Boom, bust cycles still hard to predict


We are now a full nine years since this economic recovery started and are enjoying the second longest U.S. expansion since the 1840s.

Since 2009, economists have come to realize the portion of their discipline that attempts to explain the business cycle has some deep weaknesses.

Macroeconomics, which is the field that asks these questions, provides advice to policy makers about policy response to the boom-and-bust cycle. Without better explanations for what causes recessions, that advice is likely to be, at best, of minimal use.

What follows is a bit of an explanation of the problem, which I will try to do without appealing to the inside baseball of technical modeling. I begin with what the discipline gets right.

Most economists do not actively research macroeconomic phenomenon of the boom-and-bust cycle. They study the details of the economy, such as the influence of a single type of taxation on capital formation, years of schooling on wages, the impact of toxic waste dumps on home values, or the effect of financial regulation on bank loans. This type of research remains astonishingly fruitful. In fact, this work has been so productive that trained economists are the leading researchers in many other fields, like management, marketing and education.

These micro studies construct the building blocks of the overall economy, but they have yet to be well integrated into a model that explains the various types of boom-and-bust cycles.

Now, this does not mean macroeconomists don’t know anything useful. On the contrary, they’ve been very effective at long-term growth projections. Macro models tell us where economic activity will occur and which cities will do well and which will not. Macroeconomists also understand many of the individual predictors of a recession, and such useful tidbits as ‘employment is a lagging economic indicator.’

The problem isn’t really conceptual either. We know many of the causes of recessions, or at least the events that coincide with a recession. So, we know a big price increase of oil might sometimes precipitate a recession, or a housing bust or financial collapse might lead to a recession.

The problem is that sometimes these things happen and there is no recession. This means that mathematical models of the business cycle lack the ability to convincingly detect the causal influences that are sufficiently accurate to provide policy advice. Thus, recessions might be longer and deeper than would otherwise be the case.

One of the reasons for these problems might simply be a lack of recessions against which to test our models. Economic and weather forecasters use much of the same mathematical modeling techniques, but economists have the equivalent of about one month-worth of storms from which to predict hurricanes, tornadoes, droughts and blizzards throughout the next year.

Another reason may be the simple rhythms of scientific study. From the late 70s until the Great Recession, the business cycle appeared to have been tamed. Professors cannot build a reputation asking questions that seem to be answered. So, macroeconomics maybe didn’t attract the attention of other research problems. That much at least, has changed.

Macroeconomists may also be foiled by the simple fact that this sort of aggregation cannot readily be performed, regardless of computing power.

Unlike physics, economic relationships are not reasonably static. Actors within an economy adapt to new information, so the simple act of writing something important about the macroeconomy might alter that relationship. As an aside, this is why the Federal Reserve members speak so adroitly in public.

What all this means is not that we don’t have a good idea about the causes and effects of recessions. Nor does this mean macroeconomists cannot offer words of warning and advice about the business cycle. The effect of our present lack of understanding about the boom-and-bust cycle is simply that we won’t be able to confidently predict when the next one will occur, nor will we have confident advice on how to limit its impact. In that way, we aren’t much different than weather forecasters.

Michael J. Hicks is the director of the Center for Business and Economic Research and an associate professor of economics in the Miller College of Business at Ball State University. Send comments to [email protected].

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