ELI DOURADO recently wrote that he thought America's economy was no longer in the short run, within which unemployment could be chalked up to weak demand. Lots of people, including me, wrote to disagree, and Mr Dourado has now responded. I have to say I find his dismissal of much of the criticism unduly breezy, but rather than go around again on old points let's address his key claim head on. He says:

The empirical point is summed up in the graph below. NGDP grew around 5 percent per year until around 2008, and then it fell, and then it grew at around 5 percent—or slightly less—per year again beginning in mid 2009. These facts are well known, but I bring them up here because they do constrain the kind of stories we can tell about the economy. Any story you tell has to contain a one-time shock that ended years ago, and it has to be consistent with NGDP that has grown at about the same rate over the last 3 years as it did before the shock arrived... NGDP is almost 10 percent higher now than it was at the pre-crash peak. The number of people employed, even with population growth, is still below the pre-crash peak. Even assuming that insider nominal wages are totally inflexible, nominal output per worker has grown fast enough that insider real wages have probably adjusted. Furthermore, in five years, a non-trivial fraction of insiders retire or change jobs.

Let's look at some charts. First, here is the year-on-year change in NGDP since 1990:

So, the first thing to note is that NGDP growth is clearly not back to the trend rate for recent expansions. Nominal output routinely grew above 5% per year during the boom of the 1990s (with an average closer to 7% than 5% during the latter, stronger half of that period). Nominal growth decelerated slightly during the 2000s expansion but was clearly and persistently above 5% during the period of meaningful employment growth. Nominal output then shrank at a pace matched only in the postwar period by demobilisation before settling at a rate persistently below 5%. Average year-on-year growth over the whole of this period, including recessions, is 4.7%. Average growth since the end of this recession has been 3.1%. Average growth since the beginning of 2010 has been 3.9%. Now let's add the change in employment:

The first thing that jumps out is just how closely linked these two series are. They move with each other, of course, but it also looks as though the steady downshift in NGDP growth from the 1990s to the 2000s to the 2010s is matched by a downshift in employment growth. This isn't always the case, of course. Here's what it looks like when the central bank attempts to raise demand above potential output:

The two lines still rise and fall together, but a steady shift upward in NGDP growth is not matched by a steady shift upward in employment growth. Instead, you simply get more inflation. Mr Dourado's contention is that we're now in this sort of world. I believe he's suggesting that there has been ample time for workers to adjust their wages downward, that if they remain unemployed now it is because they're unemployable, and that further increases in NGDP growth will therefore lead to more inflation than employment growth. I don't agree. After the recession, NGDP growth settled at a rate below the pre-crisis norm. Put differently, growth in spending in each quarter rose by less than everyone had become accustomed to. To maintain employment growth rates at a lower NGDP growth rate, an economy has to squeeze more incomes into the same rise in spending. That implies a need to reduce nominal incomes, which is difficult to do, as wages are sticky. But it's more complicated than that. The economy isn't simply trying to maintain job growth rates at a lower rate of nominal growth. It's also trying to reabsorb all those millions of workers that were shunted into unemployment during the recession. To do that, the economy would need to fit a lot more incomes into a given rise in nominal spending, and that would require big declines in nominal incomes, which are very hard to achieve, as wages are sticky. But it's more complicated than that. Even in tough times, some people get raises. Those people capture some of the growth in nominal incomes, leaving a smaller chunk available to go to new incomes. And the problem arises from the truncation of wage changes at the bottom end:

That chart, which you can find here, uses data from 2011 (not that long ago!). Binding nominal rigidity, unsurprisingly, is strongly countercyclical; it rises as the economy tanks. During this cycle, the share of all workers experiencing flat year-on-year pay spiked to 16%. As of last year, that rate had retreated slightly from the peak but remained well above the pre-crisis level. Return of that figure to a "normal" level might well be one useful way to date the end of the short run, and America's economy is obviously not there yet. (One interesting aside: wages appear to have been stickiest in the construction sector, perhaps because the complete collapse of the industry meant that wage reductions were unlikely to have any effect on employment prospects. Workers may instead be waiting for the industry's inevitable recovery. To the extent that that recovery has been delayed by insufficient NGDP growth, and will be accelerated by QE3, new easing may have a strong positive effect on employment growth.) So far we have established that the level of NGDP tumbled in the recession and growth recovered to a rate below the pre-crisis norm. That has forced nominal wage reductions on much of the workforce. Data indicate that wages are slowly adjusting downward, but that this adjustment is by no means complete. But there is one other thing to consider. The Federal Reserve's choice to allow only a slow recovery in NGDP has essentially created a bottleneck in the economy, behind which a large crowd of would-be workers is swelling. That crowd complicates the process of finding a job, even for well-qualified workers. A given open position will attract hundreds of applications, greatly reducing the odds of an individual getting the position and greatly raising the average time to find a job. It may take an unemployed worker a while to perceive this dynamic and to understand that aggressive action might be necessary to attract attention: a willingness to work for free (or "intern") for long periods of time, for instance, or a decision to invest in new traning and education, or a creative application strategy. Even then the strategy may go unnoticed for some time. And all the while, the worker is becoming "stale"; employers increasingly suspect that long-term unemployment may signal a worker's flaws. Such workers would need to drop wage demands even lower to find a job match.

But workers may be slow to perceive this dynamic and to lower wage expectations enough to find work. Or they may perceive it perfectly well and conclude that there is little sense in trying to find work until the backlog is reduced. These workers, and especially the young people that fall into this category, don't necessarily represent victims of hysteresis. They may opt to stay in school longer. They may perceive that at entry-level positions on-the-job training accounts for most of the requisite human capital, and so there is little harm in living with parents and goofing off until the labour market tightens. If unemployment is concentrated among young workers with only fledgling networks of connections to labour markets, erosion of those connections isn't much of a threat, either. These individuals are, at worst, semi-structurally unemployed; they are quite likely to rejoin the labour force and the ranks of the employed as soon as the queue for work shrinks.

In my view, it doesn't seem unreasonable to conclude that three years of recovery is way too little time for wages to either adjust entirely or for the long-term unemployed to fall completely and permanently out of the labour force. We can't be entirely sure of this unless the Fed actually allows a burst of much faster NGDP growth and the result is a disappointing increase in employment. Given the way the two variables have moved in recent years, that would shock me.

One final note: Tyler Cowen expresses some discomfort with this view of NGDP, that it is a tangible and scarce thing that can only be spread around so thinly. He writes:

My framing is different. My framing is that the private sector can manufacture its own ngdp. It can do so by trade and it can do so by credit and of course velocity is endogenous to the available gains from trade. Most of the major central banks are, today, not obsessed with snuffing out recovery and increases in real output. To say “ngdp is low,” or “ngdp is on a low growth path,” or “ngdp is below trend,” and so on — be very careful! Those claims do not necessarily have causal force. Arguably they are simply repeating, in a new and somewhat different language, the point that the private sector has not seen fit to engage in more trade, credit creation, velocity acceleration, and so on.

That's a fair point. But it's one I was trying to get at in my post on negative demand externalities. The Fed's role can be viewed not as turning on the NGDP machine and creating more NGDP to distribute to private firms and households but as coordinating expectations across the private sector in order to arrive at a better equilibrium. If the Fed fails to play this coordinating role, the market may not be able to clear on its own. Firms are now building more and selling more, but we need them to build and sell a lot more if the stock of unemployed workers is to return to normal levels. But right now, firms are doing the equivalent of standing around saying to each other, "Well, I'll build a lot more if you buy a lot more", "Well, I'll buy a lot more, if you hire a lot more", and around and around. The Fed can and should put out word that now is the time for everyone to take the leap.