Myths of the R-Word

With markets already in turmoil in anticipation of a possible American recession, President Bush’s stimulus plan was gasoline on the flames yesterday. But markets should not have been surprised that government policy looks limp. The myth that government policy has helped in past recessions is just one of many myths about downturns. Here are 5 of the biggest.1. We’re already in a recession.The truth is, nobody knows. The responsibility for declaring the stages of the business cycle is informally held by that most dreaded of concepts — a committee of economists. The Business Cycle Dating Committee of the National Bureau of Economic Research (NBER) uses a number of economic indicators, including personal income, unemployment, industrial production and sales and manufacturing volume, to determine the health of the economy. It’s not true that they declare a recession if economic growth is negative for two quarters in a row. If it were that simple, we wouldn’t need a committee.If you want to know about the state of the economy in real time, you can’t rely on the NBER. The NBER’s pronouncements historically come long after recessions have begun, a whopping seven months on average. By the time the bureau announced the recession of 1991, it had already ended.It’s impossible to tell whether the NBER will make a pronouncement anytime soon. Right now, we only have enough data to assess the economy accurately through last November. The best available real-time indicator of recession, a model developed by economist Marcelle Chauvet of the University of California at Riverside that has correctly called every postwar recession without ever giving a false signal, clearly indicates that the economy was not in recession in November. Things certainly have deteriorated since then, but it is an open question whether they have deteriorated enough. A recession may have started. Or it may not have.2. The stock market tanks during recessions.Not so. With the economy heading south during recessions, the conventional wisdom is that stock prices drop as well.Stocks usually drop before a recession, something that may be happening now. However, the market tends to look ahead and starts to respond favorably to the expected end of a recession long before it occurs. Influential economist Donald Luskin of Trend Macrolytics recently ran the numbers and found that stocks have produced an average return of 12.1% in post-World War II recessions. This is only slightly below the average return outside recessions.3. Recessions used to be a lot worse.Lunchroom economic conversations are inevitably graced with at least one statement from an old-timer along the lines of: “In my day, we walked 10 miles in the snow just to get to the recession.” In fact, the nature of recessions hasn’t changed much over the years.Early economic studies seemed to confirm the view that the economy has become less volatile over time, with some estimates implying that the severity of recessions declined by 75% roughly around the end of World War II. However, a prominent study by University of California at Berkeley economist Christina Romer demonstrated that the problem really was that prewar data collectors had not advanced to the exalted level of data-geekdom of today’s professionals.When important changes in data-collection methods and inconsistencies in the historical definition of the business cycle were accounted for, it emerged that recessions before World War I and since World War II have been just about equally severe.While the past three recessions may have seen slightly smaller drops in economic growth on average, there is no guarantee that the next one — when it arrives — will be mild. The superstitious might even say that we are due for a whopper.Recessions probably have become less frequent. In terms of duration, the average recession since World War II has lasted about a year. The past three recessions — in 1981-1982, 1990-1991, and 2001 — lasted about a year as well.One factor that has clearly not helped is government discretionary fiscal policy, like the economic stimulus packages currently being considered on Capitol Hill. You might think that the brilliant postwar discoveries of economists would have provided tax medicine to stop recessions in their tracks. In an exhaustive study, however, Mrs. Romer and her husband, David, found that fiscal measures such as temporary tax rebates and government spending increases have failed to push the economy out of recession because they have been too small or too late, or both.4. Recessions are bad for your health.David Mamet once told an interviewer that he got the inspiration for his 1984 Pulitzer Prize-winning play “Glengarry Glen Ross” from an account of a salesman’s fatal heart attack, caused by a recession “so vicious the competition was for jobs and sales, especially among older men.”However, for most Americans, the story is quite the opposite. Americans get healthier as the economy gets worse. Unemployment tends to increase during recessions, but economist Christopher Ruhm of the Univeristy of North Carolina at Greensboro has found that a temporary one percentage point increase in the unemployment rate leads to a 0.5% to 0.6% reduction in the mortality rate, or about 14,000 fewer deaths per year.Why the health benefits? With more free time and less money on their hands, people tend to consume less tobacco, exercise more, prepare healthier meals and lose weight. In addition, they are much less likely to have car and other accidents, and to catch communicable and sometimes fatal diseases such as influenza. Among the top 10 causes of death in America, only suicide rates show a substantial unemployment-driven increase. Even deaths caused by heart disease fall substantially.5. There is a regular business cycle.In a pair of articles in the Quarterly Journal of Economics published in 1920 and 1921, Columbia University economist H.L. Moore hypothesized that the primary cause of economic cycles was the regular eight-year cycle of the modes of the planet Venus. This type of thinking, along with 19th-century English economist William Stanley Jevons’s theory that the 10-year sunspot cycle causes economic fluctuations, perhaps accounts for the widespread notion that there is a regular business cycle.Don’t count on it. The term “business cycle” is imprecise. Economic fluctuations affect everyone, not just businesses, and they are, unlike astral cycles, anything but regular.In the nine recessions since 1949, the shortest time between two recessions has been three quarters (the recessions of 1980 and 1981-1982), while the longest has been just short of 10 years (the recessions of 1991 and 2001). When the next recession ends, a good guess will be that the expansion that follows will be somewhere between one year and 10 years in length.A better analogy might be to think of our economic future as being a road trip in a 1971 Ford Pinto. Our car might burst into flames in the next instant, there might be a truck in our lane around the bend, or we just might make it all the way to California.Mr. Hassett is director of economic policy studies and a senior fellow at the American Enterprise Institute.

Myths of the R-Word

Myths of the R-Word

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