ECONOMIC PRINCIPALS: Look out below
By David Warsh, Globe Staff, 4/1/2001
A practical attitude in the present day is to assume that recessions happen to market economies. Much has been learned about macroeconomic management these last 25 years. But nothing fundamental in human nature has changed, no magic mechanism discovered, to eliminate the business cycle.
Markets - even markets watched over by central bankers - periodically overdo it on the upside. Then begins a painful working-out. How painful depends on who you are.
You can tell quite a lot about the business cycle by gazing for a few moments at the chart of the history of the unemployment rate below. It is the story of 40 years and five recessions in America. Never mind technical definitions such as ''two quarters of declining output.'' Never mind the intricate financial events that precede and cause the loss of jobs. This is what a recession looks like from below.
There was a recession in America just as John F. Kennedy took office as president in 1961. The unemployment rate briefly topped 7 percent. The normal recovery plus a war in Indochina made for a good long boom throughout the '60s. Another recession occurred as the war was ratcheted down. Unemployment topped 6 percent in 1970 and stayed there for a time.
In the 1970s, things nearly got out of hand. The Nixon expansion was short and flaccid. Turbulence in international markets, gyrating oil prices in particular, precipitated a recession in 1974-75. The investment craze then was real estate investment trusts (REITs) instead of dot-coms.
In the early 1980s, Federal Reserve chairman Paul Volcker and President Ronald Reagan raised interest rates to unprecedented levels and kept them there. The result was the worst recession since the Great Depression. The unemployment rate climbed to nearly 11 percent briefly but remained above 7 percent for 7 years. As expected, the strong purgative paved the way for a terrific asset-led boom.
The 1990s began with another recession (it arrived early in New England). The unemployment rate reached nearly 8 percent. Should Alan Greenspan have taken another recession in 1998 when the Asian currency crisis welled up in the late '90s, instead of pumping up the US economy to record heights? It would have gone much worse for the world.
A closer look was taken last month in a working paper of the National Bureau of Economic Research by Edward F. Leamer, professor of economics and director of the UCLA Anderson Business Forecast. Last December the UCLA forecast put the probability of a recession in 2001 at 60 percent. The purpose in ''The Life Cycle of US Economic Expansions'' is to put his reasoning on view.
Working with unemployment data, Leamer identifies four phases to each expansion: recovery, plateau, spurt, and plateau. The recovery itself is easy enough to explain, he says: investors rush back into the markets from the sidelines. But what makes for the second wind? It's deliberate policy, says Leamer: the Vietnam War buildup occurred under presidents Kennedy and Johnson; expansionist monetary policy took place during the Reagan expansion; the Internet mania unfolded in the later Bush-Clinton expansion. And what brings these expansions to an end? Almost any kind of shock will do, monetary or fiscal. But essentially growth is checked because investment opportunities are played out. Sellers must adjust their prices. Investors must regroup.
At 39 quarters, the Bush-Clinton expansion is now longer than the Kennedy expansion (35 quarters) or the Reagan boom (31 quarters.) The Fed is trying to prevent a collapse of consumer confidence and spending, still trying to engineer the ''soft landing'' that would permit the longest-ever boom to continue. Sooner or later, however, it will end, and unemployment will begin to rise. (It has held steady at around 4 percent for two years. The March data will be released next Friday.)
The sobering thing about the story told by the chart is that, once unemployment starts to climb, it doesn't stop until millions of people have lost their jobs. Companies slash headquarters overhead, close down plants, lay off part-timers. The little guy in all likelihood is about to take it on the chin - if anyone any longer cares.
David Warsh can be reached by e-mail at warsh@globe.com.
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