More persistence and propagation than you might think?

Macroeconomic cycles are much more self-reinforcing and correspondingly resistant to shocks and hence longer-lasting than what is commonly thought…

The key idea is that economic developments feature strong endogenous propagation mechanisms which yield endogenous cyclical behavior ala limit cycles.

And:

What is at heart of this behavior? There are three factors that the authors point towards. First is strategic complementarity between economic agents’ behavior, such as the fact that firms want to invest when other firms are investing. Second, you need inertia in individual behavior, so that rapid changes in behavior are costly. And finally, you need dependence on some stock variable such as aggregate amount of capital or durable goods. All of these requirements seem very realistic assumption about the real world.

What are the implications of such model? Among other things this means that in certain periods of time the economy is very robust to negative shocks, because these shocks do not have the power to overturn the forces (resulting from the strategic complementarity between agents) that are pushing economic activity higher. They might push us slightly lower for some period of time, but they don’t turn things completely around. And once their effect fades the economy continues in its previous trajectory. In a sense, this view suggests that economic cycles are more like a titanic.

It also means that there is certain dichotomy in terms of shocks. Shocks ranging in size from “small” to “large-but-not-gigantic” proportions do not change the underlying trajectory of the economy, unless we are already close to turning point in the limit cycle. Meanwhile, truly gigantic shocks, like the global financial crisis, are not just deviation from the medium-term trend defined by the limit cycle, but a change in the medium-term trend.

And in conclusion:

To summarize, the limit cycle view suggests that a powerful enough shock, such as the rebound when economies re-opened after the pandemic recession, can put us on a upward spiral, and that such spiral features such a strong self-reinforcing mechanisms that even large negative shocks cannot derail us. This in contrast to standard DSGE models that feature only relatively weak propagation of shocks, and, crucially, do not feature any medium-term cyclical behavior.

Here is much more from Kamil Kovar, a good and important post.