Business Cycle Theory: Idea That Wouldn't Die
Samuelson, Robert J., American Banker
Something subtle may be happening in this economic recovery. We may be slowly accepting the old idea that business cycles are inevitable. People do not say this explicitly, but they talk about the recovery in a way that betrays their mood. Nobody, it seems, believes the recovery cna last, even though (against most predictions) it has been remarkably strong.
Every batch of economic statistics produces a new imagined threat to its resilience. In December, when some statistics indicated a slowdown, the economy was "faltering." By February, when the same statistics showed rapid expansion, the danger was "overheating": high inflation would burn out recovery. As yet, neither threat seems grave. Inflation remains in the 4%-5% range; jobs have increased 5.1 million in 15 months.
But the skittishness emphasizes the sense that, sooner or later, the recovery must end. It will, of course. This does not mean the business cycle has suddenly reappeared. In fact, it never vanished. But the 1960s promoted the idea -- which still dominates political rhetoric -- that government could eliminate cycles. If this illusion is passing, no one should mourn its loss.
The vision was not so much undesirable as impossible, and by creating unrealistic expectations, it fostered inflationary behavior that caused recessions. We now need a more sober assessment of busines cycles and how far government can -- and should -- go in treating them.
In some respects, it is difficult to improve upon the analysis of the dean of business cycle economists, Wesley Clair Mitchell (1874-1948). Mr. Mitchell saw prosperity breeding destructive pressures that would produce a downturn: prices, wages, and interest rates would rise, making business less profitable; some industries would invest excessively in inventories or plants, creative gluts; and high demand would promote inefficiency. 1913 Analysis Still Relevant
Mr. Mitchell did his analysis in 1913, but it hardly seems dated. Not that the business cycle is unchanging. Downturns before World War II depressed jobs and production far more than after the war. And they lasted longer, 20 months on average before 1945 compared with 11 months after. Economic expansions averaged 30 months before the war compared with 45 months since 1945.
The following table -- by economists Geoffrey Moore and Victor Zarnowitz -- shows the violence of prewar slumps, as measured by the average drops in industrial production and nonfarm jobs during slumps. The table also shows canges in wholesale prices.
Economists have attributed the mildness of postwar slumps to various changes. The unstable farm sector (where prices and farmers' incomes fluctuate sharply) has shrun.; it absorbed a quarter of the population in 1930 and only 2.6% in 1981. The fedeal government (25% of gross national product today against 3% in 1929) remains a large source of stable spending. And it creates "automatic stabilizers": in recession, unemployment and welfare payments rise, while taxes fall.
Financial changes have reinforced stability. The advent of federal deposit insurance in the 1930s ended banking panics. Depositors no longer demand their funds -- forcing banks to cut lending -- at any hint of economic trouble. …