Define “cause”
Tyler Cowen links to a couple of studies looking at the contribution of sectoral shocks to the business cycle. Here’s one example, from a paper by Enghin Atalay:
Next, I examine whether the choice of elasticities has implications for individual historical episodes. Figure 4 presents historical decompositions for two choices of εM. In both panels, εD = εQ = 1. In panel A, I set εM = 1; and, in panel B, εM = 0.1. With relatively high elasticities of substitution across inputs, each and every recession between 1960 and the present day is explained almost exclusively by the common shocks. The sole partial exception is the relatively mild 2001 recession. In 2001 and 2002, Non-Electrical Machinery, Instruments, F.I.R.E. (Finance, Insurance, and Real Estate), and Electric/Gas Utilities—together accounting for GDP growth rates that were 2.0 percentage points below trend.
Table 3, along with panel B of Figure 4, presents historical decompositions, now allowing for complementarities across intermediate inputs. Here, industry-specific shocks are a primary driver, accounting for a larger fraction of most, but certainly not all of, recent recessions and booms. According to the model-inferred productivity shocks, the 1974–1975 and, especially, the early 1980s recessions were driven to a large extent by common shocks.27 At the same time, the late 1990s expansion and the 2008–2009 recession are each more closely linked with industry-specific events. Instruments (essentially computer and electronic products) and F.I.R.E. had an outsize role in the 1996–2000 expansion, while wholesale/retail, construction, motor vehicles, and F.I.R.E. appear to have had a large role in the most recent recession.
Let’s think about this using an analogy. Suppose you study the causes of cycles in house collapses. Assume a community where 90% of houses have solid foundations, and 10% have rotten wood foundations. Also assume that during floods the rate of house collapses rises from 7 per week to 450 per week. A cross sectional study shows that 425 of the 450 collapsed houses during a flood had rotten foundations, while 25 had solid foundations. This despite the fact that only 10% of overall homes had rotten foundations.
How much of the “cycle” in house collapses is “caused” by floods, and how much is caused by rotten foundations? Show work.
The important question is: “How big would the business cycle be in a counterfactual where the Fed successfully stabilized NGDP growth?” I say “fairly small”.
Another question that is actually much less important, but seems more important to most people is: “How much of the instability in NGDP is due to monetary policy mistakes triggered by sectoral shocks, such as a decline in the natural rate of interest that the Fed overlooked, which was itself caused by a housing slump?”
When you read impressive looking empirical studies in top journals, do not assume that the authors are asking the right question.
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6. October 2017 at 09:59
Do you have a blog post on how NGDP targeting would’ve affected the 1970s inflation?
6. October 2017 at 11:00
The Austrian counter question might be, “how many houses would you have with rotten foundations if you didn’t try to dam the rivers?”
6. October 2017 at 11:59
(Memorial comment)
6. October 2017 at 19:48
“When you read impressive looking empirical studies in top journals, do not assume that the authors are asking the right question.”–Scott Sumner.
I guess that is true, but it sure makes understanding macroeconomics difficult for the layman.
Have empirical studies just become politics in drag?
We have left-wing economists who say raising the minimum wage has no effect on, or may even boost employment.
We have free-traders-Cato guys who insist 12 million illegal unskilled workers in the US in 2008 did not depress wages for unskilled workers
So, you know, supply and demand are out the window.
Side note: The nutty thing about all the Seattle minimum wage studies (that I have seen) is that the effect of property zoning and rapid gentrification are not even acknowledged. Seattle commercial and residential rents are skyrocketing (some commercial rents triple between leases). You are seeing upmarket businesses quickly displace the plebian, in a growing economy. House prices are booming.
Wages are higher and hiring is up? Oh gee, what a surprise.
Low-wage workers are disappearing (proving the minimum wage is hurting them)? I am shocked.
But then, some say even monetary policy is just politics in drag:
From Harry Johnson, right-wing standard-bearer of years past:
“From one important point of view, indeed, the avoidance of inflation and the maintenance of full employment can be most usefully regarded as conflicting class interests of the bourgeoisie and the proletariat, respectively, the conflict being resolvable only by the test of relative political power in the society and its resolution involving no reference to an overriding concept of the social welfare.”
6. October 2017 at 21:20
OT, FYI, Fro Tyler Cowen:
“Stanford’s John Taylor, a monetary-policy scholar who President Donald Trump is said to be considering for Federal Reserve chairman;”
ooof.
6. October 2017 at 21:39
Jim, Yes I do. Inflation would have been about 2%, with 3% RGDP growth.
7. October 2017 at 05:31
Scott is right about this. I looked at the paper, which models an economy in which money does not exist. Friedman and Schwartz established long ago that money supply shocks were the single most important source of fluctuations in the aggregate economy. To attempt an explanation of variations in output without even mentioning money seems to me to be a complete waste of time.
7. October 2017 at 17:04
OT but fun:
http://www.esa.gov/sites/default/files/FDIUS2017update.pdf
Here is a funny one: In 2010 to 2016, from what nation did the largest foreign direct investment in the U.S. come from? And by far?
Mighty, mighty….Luxembourg.
No. 3 is…Switzerland.
No. 4 is Great Britain (but asterisk notes that includes Cayman Islands, and other mysterious island nations).
The federal report says, with a straight face and without elaboration:
“FDI inflows also have come mostly from a small number of advanced economies, as shown in Figure 4 above. The top 10 investor countries during the years 2010-2016 combined accounted for nearly 85 percent of FDI inflows….Luxembourg and Switzerland also have been the 2 largest sources of FDI inflows in recent years, accounting for 29 percent of the total from 2010-2016.”
—30—
Gee, I strongly suspect something is fishy about international capital flows.
8. October 2017 at 08:26
@ Ben Cole:
I find the Harry Johnson quote absolutely baffling. When he says avoiding inflation is in the interest of the bourgeoisie, does he mean that avoiding *higher than expected* inflation is in the interest of *creditors*? If so, he is using words very carelessly. (By the way, I believe public opinion polls show that inflation is very unpopular with the proletariat.) And why does he think the bourgeoisie does not care about unemployment, i.e., recessions/depressions?
As for unskilled illegal workers: yes, they constitute additional *supply* of unskilled labor, but–because they earn a lot more than they would if they had stayed in their home countries–they also constitute additional *demand* for goods and services, many of which are produced with unskilled labor. You seem to focus on the supply, ignoring the demand.
8. October 2017 at 10:09
Philo–
I agree with much of your sentiments regarding Fed policy—and yet it always the right-wing financial class bleating for tighter money. Why?
The Fed says you get “very tight labor markets” if you have 1.2 people seeking work for every job opening. How about “labor markets are roughly balanced” when the ratio is 1 to 1?
Does the bourgeoisie want recessions? The abundant public commentary of former Fedster Richard Fisher would make you think so.
And there is still the idea that a recession cleanses the economy of weakling companies.
Less embraced is the idea that a strong economy, by boosting the demand for labor, cleanses the economy of companies to weak to pay prevailing wages.
Maybe Harry Johnson onto something.
8. October 2017 at 23:09
In the counterfactual where the Fed successfully stabilized NGDP growth in 2008 (and therefore we would not have had the great recession) would the Fed balance sheet be larger or smaller than it is now? Thanks
15. October 2017 at 08:40
Maurizio, Much smaller.