A thoroughly modern recession
Dec 4th 2008 | WASHINGTON, DC
From The Economist print edition
The current recession fits the pattern of recent ones—but is likely to last longer
BUSINESS expansions, it used to be said, did not die of old age; they were murdered by the Federal Reserve. Yet with the official announcement on December 1st that America had entered recession last December, the traditional explanation for recessions is wearing awfully thin.
Though it may end up as one of the longest recessions, if not the longest, of the post-war era, the current episode still seems to have more in common with the mild downturns of 1990-91 and 2001 than the more wrenching affairs that came before. As Robert Hall, an economist at Stanford University, notes, earlier recessions, like that of the early 1980s, were caused by the Fed raising interest rates sharply to squelch emerging inflation and holding them high even once the recession began. In the current and past two recessions, interest rates never got very high and the Fed actually began to lower them before the contraction began. In a paper written a year ago*, Mr Hall described such apparently “causeless” recessions as perplexing.
Mr Hall is chairman of the committee of the National Bureau of Economic Research, an academic group that “officially” declares when recessions begin and end. He now says that the current episode fits the “modern recession” template not just in the lack of a significant monetary spark, but also in the divergence between employment and output. It used to be that full-time employment fell more slowly than output around recessions; since 1990 it has fallen as, or more, quickly. While employment has declined steadily since December, real GDP as of the third quarter was still above its level at the end of 2007.
By October employment was down 0.9%, or 1.2m, from the previous December. If consensus estimates are correct, the drop will have grown to 1.1% by November. That is close to the 0.9% average at the equivalent stage of the six previous downturns. But the drop in output has been milder, because firms nowadays are much quicker to cut employees when sales fall.
Although the recession has not yet been much deeper than its predecessors, it almost certainly will be by the time it is over. With banks still deleveraging and home prices still declining, consumer spending will remain under pressure for many months yet. Business investment is pulling back sharply: orders for capital goods sank 4% in October and commercial construction is about to feel the effects of the collapse in the market for commercial mortgage-backed securities. Exports will be pummelled by the global recession and the stronger dollar. Many economists expect the recession to continue until mid-2009, which would be longer than those of 1973-75 and 1981-82. Moreover, employment is likely to keep falling after the official end of the recession.
So if the Fed did not cause this and the past two recessions, what did? In his paper of a year ago, Mr Hall called them “mystery shocks”. Now, though, there’s less of a mystery; in both 2001 and now one sector experienced dramatic over-investment (technology then, housing now). The paradoxical truth may be that the less volatile business cycle (until recently) encouraged investors to take bigger risks with borrowed money, driving asset prices too high and ending in damaging busts. Some would still blame the Fed, for not deflating asset bubbles with higher interest rates. In a recent speech, Donald Kohn, the vice-chairman of the Fed, rejected that charge but pleaded guilty to a lesser one: by better controlling inflation, central banks helped moderate the business cycle, which bred investor complacency. They thus “may have accidentally contributed to the current crisis.” The Fed may no longer be the prime suspect for causing recessions; but it is still an accessory to the crime.
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