Historical Viewpoint Sheds Light On Causes Of Economic Fluctuations

July 05, 1998|By David Warsh, The Boston Globe.

One of the great certainties of life at the end of the 20th century is the flow and ebb of the business cycle. Every once in a while, somebody proclaims that a new era has arrived, or, better yet, that the cycle is ended. But the pattern of expansions and contractions, recognizable in its essentials, rolls along regardless.

The main uncertainty: What event will trigger the next downturn? The Asian crisis? Is it already in the works?

"Beyond Shocks: What Causes Business Cycles?" was the subject of a conference held by the Federal Reserve Bank of Boston last month on Cape Cod. These regional Federal Reserve Bank meetings are getting harder to conceptualize, as conferences proliferate and competition among host organizations heats up. No serious researcher wants to write a paper to be tucked away in a volume published by the Fed.

So the regional banks must either choose high-brow topics (for example, the San Francisco bank, whose 1996 conference proceedings on "Managing Capital Flows and Exchange Rates," has just been published by Cambridge University Press); or make them very practical (the Chicago Fed's regular May conference on bank deregulation); or simply make them topical (the Kansas City Fed's August junket to Jackson Hole, Wyo., where the schmoozing and silly-season maneuvering in the press is more important than anything that's written down).

The Cape Cod conference last month was a model of how the Boston bank fits into the system. With Boston's dense university network--Harvard, Massachusetts Institute of Technology, Boston University, Northeastern University, and Boston College, plus the headquarters of the National Bureau of Economic Research--the city is economics' Mecca, not to mention a world center of money management. The bank's idea was to connect the top end of the banking community to developments at the frontiers of economic research.

In this case, it was the "real business cycle" literature that for a decade has pursued the possibility that economic fluctuations stem from restructuring among production technologies instead of traditionally identified fiscal and monetary factors.

Thus conference-goers heard a report on a highly sophisticated thought-experiment by Yale University's Christopher Sims designed to gauge the ability of monetary policy to affect the course of events. They heard, too, an historiographic essay by MIT economic historian Peter Temin on the causes of American business cycles.

Few newspaper readers need to worry much yet about Sims's work, though in due course it is likely to prove invaluable in scrutinizing the rules that central banks adopt to pursue their policies. "The overall conclusion might be that the aim of good monetary policy should be to make monetary policy unimportant to the business cycle, and that postwar U.S. monetary policy has largely succeeded in this respect," he wrote.

But Temin, in sorting through the causes ordinarily assigned to each of the 24 recessions since 1890, produced a model of writing about economics for the intelligent layperson that deserves a wide circulation.

With data produced by Christina Romer of the University of California at Berkeley, he divided the history of the business cycle during the last century into three periods of eight cycles each, then proceeded to classify their causes.

His ostensible target was the laugh-line caricature of his colorful MIT colleague, Rudiger Dornbusch: "None of the U.S. expansions of the past 40 years died in bed of old age; every one was murdered by the Federal Reserve." His deeper topic was that thorny question: How much discretion does a central banker really have?

Temin divided his business cycles into four distinct types. Either they were real shocks--domestic ones (such as the debt-ceiling recession of 1958, the Vietnam wind-down recession of 1970), or foreign (such as the Armistice depression of 1921 and the two oil price hikes of the 1970s). Or they were monetary shocks--domestic (such as the budgetary stringency following the payment of the second Soldier Bonus of 1937, the unanticipated monetary tightening of 1960, the Volcker battle against inflation in 1981) or foreign (such as the Panic of 1907 or the external gold drain that led the Fed to tighten sharply in 1931).

Moreover, each of the three periods exhibits its own special characteristics: Those from 1890 until World War I tended to be frequent and abrupt; those of the years between the wars were unprecedented in their severity, "contractions" rather than "panics." The business cycle of the postwar years lived up to its reputation: gentler, less frequent events, in general deserving of the term "recession."

The paper itself dwells mainly on the four largest cycles: the short, sharp depression following 1920, and the three phases of the Great Depression of the 1930s. The next-largest cycle occurred in 1973, when the oil-producing nations quadrupled the price of crude oil overnight, and the Fed tightened to limit the resulting inflation.