FRBSF Economic Letter
99-16; May 14, 1999
Changes in the Business Cycle
In December 1998, the current expansion reached a milestone - it became
the longest peacetime expansion in post-World War II U.S. economic history,
surpassing the record previously held by the 1982-1990 expansion. In fact,
if the expansion continues through January 2000, it will tie the expansion
associated with the Vietnam War as the longest expansion since our records
of such things start in 1854.
The experience of the U.S. during the last twenty years has been quite
remarkable. The long economic expansion of the 1980s was followed by a
relatively short recession in 1990-91, and the economy has been expanding
ever since. The U.S. has experienced only 8 months of recession in the
last 16 years. The most visible sign of the continued expansion is provided
by the unemployment rate. For the past year, it has remained below 4.5
percent, hovering at levels not seen since the early 1970s.
Not surprisingly, the long expansion has raised questions about the whole
notion of the business cycle. Extended periods of expansion always lead
a few commentators to speculate that the conventional business cycle is
dead. In 1969, for example, a conference volume titled "Is the Business
Cycle Obsolete?" was published just as the 1961-69 expansion came to an
end and the economy entered a recession. With two record-setting expansions
in a row, and the current one still going, it is to be expected that the
notion of regular business cycles is again being questioned. The current
favorite hypothesis is that a "new economy" has emerged in which our old
understanding of business cycle forces is no longer relevant.
While few economists believe we have seen the end of business cycles
(just look at Asia and Latin America!), the views of economists about
business cycles have changed. These changes reflect real changes in the
U.S. economy, changes in our ability to measure economic developments,
and changes in economic theory.
Dating business cycles
Although virtually all data used to analyze the U.S. economy are produced
by some agency of the federal government, the standard dates identifying
business cycle peaks and troughs are determined by the Business Cycle
Dating Committee of the National Bureau of Economic Research (NBER). The
NBER is a private, non-profit research organization whose research affiliates
include many of the world's most influential economists.
The NBER defines a recession as "a recurring period of decline in total
output, income, employment, and trade, usually lasting from six months
to a year, and marked by widespread contractions in many sectors of the
economy." Recessions are, therefore, macroeconomic in nature.
A severe decline in an important industry or sector of the economy may
involve great hardships for the workers and firms in that industry, but
a recession is more than that. It is a period in which many sectors of
the economy experience declines. Recessions are sometimes said to occur
if total output declines for two consecutive quarters. However, this is
not the formal definition used by the NBER.
Business cycle peaks and troughs cannot be identified immediately when
they occur for two reasons. First, recessions and expansions are, by definition,
recurring periods of either decline or growth. One quarter of declining
GDP would not necessarily indicate that the economy had entered a recession,
just as one quarter of positive growth need not signal that a recession
had ended. The recession of 1981-82 provides a good example. Real GDP
declined from the third quarter of 1981 to the fourth quarter, and then
again from the fourth quarter to the first quarter of 1982. It then grew
in the second quarter of 1982. The recession was not over, however, as
GDP again declined in the third quarter of 1982. Only beginning with the
fourth quarter did real output begin a sustained period of growth.
Second, the information that is needed to determine whether the economy
has entered a recession or moved into an expansion phase is only available
with a time lag. Delays in data collection and revisions in the preliminary
estimates of economic activity mean the NBER must wait some time before
a clear picture of the economy's behavior is available. For example, it
was not until December 1992 that the NBER announced that the trough ending
the last recession had occurred in March 1991, a delay of 20 months.
Expansions and contractions since 1854
U.S. business cycle peaks and troughs going back to the trough in December
1854 have been dated by the NBER. Based on their dates, we can ask whether
basic business cycle facts have changed over time.
One important aspect of a recession or an expansion is its duration.
The lengths of recessions since 1854 are shown in Figure
1. Several interesting facts are apparent from the figure. First,
measured solely by duration, the Great Depression of 1929-1933 pales in
comparison with the 1873-1879 depression that lasted over five years.
And the 1882-1885 recession lasted nearly as long as the Great Depression.
Some lasting images of American history survive from this period, including
the great debate over silver coinage.
Second, while the Great Depression was not the longest period of economic
decline, it does appear to represent a watershed; no recession since has
lasted even half as long as the 1929-1933 contraction.
Third, it is not just that recessions have been shorter on average in
the post-World War II era, they have all been much shorter. Of
the 19 recessions before the Great Depression, only three lasted less
than a year; of the 11 recessions since the Great Depression, only three
have lasted more than a year.
Figure 2 shows the duration
of economic expansions since 1854. Darker bars mark wartime expansions.
Based on duration, the changing nature of expansions is not quite as evident
as for contractions. But of the 21 expansions prior to World War II, only
three lasted more than three years. In contrast, of the 10 expansions
since, only three have lasted less than three years. Even if the wartime
expansions associated with Korea and Vietnam are ignored, post-World War
II expansions have averaged 49 months, compared to an average of only
24 months for pre-World War II peacetime expansions.
Is the economy more stable?
A simple comparison of the duration of expansions and contractions does
suggest the U.S. economy has performed better in the post-World War II
era. Recessions are shorter, expansions are longer. These changes strongly
suggest that business cycles have changed over time. However, a simple
comparison of duration cannot tell us about the severity of recessions
or the strength of expansions. This would be better measured by the decline
in output that occurs in a recession or the growth that occurs in an expansion.
However, most studies that examine how volatile economic activity has
been do conclude that output has been somewhat more stable in the post-World
War II era.
This conclusion, however, is not universally accepted. There are three
reasons that comparing the business cycle over time is difficult.
First, the quality of economic data has improved tremendously over the
past 100 years. If the earlier data on the U.S. economy contained more
measurement error because the quality of our statistics was lower, the
measured path of the economy may show some fluctuations that simply reflect
random errors in output data. This will make the earlier period look more
unstable. In addition, earlier data on economic output tended to provide
only a partial coverage of the economy. For example, better statistics
were available on industrial output than on services. Since services tend
to fluctuate less over a business cycle, the earlier data undoubtedly
exaggerated the extent of fluctuations in the aggregate economy.
Second, NBER dating methods have not remained consistent. Romer (1994)
argues that the dating of pre-World War II business cycles was done in
a manner that tended to date peaks earlier and troughs later than the
post-World War II methods would have done. This contributes to the impression
that prewar recessions were longer and expansions shorter.
Third, the economy is increasingly becoming a producer of services, and
productivity in the service sector is often difficult to measure. In general,
the tremendous changes experienced in recent years associated with the
information revolution are likely to affect the cyclical behavior of the
economy in ways not yet fully understood.
Implications for macroeconomic policy
Understanding changes in the nature of the business cycle is important
for policymakers. Most central banks view contributing to a stable economy
as one of their responsibilities. Promoting stable growth has important
benefits, and reducing the frequency or severity of recessions is desirable
as part of a policy to ensure employment opportunities for all workers.
Preventing expansions from generating inflation is also important since
once inflation gets started, high unemployment is usually necessary to
bring it back down.
One might think, then, that policy designed to stabilize the economy
should attempt to eliminate fluctuations entirely. This is not the case,
for a very important reason. A business cycle represents fluctuations
in the economy around full-employment output, but an economy's full-employment
output, often called potential GDP, can also change. It grows over time
due to population growth, growth in the economy's capital stock, and technological
change. Developments in economic theory have led to a better understanding
of how an economy adjusts to various disturbances. These adjustments can
cause potential GDP to fluctuate, and it would be inappropriate for policy
to attempt to offset these fluctuations. Identifying fluctuations in potential
GDP from cyclical fluctuations can be difficult, however, as the current
economic expansion illustrates. Is the economy in danger of overheating,
risking a revival of inflation? Or have changes in the economy increased
While the U.S. economy has enjoyed two consecutive record expansions,
a longer historical perspective does help to remind us that business cycles
are unlikely to be gone for good. Despite talk of the "new economy," all
economies experience ups and downs that are reflected in swings in unemployment,
capacity utilization, and overall economic output. Though changes in the
structure of the economy may alter the extent of these fluctuations, they
are unlikely to eliminate them.
In addition, the business cycle record is not independent of policy decisions.
The economy may not have changed fundamentally; perhaps we have simply
benefited from good economic policy (see Taylor 1998 for a discussion
along these lines). With less successful policies, recessions could become
more frequent and longer again. The Great Depression, for example, was
prolonged by, among other things, poor economic and monetary policy decisions,
and the recessions of the early 1980s were the price of policy mistakes
in the 1970s that allowed inflation to rise significantly (Romer 1999).
Thus, one reason business cycles can change, even if the underlying economy
or source of disturbances haven't, is because policymakers do a better
(or worse) job of stabilizing the economy.
Carl E. Walsh
Professor of Economics, UC Santa Cruz,
and Visiting Scholar, FRBSF
Romer, Christina. 1999. "Changes in Business Cycles: Evidence and Explanations."
NBER Working Paper 6948.
_________. "Remeasuring Business Cycles." Journal of Economic History
54, pp. 573-609.
Taylor, John B. 1998. "Monetary
Policy and the Long Boom." Federal Reserve Bank of St. Louis Review
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