• The aging business cycle


    WASHINGTON, DC: At her most recent press conference in December, Federal Reserve Board Chair Janet Yellen had this (abbreviated) exchange with ABC News reporter Rebecca Jarvis.

    Jarvis: Historically, most economic expansions fade after this long. How confident are you that our economy won’t slip back into recession in the near term?

    Yellen: … I think it’s a myth that expansions die of old age. I do not think they die of old age. So the fact that this has been quite a long expansion doesn’t lead me to believe that … its days are numbered.

    Yellen is wrong — and she has a lot of company. It is an amazing reality that, among economists, the faith in the possibility of endless expansions has survived the 2008-09 financial crisis and the Great Recession.

    It is true, as Yellen explained, that there is no magic threshold (say, six years) beyond which an economic expansion must give way to a recession, usually defined as two quarters of falling output (gross domestic product). Business cycles differ. But it is also true that the longer an expansion continues, the more it changes attitudes, behavior and spending patterns in ways that doom the expansion. Sooner or later, old age is fatal.

    Some threats are widely recognized. Pent-up demand for cars or homes is exhausted. Inventories of consumer goods become excessive, as personal purchases slow faster than production. There’s overinvestment in some sector (example: high tech) that results in bankruptcies. Higher inflation convinces the Fed to raise interest rates. Or there are outside “shocks” to the economy — for instance, a huge jump in oil prices.

    All these causes are standard. They usually take about a year to work through the system. (The average length of the 12 recessions since 1945 has been 11 months, says the National Bureau of Economic Research, an academic group that designates recessions.)

    Less understood and more destructive are the widespread changes in economic behavior induced by the two longest business expansions in U.S. history: the 106-month stretch in the 1960s, almost nine years from February 1961 to December 1969; and the decade-long expansion from March 1991 to March 2001. At the time, they seemed pleasurable triumphs; with hindsight, the booms led to destabilizing busts that lasted for years.

    The 1960s’ legacy was inflationary psychology. Government had seemed to promise that, with the right economic policies, it could end recessions and guarantee “full employment.” This liberated companies and workers from price and wage restraint. The consequences were devastating. In practice, both inflation and unemployment got worse, as the Fed vacillated between fighting one and then the other. Inflation peaked at 13 percent in 1980. There were four recessions from 1969 to 1981. Americans were frightened. In Gallup polls from 1973 to 1981, they consistently ranked inflation as the nation’s No. 1 problem.

    The boom in the 1990s and early 2000s had a similar, though not identical, effect. The economy seemed to have become less risky. Economists proclaimed the “Great Moderation” of the business cycle. The Fed had crushed inflation. By tiny changes in interest rates, it could defuse serious slumps. There were only two mild recessions (1990 and 2001). A less-risky economy justified once-dangerous practices. Banks became overly dependent on short-term borrowings. Home loans could go to less worthy borrowers because jobs would be plentiful and house prices would always rise, making the collateral stronger.

    We now know that this was mostly wishful thinking. The economy had not become permanently more stable. Paradoxically, the longer the prosperity lasted, the more it bred self-deceptive and self-destructive thinking. Psychology shifted for the worse, just as in the 1960s.

    No one wants the present business expansion to end soon. Though the recovery is approaching seven years, it still doesn’t feel like a recovery to millions of Americans. As with the 1960s, the aftermath of the boom has been a prolonged period of heightened instability and anxiety. But we also dare not ignore the larger lesson of these episodes.

    What history teaches is disquieting. It is that the quest for unending prosperity is doomed to fail. Indeed, it may backfire. Periodic recessions and bear markets perform a useful, if distasteful, function. They remind people of risk; they restrain inflation. Too many setbacks, of course, transform a desirable discipline into social tragedy. What is the optimal mix of recessions and expansions? This is a hard, perhaps impossible, question to answer, but economists ought to be trying and aren’t.

    The trouble with thinking that expansions don’t die of old age is that they do — not on any predictable schedule but simply as a practical matter. Ignoring this holds out the false promise that some ideal set of policies can sustain economic expansion forever. It can’t.



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