Do you remember Friedman’s “plucking model”?

Clark Johnson’s paper on the Great Recession has reminded me of Milton Friedman’s so-called “Plucking model” as Johnson mentions Friedman original 1966 paper on the Plucking model. I haven’t thought of the Plucking model for some time, but it is indeed an important contribution to economic theory which in my view is somewhat under-appreciated.

At the core of the Plucking model is that the business cycle is asymmetrical. If you studies modern day textbooks on Macroeconomics it will talk about the “output gap” as it is something we can observe in the real world and a lot of econometric modeling is done under the assumption that real GDP move symmetrically around “potential GDP” over time.

The idea in the Plucking model is, however, that the business cycle really can’t be symmetrical as no economy can produce more than at full capacity. Hence, all shocks in the model will have to be negative shocks – or shocks to the potential GDP. Simply expressed negative shocks are demand shocks and positive shocks are supply shocks – and Friedman assumes that the demand shocks dominates.

A numbers of older and relatively new research confirms empirically the the Plucking model, but for some reason it is not getting a lot of attention.

A key implication of the Plucking model is that there is not correlation between the extent and the size of the “boom” prior to a crisis and how fast the recovery is afterwards. The implication of this is that the idea of “The New Normal” where we will have to have lower growth in the coming years because of “overspending” prior to the crisis simply does not find support in economic history.

Here is a recent interesting paper that finds empirical support for the Plucking model – including for the period covering the Great Recession.

Needless to say – Austrian business cycle fanatics do not agree with the conclusions in the Plucking model…

More research on the Plucking model would be interesting and it would be interesting to see how Market Monetarists can learn from the model.

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5 Comments

  1. Rob

     /  October 23, 2011

    Regarding your comments on Austrian fanatics:

    You may be interested in Roger Garrison’s Austrians view of this model if you haven’t seen it:

    http://www.auburn.edu/~garriro/fm1pluck.htm

    I believe he does a good job of showing that the model fits into the Austrian framework quite well.

    Reply
  2. John Hall

     /  October 23, 2011

    As far as I can recall you can estimate a plucking-type model by regressing log changes on GDP growth against the size of the output gap in the previous period (or adding in terms so that there is an asymmetry in above or below the output gap). I don’t recall how good that fit is, but I prefer a regime-switching framework to this. However, you could estimate the plucking model with regime switching. For instance, sometimes the coefficient on the lag output gap could be big and sometimes small.

    Reply
  3. John, that makes sense – even though just using the output gap does not take into account the expected asymmetrical response to a negative and a “positive” output (well, a positive output gap does not exist in the model…).

    I am no expert on econometrics, but there could be a story story to pursue there…

    Reply
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