Do economists know more today about the economy than they did in
the 19th and early 20th centuries?
Has this knowledge been the primary reason that business cycle downturns
have been less severe in the post war years? Have the banking industry
and the Federal Reserve played a role in promoting stability since 1950?
The economy and the study of economics have changed dramatically from
the 19th and early 20th centuries. Technology and data also have changed
substantially, just in the last half of this century. Some of the changes
may affect both our knowledge of, and the strength of business cycles,
which historically were often characterized by periods where financial
panics were followed by bank failures, business bankruptcies, and economic
downturns or recessions.
One important change that may affect the severity of business cycles
today versus 50 or 100 years ago is the composition of the economy. In
the 19th and early 20th centuries agriculture production workers made
up the bulk of the labor force. Today they account for less than 2 percent
of the labor force. Post war changes in the industrial structure, mainly
the shift from a manufacturing-based to a service-based economy, also
are dramatic and may affect business cycles as well. These shifts may
be seen in Chart 1.
As economists Diebold and Rudebusch note in their 1999 book, Business
Cycles: Durations, Dynamics, and Forecasting:
The possible postwar stabilization of the economy has been
the subject of much controversy. After reviewing the evidence, our tentative
conclusion is that the economy has undergone somewhat shorter and shallower
recessions in the postwar period.
They analyzed several potential changes in the economy that may have
an influence on the severity of postwar business cycles:
- Changes in the composition of production
- Changes in the composition of the labor force
- Changes in the technology of inventory management
- Changes in the importance and behavior of government
I will focus on the dramatic shift in the labor force and production
away from manufacturing and into the service sector during the post war
period. Remember that changes between the 19th and 20th century economies
are even more dramatic.
In 1999 the national economy is much less dependent on jobs in industries
like manufacturing, and transportation and public utilities, than it was
in 1950, as can be seen in Chart 1. In 1950
manufacturing was the largest employment sector; it made up more than
one-third of all the nonfarm payroll jobs in the nation. However, by year-end
1998 the manufacturing sector accounted for less than 15 percent of payroll
jobs and it now includes a smaller share of jobs than either the service,
trade, or government sectors.
At the same time the manufacturing sector was declining in relative size,
the service sector was rapidly gaining in importance. The service sector
grew from nearly 12 percent of all payroll jobs in 1950 to 31 percent
in 1998 and it is now the largest industrial sector.
This shift in job composition also has implications for business cycle
stability. The service sector tends to exhibit much smaller swings in
job growth rates over the business cycle than does manufacturing employment.
Manufacturing, especially durable goods manufacturing, including such
key manufacturing industries as high technology and aerospace, exhibit
large swings in employment growth rates over the course of the business
cycle, as can be seen in Chart 2. In the
post war era, the shift in job composition from manufacturing to services
jobs and production alone would tend to damp volatility over the course
of the business cycle.
In addition, better information technology and inventory control procedures
in the computer era also may have served to reduce inventory cycles that
often accompany business cycle swings.
Promoting stability in the economy also is an important central bank
and governmental policy consideration. Since the creation of the Federal
Reserve System in 1913 one of its primary responsibilities has been to
promote economic stability through its conduct of monetary policy. The
Federal Reserve Act specifies the goals of monetary policy as seeking,
"to promote effectively the goals of maximum employment, stable prices,
and moderate long-term interest rates."
Finally, from the beginning of the post war period until 1999, the changes
in the economy are extraordinary. For example, real (adjusted to exclude
the effects of inflation) gross domestic product (GDP), the broadest measure
of the output of the economy, is approaching $8 trillion on an annual
basis, about four times the output in the late 1950s. Real per capita
GDP had grown from about $12,500 in 1960 to nearly $28,000 in 1998. Nonfarm
payroll employment has nearly tripled since 1950, increasing from 45.2
million to nearly 124 million in 1998 as labor force participation has
climbed from under 60 percent to over 67 percent of the adult population.
Likewise, financial markets and assets have recorded tremendous growth.
Thus, the post war economy is much larger, more diverse, and has accumulated
substantially more wealth than it had during the 19th and 20th centuries,
changes that may make it more robust.
Diebold, Francis X., and Glenn D. Rudebusch. Business Cycles: Durations,
Dynamics, and Forecasting. 1999. Princeton: Princeton University
The Federal Reserve System
Purposes and Functions. 1994. Board of Governors of the Federal Reserve