How do trends and cycles interact?

In a piece I already have linked to, Binyamin Appelbaum makes a point in passing that I think deserves further comment:

The new paper, like others of its genre, basically requires belief in a big coincidence: that a short-term catastrophe happened to coincide with the intensification of long-term trends — that the economy crashed at the moment that it was already beginning a gradual descent.

I view this somewhat differently.  Very often trends accumulate, often without much notice, and then a cyclical event causes that trend to explode into full view.  Such a coincidence of cycle and trend is very often no accident and in fact the two are closely related.

Let’s say, as seems to be the case, that wages stagnated, labor market mobility slowed down, and non-outsourcing productivity was slow during 2000-2007 (or maybe longer).  Those are all long-term economic trends and they are all bad news.

During 2000-2007 most Americans acted as if were are on a good trend line when in fact they were on a less favorable trend line.  This influenced spending decisions, borrowing decisions, real estate decisions, and so on.  People overextended themselves and they also created unsustainable bubbles.  Sooner or later the debt cannot be rolled over, the bubbles pop, the crash ensues, AD falls, and so on.  This often takes the form of a discrete cyclical event, as indeed it did in 2008.

One point — still neglected in much of today’s macroeconomic discourse — is that the mis-estimated trend was a major factor behind the cyclical event.  But there is yet more to say about this interrelationship between cycle and trend.

The arrival of the cyclical event, in due time, makes the negative underlying trend more visible.  At first people blame everything on the cycle/crash, but a look at the slow recovery, combined with a study of pre-crash economic problems, shows more has been going on.

The cyclical event itself places greater stress on labor markets, on firm liquidity and thus on R&D, on perceived stocks of wealth, and so on.  As individuals observe the reaction of the economy to this added stress, they start seeing just how wide-ranging and deep the previously existing structural problems have been.

Those observations, and the accompanying economic responses, make the problems worse.  Forecasts become more pessimistic, investment declines, firms will be less keen to commit to workers who are less than the “sure thing,” and so on.  Sometimes this is moving along curves, other times there are shifts in multiple equilibria (“is Greece a European country or a Balkans country?”), toss in some herd behavior too.  In any case these changes are ill-served by the terminology of cyclical vs. structural.  They are cyclical and structural in an intertwined fashion.  And of course this all leads aggregate demand to fall all the more.

I am reminded of the literature in finance that shows how apparently small shifts in information can lead to big movements in market prices.  The initial small shift illuminates the reaction functions of other market traders, which illuminates depth of sentiment, which in turn causes a revision of expectations and thus prices.  For instance the market as a whole may learn from a small shift in orders that core traders were never so optimistic in the first place.

It’s also worth visiting the literature on how sand piles can collapse rather suddenly (“self-organized criticality” is one term used in the economics literature).  That too is a cyclical event yet based on underlying structural problems.

If you hear someone say “if this were structural unemployment, wages would be rising a lot right now,” that is a sign they have not thought through this issue deeply enough.

If you hear someone argue or rebut “so what, did everyone get lazy or stupid in 2009?”, that too is a sign only one dimension of the problem is being considered.

In macroeconomic debate, most one-line zingers are not very good.


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