Since I posted this graph, I should post the follow-up from Justin Wolfers:
Taylor’s conclusion: the data on spending shares show that the most effective way to reduce unemployment is to raise investment as a share of GDP. But why begin the scatter plot in 1990? There’s no good reason. In fact, most folks typically download the entire history of available macro data. So let’s see what happens if we extend it back to, say, 1970:
Hmm… What conclusions should we draw about this relationship? And now why do you think Taylor began his sample in 1990?
Actually, we should use all the available data. The chart below goes back to 1948, when these series—in their current form—began:
Now what’s your conclusion?
Here’s Mankiw’s assessment of Taylor’s claim: There’s no doubt that the strength of the correlation is impressive.
But when you look beyond the cherry-picked sample, the correlation is a decidedly unimpressive -0.14.
Here’s my conclusion: On balance, times in which the investment share is higher, are slightly more likely to be good times. But I’m not sure why. Is it—as Taylor asserts—that high investment shares create good times? Or is it that good times encourage investment? Or is it a third factor—perhaps in good times the government doesn’t need to prime the fiscal pump, and so the investment share is higher? Or is it something else?
Be wary of economists wielding short samples.
Paul Krugman on Taylor:
What’s Behind Low Investment?, by Paul Krugman: This post by John Taylor is getting a lot of attention, because it does show a striking correlation between investment and unemployment
But when Taylor leaps from that correlation to saying that what we need for economic recovery is to “lighten up on the anti-business sentiment coming out of Washington,” I wonder what is going on in his head.
I mean, Taylor presents another graph, showing a plunge in fixed investment since 2006:
But that’s overall fixed investment. Let’s decompose it:
It’s mostly the housing bust! Yes, business investment is low — but no lower than you might expect given the depressed state of the economy. In fact, business investment is roughly the same percentage of GDP now that it was at the same stage of the much milder 2001 recession.
What the data actually say is that we had a catastrophic housing bust and consumer pullback, and that businesses have, predictably, cut back on investment in the face of excess capacity. The rest is just politically motivated mythology.