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The End of the Traditional Business Cycle and an Apology

Posted by: Michael Mandel on October 31

First, the apology. I’m sorry for the lack of posts—I was pounded by a bad upper respiratory infection at the end of September, and it has taken me a full month to get back to (more or less) normal.

I’m going to attempt to maintain a regular posting schedule from here on out….once I figure out what it is.

Now, on to the business cycle. Over the past month I’ve written two pieces for the magazine (“The Economy’s Safety Valve” and “The Even-Keel Economy”) where I argued that the pain from the subprime housing crisis was going to be deep but narrow.

The broader point is that business cycles in the traditional sense may no longer exist. The National Bureau of Economic Research defines a recession as “a significant decline in economic activity spread across the economy, lasting more than a few months”.

The key words are “spread across the economy.” Now, business cycles and recessions have always posed a problem for economists. It’s easy to construct a model of the economy which only predicts a recession in response to a very very big negative shock. That is, different sectors of the economy are only weakly linked, so that the impact of a negative shock is dissipated over time. (Most of the big macro models have this property).

It’s also easy to construct a model of the economy where recessions happen all the time. Just assume that economic actors adjust very quickly to a fall in their expectations about the future, so everyone cuts back simultaneously when there is a negative shock. A big rise in the price of oil, for example, would immediately propagate across the entire economy, causing a fall in production, a cut in employment, and so forth. The flip side is that the economy would jump quickly in the case of a positive shock. Bounce, bounce—but the bounces are smaller.

However, it turns out to be very difficult to construct a model of the economy which reproduces the historic frequency of recessions. Instead, what you get is either too many or too few recessions, relative to what we have actually seen.

As a result, virtually all useful models of the economy have incorporated some types of rigidities. That is, it is assumed that some combination of prices, quantities, and expectations adjust slowly to negative shocks, rather than immediately. With the proper calibrated assumptions, you get something that generates roughly the right frequency of downturns.

Now, I think what is happening is that many of these rigidities, especially in the financial markets, have been disappearing over time. As a result, the links between different sectors of the economy have been attenuating.

Instead, we now may be in a world of mini-recessions—sharp falls in one or two sectors which do not pull down the whole economy. Think about the different parts of the economy as being connected by springs (or slinkys, if you want). A sharp drop in one sector—say, housing—may pull down a couple of adjacent sectors, such as furniture. But the rest of the economy steams on, and maybe even accelerates, as resources are transferred from the weak sectors to the strong sectors.

This picture of the world actually fits very well with neoclassical economics. We may get a couple of quarters of negative GDP growth, but deep economy-wide recessions may be an anomaly rather than the norm.

Of course, a big enough shock could lead to a full scale downturn. Massive terrorist attacks, a major financial crisis in China, nuclear war in the Mideast all could cause a global recession. But those disasters aside, the old world of the synchronized rise and fall of different sectors may be over.

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Reader Comments

Jon B.

October 31, 2007 01:24 PM

“... we now may be in a world of mini-recessions--sharp falls in one or two sectors which do not pull down the whole economy.”

You could be right, and it would be a good thing – it would mean soft landings rather than wrenching transitions. But I can’t help but wonder whether this is a case of Irving Fisher ("stocks have reached what looks like a permanently high plateau") meeting the Business Week cover jinx -- in which case watch out below.

Brandon W

October 31, 2007 03:35 PM

It will be interesting to see if the currency-war we're waging on China will cause a collapse of the dollar. Today's 25bp cut won't help the matter. Ultimately, all fiat currencies go to zero.... we might be testing that theory sooner rather than later. We'll be wishing all we had was a "recession", then.

The Smart Money is getting its assets out of US Dollars.


October 31, 2007 06:02 PM

I agree with this view. The average GDP growth trendline may be the same, but the standard deviation is dropping.

Thus, it will be very rare to have negative GDP growth for 2 quarters, just as it will be rare to ever have a quarter with over 6% GDP growth (of which there has been only 1 in the last 28 quarters).

Now, I would suggest that this 'de-linking' is due to the deflationary aspects of technology. No downturn in the semiconductor industry can every last for more than 3 years, simple due to Moore's Law.

Joe Cushing

November 3, 2007 05:42 PM

Everything you said makes sense but there is something familiar about it. I remember when they said we had a new economy right before the Dot Com Bust.

Mike Reardon

December 3, 2007 10:40 PM


We found out today that nuclear war in the Mideast is not as likely as we have though for the last few months, because the tension with Iran gaining a nuclear weapon has some what abated.

Though that international tension has had its effects on oil prices throughout the last several months with its direct impact on our domestic gasoline prices. We can now hope that oil prices lighten up some over the next year and that aides the consumers purchasing power.

Thank you for your interest. This blog is no longer active.



Michael Mandel, BW's award-winning chief economist, provides his unique perspective on the hot economic issues of the day. From globalization to the future of work to the ups and downs of the financial markets, Mandel-named 2006 economic journalist of the year by the World Leadership Forum-offers cutting edge analysis and commentary.

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