ECONOMIC FLUCTUATIONS AND FORECASTING

The long pull of American economic growth is impressive. But that growth has come spasmodically, in spurts separated by recessions and sometimes major depressions. Prosperity, with heavy investment spending, means rapid economic growth.

Unemployment and recession mean lagging economic growth. In perspective, the booms and depressions of American history are thus fluctuations around a long-term growth trend. And this is the right way to look at them. For seldom has the trough of a recession been lower than the peak of the boom before last. Growth has been more dominant in our history than fluctuations. But this doesn’t mean that repeated booms and depressions have been unimportant. Far from it! Some economists believe we have conquered the business cycle, and that wise use of monetary and ~scal policy can now produce stable economic growth. But even if this belief happily turns out to be true, we need to understand the forces producing economic fluctuations to be able to counteract them effectively. And the theory of the preceding chapters gives us the basis for this understanding.

GROWTH AND FLUCTUATIONS IN AMERICA

The long sweep of growth in America, interrupted by repeated recessions, is shown by Fig. 16-1 and by the top line of the graph inside the front cover. Figure 9-1 points up both these characteristics another way. The fluctuations of real g.n.p. around its persistent growth rate of about 3—4 per cent per year are bounded on the top and bottom by two trend lines, roughly connecting the peaks of the booms and the troughs of the depressions. Thus, growth can be seen as the basic process, with the economy pushing up toward the bounds of productive capacity in boom periods and slumping down toward an (ill-defined) floor in depressions and milder recessions. The vertical shaded areas are recession or depression periods. Note that the light (upswing) periods are substantially longer than the shaded (recession) areas. This emphasizes that growth is the basic process which dominates our economic history, and that growth occurs in the recovery-prosperity periods.

Business-cycle experts have dissected the upward sweep of g.n.p. into its component parts. Most believe they can discern fairly regular fluctuations in g.n.p. and employment, usually every 3 to 5 years, but sometimes with shorter or longer duration. These are what are commonly called “business cycles,” a misnomer if the term connotes a truly regular “cycle” of fluctuations. Be yond these fluctuations, the experts also find “long swings,” especially in construction and investment activity, averaging from 10 to 20 years in duration. These surges in investment activity appear to have been occurring at least since the early 1800’s, but they are less clear and well-defined than the shorter fluctuations. And they don’t show up well in Fig. 9-1 because they are obscured by the sharper shorter fluctuations. Nevertheless, some experts argue that when we are in the upward phase of the long swings, growth is strong and rapid; in the down phase of long swings recoveries tend to be anemic and the growth rate slows down.

FIG. 9-1 The shaded areas show the recessions and depressions since 1919. Recessions since World War II have been mild, hardly more than a flattening out of the growth in real g.n.p., though quarterly data would show sharper fluctuations. (Source: U.S. Department of Commerce and National Bureau of Eco-nomic Research.)

One way of studying economic fluctuations is to separate the fluctuations from the long-term upward trend, or growth. Figure 9-2 does this for industrial production, a major sector of the modern American economy. This sector is also one that fluctuates widely in booms and depressions. To construct Fig. 9-2, we first draw a “trend” line through the actual monthly data for industrial production (per capita) over the period, a rapidly, irregularly rising series. A trend line is a line drawn roughly through the middle of the fluctuating series—so the readings on the industrial production curve above the trend line about equal those below it.8 If, then, we lay the trend line out flat, it becomes the zero line in Fig. 9-2. Thus, periods when industrial production was above the trend line are shown above zero, and conversely for those below.

All the data are shown as percentage deviations from trend. Thus, the prosperity of 1961—64 runs about 10—15 per cent above “normal,” as does that of 1905—07. In absolute terms, of course, industrial production for 1961—64, and its expansion from the preceding low, were many times what they were for 1905—07. The vast area below normal in the 19 30’s and those above normal since the 1940’s on the chart are thus far smaller in comparison with earlier cycles than they would be plotted in terms of absolute, rather than percentage, deviation.

The huge depression of the 1930’s and the great output expansion during World War II stand out. But most recessions and prosperities have involved smaller percentage deviations from the long-run growth trend.