Is the Business Cycle Dead, Or Just Hibernating?

Eight years since the official end of the Great Recession in July, 2009, rumblings of another recession are conspicuous by their absence. Is the business cycle dead? Although expansions will eventually die, old age itself is not among the direct causal factors, despite the popular adage. Moreover, expansions—like humans—are living longer while the duration of recessions has shrunk.

What might be a proximate cause of this change? The last period in the chart above is of particular note. Of the nine recessions since 1950, all were preceded by a series of increases in the Fed funds rate. In seven cases, the tightening was, at least in part, a response to a notable year-over-year increase in the urban CPI (Consumer Price Index). Inflation followed by tightening was characteristic of the business cycle from 1950 through 1980. The only exception to this pattern was in the early 1960s, when the trend was reversed. The CPI declined for two years as the Fed raised rates heading into the recession of 1960. History suggests that the Fed was anticipating inflation to surge given the confluence of the Korean War armistice of mid-1953, a booming economy, booming suburbs, and, most of all, the so-called “baby boom.”

The most extreme use of tightening was the repressive monetary policy implemented during Ronald Reagan’s first term. It effectively turned the inflation tide for decades to come. A double dose of Paul Volcker’s monetary policy induced back-to-back recessions. That stopped inflation in its tracks, sinking to less than 1% by 1986. The rate of increase in the CPI has remained relatively low ever since, and has averaged only 2.2% since 2000. When it dipped into negative territory—a -2% rate in the summer of 2009 (the date that was later declared as the end of the recession)—policymakers, extrapolating recent trends, became obsessed with the potential for deflation. Ever the reactionary, the Fed met fears of deflation with an extraordinarily loose monetary policy that has produced neither targeted inflation nor commensurate real economic growth.

The mild recession that began in the summer of 1990, followed by the dot-com bust recession that appeared in the spring of 2001, tracked with the traditional pattern of rising inflation countered by a monetary tightening.

From 2001 through 2007, however, the CPI remained uncharacteristically subdued, fluctuating around 3% year-over-year. Attempting to contain the economic contraction following the dot-com crash, the Fed had lowered its funds rate to 1% in June of 2003. It began a march toward normalization and had systematically raised the benchmark to 5.25% by mid-2006.

The Business Cycle & the Great Moderation

Two years after Ben Bernanke had been appointed to the Federal Reserve Board in 2002 he gave a speech, the title of which was both symbolic of the time, as well as symptomatic: “The Great Moderation.” Bernanke lauded 20 years of declining macroeconomic volatility, citing structural economic change, improved performance of macroeconomic policies (particularly monetary policy), and, most of all, good luck. As the man with a hammer who sees everything as a nail, the professorial Bernanke quickly launched into a short form dissertation on “The Taylor Curve and the Variability Trade-off,” leaving the structural factors and serendipity for another time. He concluded, optimistically, that policymakers would not forget the lessons of the 1970s and would have the stomach to get out in front of inflation with the sort of monetary tightening utilized by Paul Volcker.

But Bernanke was looking backward. He was claiming to have tamed consumer price inflation just as runaway asset price inflation was reaching bubble proportions in residential real estate. This was exacerbated by highly leveraged consumers and financial institutions, overly complex financial instruments, and, essentially, nonexistent regulation. Bernanke, though, was fighting the last war. He correctly reacted to the liquidity crisis of 2008, but was blindsided by a solvency and deflationary storm he did not see coming until it was too late. On September 15, 2008, panicking policymakers warned of repeating the Great Depression. What had been the Great Moderation just months before found itself renamed.

Since the recession of 2007–2009, the CPI has been benign, averaging under 2%. The Fed has timidly tiptoed into tightening since its first bump in the fed funds rate in December 2015, a largely symbolic uptick from 0% to 0.25%. After 18 months, it stands at 1.16%, an unmistakable indication that rising consumer prices pose no clear and present danger. In fact, two of the very characteristics that Bernanke credited for the Great Moderation—structural economic change and improved performance of macroeconomic policies—were actually accomplices to the recession and the subsequent anemic recovery. Despite the much ballyhooed 4.1% unemployment rate, the massive structural fissures in bedrock employment below the headlines seem almost insurmountable, with social, economic, and political consequences too frightening to mention in polite company. And what Bernanke heralded as the panacea of enlightened monetary policy has become the scourge of rogue central banks that have abandoned every vestige of sound money. Finally, have we been lucky? Only if by fending off the inevitable, there are no consequences related to buying time.

Echoing David Stocktman’s sentiments,[1] Fed policy has allowed Washington to monetize massive amounts of public debt, a.k.a. “deficits without tears.” To wit, the attempt to railroad the current tax bill through Congress for political bragging rights in advance of 2018’s midterm elections, pays little heed to the consequences of adding to a public debt burden that, Keynes notwithstanding, will actually retard economic growth. Keynes never envisioned such extreme peacetime deficits; his doctrine is anachronistic to the current situation. No less threatening, the abandonment of sound money has enfeebled the interest rate mechanism as an honest price signal in the capital markets, turned the treasury yield curve into a front runner’s bonanza, and fueled massively leveraged carry trades which feed the top 1% with windfalls that, when they come a cropper, are followed by petulant demands for bailouts. Turning Wall Street into an avaricious sub-culture embodied in the “Wolf of Wall Street,” the Fed has at the same time “crucified the nation’s savers on a rack of ZIRP (Zero Interest Rate Policy).”

Under a façade of tranquility, the tectonic plates are shifting. The reach for yield is tempting the naïve and needy alike, edging them ever closer to the abyss. With the real cost of money beguilingly low, non-financial debt in the United States threatens to be a precipitating cause of the next financial and/or economic crisis. And, lest we forget, the most vicious of bears are those awakened during hibernation.

[1] David Stocktman was Pres. Reagan’s controversial Director of the Office Of Management and  Budget, 1981 to 1985. His vituperative style tainted his otherwise provocative book published in 2013: The Great Deformation: The Corruption of Capitalism in America. Rereading it four years later, attempting to overlook Stocktman’s offputting bend, there’s more wheat than chaff than originally thought.