February 02, 2002

Why Did the 2001 Recession Come as Such a Surprise

A historical look to understand why markets and investors get caught by booms and busts--both now and in the past.

Discussion Leaders:

  • J. Bradford Delong, Professor of Economics, University of California, Berkeley, USA
  • Harold James, Professor, Department of History, Princeton University, USA

Moderated by Betsy Stark, Business Correspondent, ABC News, USA

Possible Theoretical Explanations:

  • The Ecology of the Market: A boom is a time when there is a run of good luck--when for some extended interval things turn out better than expected. As a result, during a boom people and institutions become "trained" to be overoptimistic. When that overoptimism comes into conflict with reality at the end of a boom, individuals and institutions are highly leveraged and overextended...
  • Different Causes: This current recession and the NASDAQ crash that proceeded it are the first time since World War II that a recession was not deliberately or semi-deliberately brought on by the Federal Reserve. Since World War II recessions have come in the United States at least when inflation is rising, and when the Federal Reserve concludes that it has to shift to reducing inflation whatever the consequences for the real economy. That's not what happened this time: the Federal Reserve was seeking a "soft landing" and miscalculated. It had not made reducing inflation job #1...
  • Extended Lags in Inventory Control: Businesses don't know enough about--or don't pay enough attention to--the aggregate situation. As a result, a typical industry won't recognize that demand is running behind supply until there has already been a considerable inventory build-up--and it is the working-off of that excess inventory that is the key cause of recessions...

Useful Historical Analogies:

  • The Roaring Twenties: (Of course...)
  • Post-WWII Inflation-Control Recessions: These are not terribly relevant or useful...
  • The Great Nineteenth-Century Railroad Busts: In the U.S., 1873 and 1892 and 1907 stand out as key dates...
  • Further Back: The South Sea Bubble? The Tulipmania?
Posted by DeLong at February 2, 2002 10:15 AM | TrackBack

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