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Patterns in the eye of the beholder Samuel Brittan The Financial Times 11/12/09 One book I read as a precocious adolescent was the now almost forgotten G.D.H. Cole's The Intelligent Man's Guide to the Post-war World. The word "man" from an avowed socialist dates the book as much as the title. Yet he did have at least one economic point to make that struck me as very sensible and still does. This is that regular business cycles existed in the eyes of the beholder and that there was simply an irregular wave-like movement. These are not just esoteric academic arguments. During the "Great Moderation" of the late 1990s and early 21st century, it was not only Gordon Brown in the UK who announced the end of "boom and bust". Many other politicians and economists in different countries said much the same, if less stridently. Hardly any authority is saying that now. Today's cry, resurrected from wartime plans for postwar reconstruction, is for cyclically corrected measures and policies. It is almost orthodox to suggest that bank capital ratios should vary with the state of the cycle. On the fiscal side there is the argument between those such as Dominique Strauss-Kahn, managing director of the International Monetary Fund, who believe it important to delay fiscal retrenchment until there is clear evidence that the recession is over and those such as George Osborne, the Conservative shadow chancellor in the UK, who believe in cutting the budget deficit now. The argument partly depends on where in the supposed cycle we are. The issue is closely related to another I have discussed in these columns, which is how far the credit crunch and associated recession have affected the underlying trend of output. UK real gross domestic product rose by only ½ per cent in 2008, against an estimated earlier trend of 2½-3 per cent per annum. The Treasury expects it to have fallen by 4¾ per cent in 2009. A return to positive growth of 1-1½ per cent is expected in 2010. Does that mean we will be in recovery? On one view, the answer is "No". For we will still be in what is sometimes called a growth recession, nearly 10 per cent below the previous trend line, and the so-called output gap will still be increasing. Even if we believe the Treasury estimate that the recession has permanently destroyed 5 per cent of usable productive capacity, the output gap will still be growing and not start to shrink on official forecasts until 2011. A simple look at the numbers cannot establish or disprove regular cyclical movements. A crude inspection favours irregular fluctuations, even if one ignores the two world wars and the immediately following years dominated by mobilisation and then a return to peace-time production patterns. One can hardly expect strict regularity in a world influenced by changes in sentiment and unpredictable political and technological developments. The recognised US authority on dating business cycles is the National Bureau of Economic Research. The popular view is that it defines a recession as two or more quarters of falling real GDP. But the bureau insists this is only an approximation, as it takes other data into account. It also insists it makes no predictions. Its records, from 1854, suggest full cycles averaging 4½-5 years with a tendency to get longer after 1945. But cycles as long as 10 years and as short as a year have been recorded. The UK's statistical office experimented with cyclical indicators but abandoned the effort. Those with more ambitious interests can spend many happy hours with Business Cycles and Depressions: An Encyclopedia edited by David Glasner, published in 1997. Any statistician can find a cyclical pattern in however jagged a series if he or she decomposes the irregular variations into several superimposed cycles of varying lengths. Joseph Schumpeter thought in terms of a superimposition of "Kondratieff" long waves of 45-60 years, 8-11 year "Juglars", both touched off by waves of innovation, and "Kitchin" cycles averaging 40 months. But he did not see these as predictable. Indeed all kinds of weird and wonderful explanations of economic fluctuations have been given since almost the beginning of time. A serious 19th-century economist, William Jevons, linked periodic credit contractions to sunspot cycles of 11 years. John Maynard Keynes, himself, spoke of herd-like waves of optimism and pessimism. But he attached more importance to his view of the world being rarely at full employment due to hoarding propensities exceeding genuine investment opportunities. An alternative academic view today attributes fluctuations to delayed adjustments to "shocks" such as the oil crises of the last few decades and the recent banking near-collapse. At the end of it all, my first injunction would be the Hippocratic one of "Do no harm", and second: do not rationalise give-away fiscal policies in normal times by attempted cyclical corrections.
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