The Long Wave in Inflation and Real Interest Rates

By Synnot, Thomas W.,, III | Business Economics, January 1995 | Go to article overview

The Long Wave in Inflation and Real Interest Rates


Synnot, Thomas W.,, III, Business Economics


ALTHOUGH THE U.S. economy is perceived, more and more widely, to be on a sustainable growth path, there is not much cheering about it. Media articles continue to focus on the loss of the American dream and the lack of growth in "high-quality" jobs. As the debate over NAFTA revealed, there is a lot of zero-sum thinking around. Indeed, a prominent economist's book, The Zero Sum Society, became a best seller in its field. All in all, there seems to be considerable self-doubt on the part of government policymakers, businessmen and the general public about long-term U.S. economic prospects. This attitude reinforces other forces pointing toward slower growth.

The striking parallels between our current economic setting and that of the last quarter of the nineteenth century suggest that a review of the economic history of that period can make an important contribution. Then, as now, new industrial competitors were emerging on the world scene (the U.S. was one of them), moderate real growth was accompanied by intense downward pressure on prices in established industries, and the growth of new industries -- such as electric power and light -- could then only be dimly foreseen.

A BRIEF HISTORY OF LONG WAVE ANALYSIS

Economists have long been fascinated by fluctuations in economic activity and by apparent repeating patterns in prices and interest rates. By the latter part of the nineteenth century, the ordinary business cycle was pretty well understood to be the result of an interaction between monetary conditions and business inventories. Work done at the National Bureau of Economic Research (1920-46) by Wesley C. Mitchell and Arthur F. Burns resulted in a thorough description of this three- to four-year cycle and how it operates.

However, even in the early years of business cycle analysis, some economists saw cycles of a longer duration in the historical economic data. According to Joseph Schumpeter (History of Economic Analysis, Oxford University Press, 1954), Clement Juglar in 1862 "was the first to use time series material systematically with the clear purpose in mind of analyzing a definite phenomenon." He identified a cycle of roughly ten years duration containing phases with the very modern labels of upgrade, explosion, liquidation, and depression. His famous statement that "the only cause of depression is prosperity" implies that both prosperity and depression are natural consequences of the same economic system. Some nineteenth century economists saw the cause of this Juglar cycle in changing weather patterns.

Since then, however, many economists have come to believe that there is a capital investment cycle of seven to eleven years duration and that low points in this cycle are associated with severe recessions. In the United States in the past twenty-five years several major cycles have occurred in commercial real estate investment, while business investment in plant and equipment has been less volatile. In Japan, however, a high rate of investment in plant and equipment as well as in office buildings during the "bubble-economy" era created a substantial excess capital stock. It will take a long time to absorb this excess capacity. The medium-term cycle basically rests on the fact that office buildings and major factory expansions take a considerable period of time to plan and execute.

Furthermore, the decision to invest or not depends on expectations about future prices and costs as well as on current interest rates. In addition, investment has a self-reinforcing aspect. At one point during the recent office building boom, it was estimated that one-third of the demand for new office space was coming from the architects, engineers and contractors who were planning new office space!

Early Long Wave Analysis

The severity of the Great Depression of the 1930s sparked a good deal of interest in theories of long cycles, because it was observed that the most severe depressions were separated by fifty-year intervals. …

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