rebound This Time,” Federal Reserve Bank of
Dallas Economic Letter, vol. 6, no. 9, 2011.
5

“Aggregate Hours Worked in OECD Countries:

New Measurement and Implications for Business

is published by the
Federal Reserve Bank of Dallas. The views expressed
are those of the authors and should not be attributed
to the Federal Reserve Bank of Dallas or the Federal
Reserve System.
Articles may be reprinted on the condition that
the source is credited and a copy is provided to the
Research Department of the Federal Reserve Bank of
Dallas.
Economic Letter is available free of charge by
writing the Public Affairs Department, Federal Reserve
Bank of Dallas, P.O. Box 655906, Dallas, TX 752655906; by fax at 214-922-5268; or by telephone at
214-922-5254. This publication is available on the
Dallas Fed website, www.dallasfed.org.

Cycles,” by Lee E. Ohanian and Andrea Raffo,
Journal of Monetary Economics, vol. 59, no. 1,
pp. 40–56.
6

The trends underlying Chart 3, as calcu-

lated by the source, are implied by theoretical
relationships between TFP and output in a
model calibrated to long-run features of the U.S.
economy and are, therefore, not comparable with
the empirical linear trends of the previous charts.
Furthermore, the measure of output in Chart 3
is not real GDP per member of the working-age
population, as in Chart 1, but real GDP, net of
the value added by the government sector, per
member of the working-age population.
Richard W. Fisher
President and Chief Executive Officer
Helen E. Holcomb
First Vice President and Chief Operating Officer

Landry is a senior research economist and
Zarazaga is a senior research economist and
advisor in the Research Department at the Federal
Reserve Bank of Dallas.

Harvey Rosenblum
Executive Vice President and Director of Research

Notes

Director of Research Publications
Mine Yücel

1

The U.S. and euro zone prerecession trends are

linear from first quarter 1991 to fourth quarter
2007, when U.S. real GDP peaked.
2

See, for example, “Are Deep Recessions Fol-

lowed by Strong Recoveries?” by Mark Wynne
and Nathan S. Balke, Economics Letters, vol. 39,
no. 2, 1992, pp. 183–89.
3

International Monetary Fund, World Economic

Outlook, October 2009. It’s important to note that
the results of this study are influenced by the

Robert D. Hankins
Executive Vice President, Banking Supervision

Executive Editor
Jim Dolmas
Editor
Michael Weiss
Associate Editor
Kathy Thacker
Graphic Designer
Ellah Piña

inclusion of episodes in which output was above
trend before the financial crisis. To the extent that
output was converging to its deterministic trend
from above in the aftermath, no recovery should
be expected. Neither should it be when the output
trend is stochastic rather than deterministic. In
that case, any recession, whether associated with

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