Notes for the Symposium on Business Cycles

Romer, "Changes in Business Cycles: Evidence and Explanations."

"economic fluctuations have changed somewhat over time, but neither as much or in the way envisioned by [Arthur] Burns. Major macroeconomic indicators have not become dramatically more stable... recessions have become only slightly less severe... [but] recessions have... become less frequent are more uniform." <a 7% fall in the standard deviation of changes in the unemployment rate, a 32% fall in the proportion of time the economy spends in recession, a 42% fall in the fraction of potential industrial production "lost" due to recession>

"...increasing government control of aggregate demand... has served to damp many recessions... [but] demand management... has not been used single-mindedly to effect [output] stabilization... the rise of the policy-induced recession... explains why the economy has remained volatile [in output]."

"Furthermore, the replacement of the large and small shocks from a wide variety of sources that caused prewar recessions with moerate shocks from the Federal Reserve can also explain why recessions have become more uniform over time."

"Showing that policy-induced recessions to reduce inflation account for the continued volatility of the postwar era only pushes the mystery back a step. The obvious question is why inflation has been a persistent problem in the postwar era, at least up until 1985. At some fundamental level, policy mistakes have to be key..."

"In essence, we have replaced the prewar boom-bust cycle driven by animal spirits and financial panics with a postwar boom-bust cycle driven by policy...:

"Far from being the inevitable result of structural changes, globalization, or the information revolution, the new economy has emerged because we have had a steadier hand on the tiller in the last twelve or so years than in the years before. Whether the management of aggregate demand has been steadier because of new economic theories, the skill of particular policymakers, or a new consensus about the goals of policy is hard to say. What is clear is that replace that steady hand with an unsteady one, and the old economy could reemerge in a flash."

Susanto Basu and Alan Taylor, "Business Cycles in International Historical Perspective"

"We seek to turn business cycle theories loose on perhaps the greatest macroeconomic laboratory available: the extant record of macroeconomic historical statistics..."

"One advantage of this international and historical approach is that a robust and useful theory of business cycles should be able to account for the patterns seen in the long-run data for many countries..."

"Another advantage is that an analysis of business cycles at the global level forces us to confront the open-economy extensions of all the theories..."

"... the usual division of the... time frame into distinct international monetary regimes... the classical gold standard... the second period... almost autarkic... gold standard credibility broken... the third period, the Bretton Woods era... the fourth period, the era of floating exchange rates..."

"... the standard deviation of output, consumption, investment, and the current account... rises by about one-half from the time of the gold standard (1870-1914) to the interwar period... then in the Bretton Woods period... fall[s] back to the level seen during the gold standard period, and in the more recent period of floating exchange rates the level of volatility falls lower still..."

" would be difficult to make a definitive case that today's business cycles are less volatile than those of a century ago..."

"... although the volatility of consumption and the current account ratio are similar to that of output, the volatility of investment is about three to four times higher..."

"... we believe that the puzzling behavior of real exchange rates provides additional compelling evidence that money is not neutral..."

"... the volatility of real exchange rates depends crucially on the nominal exchange rate regime... particularly difficult to square with a model of pure monetary neutrality..."

"... further evidence in support of sticky price theories arises from the experience of the Great Depression. Countries that abandoned the gold standard, particulary those that devalued aggressively and used their new-found monetary-policy freedom, experienced faster recoveries... by the successful forcing of short-run real deprecation, which drove their current account balances to a surplus..."

"... a clearing labor market is an embarrassment for almost all business-cycle theories. In the context of the real business cycle... it means that the shocks hitting the economy must be extremely large--and such shocks are hard to identify. In the context of sticky-price models, it means that firms' marginal costs or markups are extremely procyclical--more so than seems readily plausible."

"... in the first three periods, the wage is not so procyclical as to support the hypothesis that the labor market clears, but neither is it strongly countercyclical as 'old' Keynesian theory predicts it should be.... we can question the validity of the data... it could be that... supply and demand shocks are roughly offsetting each other... even in response to a great world-wide monetary contraction--a clear demand shock if ever there was one--the behavior of real wages seems to depend sensitively on country-specific circumstances and institutions..."

Victor Zarnowitz, "Theory and History Behind Economic Changes of the 1990s"

Start with section 1.3--because that is the real introduction to the vision of the economy presented here. 1.3 is a *theory* of business cycles. It is a theory based on short horizons of businessmen (or some kind of short-run market selection process that selects for the overoptimistic during booms) that breeds "misdirected or excessive investment," euphoria, and "irrational exuberance." Then something pricks the bubble... To the extent that this is what Zarnowitz believes--and it is very consistent with what Mitchell and Burns believed--it should be highlighted. It should be highlighted most of all because there is in it an implicit belief that the boom contains the seeds of its own destruction that I (and many others) would challenge.

Then jump to section 2.1 (which, however, needs to be expanded: the idea of the "profit accelerator" is not as clear as it should be), 2.2, and 2.3. To my mind 2.3 is key to Zarnowitz's argument: that somehow "malinvestments" during the boom trigger the subsequent recession. Yet this part of the argument is not at all clear. If output is still rising rapidly, then why should the fact that some investments have turned out badly lead to a reduction in total investment? There is something wrong with the explication of the profit accelerator theory of the business cycle. When demand increases faster than productive capacity there is supposed to be a profit squeeze. But one man's windfall increase in costs is another man's windfall profit. The three reasons why (rational) expectations of future profitability are trumped by current profits as determinants of investment need to be laid out at greater length.

I would follow 2.3 with 2.5--and demand more references, and more specifics about just how this process of "malinvestment"--investment running ahead of savings--takes place. "A long cumulation of such overinvestment can put an end to a business expansion." This is key to Zarnowitz's argument. It needs to be flagged as such. And, once again, I want references--what are these "variety of theories of long standing"? If output is still rising rapidly, then why should the fact that some investments have turned out badly lead to a reduction in total investment? What is it about malinvestments reaching a "critical mass" that causes things to turn down? Is it just that the K/Y ratio rises, and so r drops? Is something else going on. "In a boom, credit standards are often unduly relaxed as the deals seem too good to miss." This, too, needs more explication. Is this an "animal spirits" theory of the cycle? Or just an "animal spirits" theory of financial vulnerability?

2.6 perhaps poses us with the biggest difficulties. Our readers are not familiar with Knut Wicksell and his idea of the "cumulative process." And the "cumulative process" analysis has its own long-run problems: it explains what keeps a boom (or a recession) going beyond all reason as a result of lags in expectations and fixed contract terms; it doesn't account for the turning point at all. There needs to be something about the turning point other than "some disastrously large and costly failures awake markets and businesses."