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    Business Cycles

    Copyright:

    © All Rights Reserved
    Download as PDF or read online from Scribd
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    Download as pdf
    100 views12 pages

    Rock Creek Business Cycles

    Uploaded by

    fjaten
    Business Cycles

    Copyright:

    © All Rights Reserved
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    Rock Creek "THE BIGGEST PUZZLE: UNDERSTANDING BUSINESS CYCLES, ‘his fal caf wih totions of presentation made by ese Enho: reset Serior _ Adviser at Rack Creek, on October 16, 2017. I.introduction meena leis d decephivs. ts heny mats move a meen pecans of eptring by canal bakers respong to woth, whl the cara tarts sd the ‘aero alevite cone Conese igh the Uwe oe tow te it Yur o> Swseereant teh se nae suite The ptt of growth and dene of the economy cles ns nd the central puzzle in economics, challenging miro and macro economist ae, "My goal inthis paper isto review the history of both theory and data on the businass cycle. find ito be a rich and fascinating stor. There's no unfed theory and no single model has yet ‘been created to forecast tudowms. The work of ohn Maynard Keynes marked a turing point In what variables to focus on, with fiscal model folowing in his fctsteps and monetary models arguing agaist his poi stance, 1 was lucky to come eros a highly readabée and encompassing bok by Profesor Tol Kroop 2 Corel College in iowa.” He urate the book fr bi undergrduste student Who were not ‘athematcsl inclined. Knoop’ book wil win no prices but It sitio educators ad yan ‘readers. this dcusion, | rely heavy en notes rom his book. My bibliography of reading abo includes: several oustanding papers published by the National @ureau of Economic Research (NBER). particulat Victor Zamovite is high regarded for his books and many papers onthe topic But admiredthe wey which 000’ volume managed ro encomoass the fall menu of ideas, both historia! and current ‘aaopisoverarcing” premise tenar-"noxhing- Improves SISTA O- OY MES BN ‘macrconomics works mare than economic unt Recessions and depressions are "amt om “et ane Gow, That Soto gat 207 slit ‘to tes Go omni Rene ep bm ut eth ag, SRI | WORE ET OR TTT HSS TSE 1 Rock Creek close as economists can get to sclontife experiments. The Great Depression was the tage for ‘economies moving from miro to mact, with Keyes tthe ulrum. Knoop has three organizing > questions: ‘Theres no consensus on causes of recessions. Take one example: the recession of 1990-199, in ‘the wake ofthe Gulf War. Was it caused by @decne in DEMAND wien consumer confidence ‘was hit bythe shock of war, or wast caused bythe decrease n money supply by the Fed to ‘ward off lation from increased ol prices? Or was it caused bya decrease ino SUPPLY when -or perhaps the delayed effects ofthe tax facesions have rea word effects, hurting the poor and volnrabe th _homlede ese, poverty increases, diorce rates increase, bth rats deine, bor sis decline and the clustering of manufacturing can lead to whole "communis ng destroy He could pret hem the or pul ip ery llr, pce. Ad be phey Sheced Happan h) stumpret Sasa, Ves pee M4 we have Ar Joys now. 1, How do we mark the business eyele? ‘You might be surprised to learn that the definition and making of business cyces ea tak that is formaty handled bythe “Business Cyle Outing Committee” ofthe NBER. A recession occurs ‘when 2 "significant decline in economic atvt spreads across the economy and can ast from a few months to more than a year” The peak is when GDP reaches its highest level belore decline andthe trough is the lowest level before begins 10 se. Wating for data means you ‘can only declare the recession months after ihas begun. A depression | Informally considered ‘Farop oF more than 10%, which has not been experienced since the 1930's “The leading and lagging indicators of downturns are derived from experience and are often reportd inthe finandal prez. One important technical note fe hat “to eau tho ele ‘component of macroeconomic dat, the movements consistent with trend behavior must ba. {er ath te nto mtr aero bom tS ar, TES Teme Rare] Woegh ES] Tone DTT Fe TST 2 Rock Creek sects nc aD tos ae Se armenamtae _average length rom trough to trough ofa business cycle.® Knoop comes up with even basic business cyte acs: 1 Business cycle vary @ lt in size and duration, 1980-81 was shor but steep ating only se months, fellow by an expansion of 12 months. The longest recession was 193337, lasting 43. months: While the longest expansion ended in 981 after ten vents (12) ‘month, Thatisthe one:we-aaaguisgnays.? 2. usness cycles are not symmetrical. n the US. expansions are twice as long as recessions but the downturn is steeper than the slower growth in the upturn. Ths i more or less the general ala actoss countries dum 3 Business cys have moderated over tne; recesions are shorter and expansions Rug longer. 4, ‘The datas dominated by the declines ofthe Great Depression and the bounce back of ‘Wold War 5. The components of GDP (conumpton, lavestment, government spending, and net exports) are more volatie than GDP over Investment durable-consumatian-and, ——+ fipors sore volte. Nondurable consumption gounmest-nuschases 0d Sasa tly inno sac ere taro care Loven SOP in recessions and invastmat i tne Jeading indestor of business cle tumne, A, 66, There ave big changes in the labor market during recessions. Unomplovment is, _countereylial. If goes up with decines in economic activity. But eal wages are not ‘consistent correlited because infltion not wel corel 7. Fray, sins ces are more severe in le-deveonedeconamiss than neater With the present runiup in prices inthe stock marke, itis important to note that stock pricas fare much more volte than GOP. So stock pies can gve false signals Al the fancil press “kee ans cp rs nen mt fm eam Bo it: ae ‘haar ree sen op, Ton ene re tcnome Unease ae ‘i ta ome je ams: Reso Cpe fom oom Bt Bs ane TRE RTT WOR OT MT ean TS ae TST a Rock Creek aout the current market highs cannot be relied on a: signal of GOP alec, They vellect consumer confidence, another highly volatile factor. Early economic theories onthe business ele aly theories onthe business cycle, before the Great Depression, focused on mica factors and tid-not For example, economists saw cyeles in agrcuural production, with names Ike the “sunspot” theory and the “cobweb theory (farmers plant what ‘grew well the yar before). Thomas Maths belongs within hs exp. ‘There were ako monetary theoves of cycles under the gold standard, ae # worked its way ‘through the trade balance, causing demand to be constrained. And there were houschold ‘consumption theories, under which housahols save more of thelr Income as Income ses. ‘The Cassa! model, based on concepts of Adam Smith, David Ricardo, Jean-Baptiste Say and John Stuart Wil ested on thre assumptions: 1) There was prfect competion n all market; 2) decisions were made onthe basis af ral pices (no money lusion); and 3) the economvs based on one set of preferences encompassing everyone. Elegant, but wrong on all tree In these modes, demand only detemines pics, whieh are constant in real terms. Suply factors are more important, affect labor, capital, ond technology. The lassi! prince, kitown as Ss aw, that supply creates its own demand” Susiness cies were not caused bby permanent changes in supply; they were the ou Changes in taxes or regulation, This isthe basis of the “Tbser faire” approach that prescribes Feting the markets function without government intervention, ‘And thn came John Maynard Keynes. 1V. Keynes and Keynesian Kayes rapes fon ener rented macoaconamks by sfjegting al he fais nan econo nd psting he fist quastgeneral equlrum model fcudng goods, abr, mane, and bond markets. He {ound the clase model argument, that al unemployment was voluntary, tobe ofensie and Incuting,2¢ wall fake, He thought conumtion and goverment demand wee, hot Inhereny unstable, but that investment demand unstable because depends on tant _urlets which are subject 6 tre ucadtainy.People have no bass on which to pred the future 8 one cannot really speak of rek. The busines cycle Is the outcome of Keynes farnous "gen ath Bue eam: nde on Oe omoma Bat es Pe 4 Rock Creek ‘animal spits whereby expectations create insabliy,in asset macets Jnvestment, and regate demand.” When ouput als blouthe potential of the economy, fllerployment i Unde 0 for Keynes, changes nGpectiion3preste downturns and goverment needs 9 stoi demand through monetary oF Fal poly. But he goes on to eliminate monetary {nstrumens because ofthe danger ofthe “haut,” when interest ates fa 10 fr, Thal hell that lead to defi financing to smooth out the busin Alter Keys, thera was an explosion of research by young economists who sought to beng ‘theoretical discipline to Keynes wrings, and to elaborate a formal Keynesian theory. You may recall the IS/LM model from school das, In which supply is 2 horizontal ine and it all about ‘demand, Other model focus on consumption more than Investment and thus defect attention from the financial markets, in the monetary ate, there was the Philips Curve witha negative relationship D ver heen In 1965, ln Binder dined Keynesian economies via ive princes wens yey 1LAaaregate demands volte ands the source of business yc fluctuations 2. In the short run, output and-employment-ace-moreolatie than pies and wages, which are "leks 3. Following recession, the return to potential output aes place ver slowly; 4. Monetary and fiscal policy an be used to stable output and 5s. Keynesians are more worried about high unemployment than high inflation. DISGenm/ eX {As Knoop puts keynes so clearly defined the sues relating tothe debate that all ofthe work ‘on business cycles since The General Theory can be thought of as a erique of his and his follower’ inertial models of what causes recessions and depressions" V. Cites ofthe Keynesians Bia ees te ame given to one grup of cris who were steptal of models ‘and quantitative approaches to business cigs. Economists Ie Joseph Schumpeter and Free Hawk beloved that th not some representative agent of al; ‘that a lack of information & atthe heart ofthe dscpine; and that capitalst economies evoWe ‘yer me du to actors ke technology. “According to the Austins, one ofthe primary fllures of me iuce He STUDI d Se "ong sh une Gott nko on Dp fom Ro Bt St Se a 5 Rock Creek "Moneta like Miton Friedman took 2 vory diferent view and elaborted so-called now sical models based on a similar idea that perfect information does not ext and that ‘governments cause prolams rather than provide solutions. Instead of having ceatral banks ‘manage money suppl, FHledman recommended the adoption of a money growth rule that ‘would avoid policy swings and stabilze growth. Inflation shoul be kept low and steady Natine bs Uke the Austrians, manctasm did not hold up against epiical reality but th ists di ‘ake major contributions to modern business cycle theon by focusing on the role of the ental ‘Bank, and porting» “natural rate” of intrest, whlch ithe real rate of interest that would hold post” when the economy fufiled potential GOP. They aque that expetatlons can undenine poley joxS acne, noting that people with wa angpate central bank actos, * ‘thereby nullifying their efforts to ft controling cel versts nominal raya Overaly they were casting Het on the destabiing ete ef alten ply? ee Ro suk, Worms ‘Another set of models are called “Real business cycle” models, which depend on changes In supply, not changes in demand. For example, Tere are supply side models that respond to productivity shocks such as the oil price shock, technology, government actions (ta¥es, equations, wars or natural disasters, demographic changes. Microeconomic is back nthe picture, ‘Knoop summarizes neath: "New Keynesian models borrow the concepts of market faluce and price inflesititty from Keynesian economies, the natural rate hypothesis and a focus on ‘moneiary palcy from monetarst ecanomics, the concept of rational expectations from the rational expectations model, and a belief in the importance of developing. modes with rmroeconomic foundations from real business cycle models." Together they are striving to "phn hy mares are ot perfect an the rol mara fares business ye. ‘Vi Globalization and Financiolization For 50 years after Keynes, economists sought to explain business cycles through approaches. ‘that saw Financial Istablty asa byproduct or symptom of business downturns, nota cause, (6.145. But in those decades the financial sector share of GOP rose to 9% by 2013. Globalization "eeepc erent nl pcan sacra ery enh Impure om ump oan cata ha fad Sse le [Eenonss Uns esr tm aso uate: hg 8 Sth ate ans nao hn nope fon emt Ss oa: TSE WORE DC OH TTS IS TOT 5 Rock Creek was fandislzaton of the gba economy.” indeed over he pst 10 year, eet eyes have feenimportantinalthetmancalsses” yar tl FED iyworey diem ucts fhe en of eos males 00m fr he on Ar dfs cee predict. Te Nobelpvinning tum of Aor Tok end Dane faery ew attention to how human beings make decison. Kahneman' book, Thinking, Fast and Slow, explalned how much decision-making itultve asa Coot rational) The intulive decisions zr tuto pool bts bed on expres and on gets, Uses weth more Kah were heavy than gains, information we know counts mare than what we detains bunts, peope ger ot we ar too confer tne highly probable afd Asoun the tal, and thelist goes on, “his brings us othe st set of mada, wich tak ino acount the bebo factors Knoop dies these into bales aged there and fundamentals based thats nthe st ctepo, te laced hares Kindebergs). wh has writen wil about deb-foanced speciation, with terd behavior Gare Bet) lading to mani set bubbles and ther-paic and busts, ‘Encop identifies “financial innovations asthe trigger forthe booms that precede asset busts and mikes "Brhewtss, Teli 9s, In the fundamental based models, triggars encompass negative shocks to the profitability of ‘anis or the abiliy_of borrowers in_our increasingly leveraged socatiss to make timely Increasingly, lvera ie to. make time BYMENS, Inflation, deflation, recession, exchange rates, higher intrest rates, and sovereign debe crises canbe triggers. but there are no perfect solutions "The most important protective measure sto enact prudent Anan egulton tat allows for sense credit eouth bt that preven eles booms in “edt and talooning asset ices tha el short-term economic surges bu eventual lead to Tancal busts nd prolonged recesons™ Proder, see, recess how do we implement ‘hat? Independent central banks are pat of i andthe rest sup to the electorate, Respected figures have stated their conviction that the Great Depresion could not recur because we have learned from history. But # our political leaders have not shared in that learng, then the rks tovate ep ot sire vom Ueto een aren fo fan ttt: et ney ate Enea "tno adh er nome: Unter Reo ote fon a Bt St rr 7 Rock Creek IL Thistme ti eterent ‘tis natural that whenever the growth part of the business cca prolonged, thee wll be some ‘economist or pundits who argue tha his tme iti iffeent™no downturn coming. Sut ike the ‘an wie jumps fom 50 strips and cals eu as he passes the twentieth floor, “so at s0 good,” ‘he end i probably nigh ‘Victor Zamawite was a Jeadhg scholar on business oes, indeators and forecasting. Hl biography fe marked by the tragedies of the 20° century, having been born in Poland led to ‘escape the Naa, and then impriconed by the Soviets and worked ina Siberian labor camp, After ‘World War he earned his PRO in Heidelberg and then came to U.S. ven the role of economic ‘conditions in paving the way fr Hitler, Zamowitz appreciated the devastating consequences of ‘harp deterlorations in economies He published ma ovale In 1988, Zarowitz published an overview esay called "Has the eSiness Cycle Been Abolished?” {oe the NBER.” He wanted to remind people tha but any belie that downturns can be permanently avotded Is both “ahistorical and atheortical” He

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