Frustrations of recession

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Recession is one of the best economics books I’ve read in a long time, and it’s accessible to the educated layman. It will help anyone understand the risk of a recession as well as the likely depth and duration of a downturn. It is light on policy guidance, aside from what to avoid. That’s much to its credit, as it does not come off as a political argument for more government or less.

Prior to John Maynard Keynes’ The General Theory of Employment, Interest and Money (1936), economists generally expected recessions to be self-correcting, with relatively little discussion of causation. Those who did theorize on why we had recessions mentioned money and credit creation, overproduction, excessive debt and other possible triggers. Keynes emphasized swings in business capital spending, which were amplified by workers whose spending fell when they lost jobs. Milton Friedman brought to the fore the role of money supply changes as a cause of cycles. After the oil price hikes of 1973 and 1979, many economists discussed supply shocks, an approach that seemed to also fit the pandemic in 2020.

Tyler Goodspeed, Recession’s author, is unusual in not focusing on one particular issue. He describes a market economy as generally resilient in the face of small shocks. But an unusually large shock, such as the pandemic of 2020, can cause a recession. More commonly, the unlucky coincidence of several small shocks occurring at once will trigger recessions. Some economies are more resilient—handling the shocks better—especially with regards to their banking systems, a point Goodspeed emphasizes.

Economists have no great experiment to prove the cause of recessions. Biologists celebrate Edward Jenner’s cowpox vaccination. Physicists teach Galileo’s experiments. But economists don’t have any clear-cut demonstration for a theory of recession. The historical data are messy, with multiple factors at work in the short run, and gradual changes in production processes and institutions over long time periods, which make statistical analysis difficult.

Goodspeed argues strongly against the common narrative that recessions arise after unsustainable booms, which he describes as more a religious allegory than sound economics. For example, he doubts the view about the 1800s that the railroad construction booms and subsequent slowdowns in construction were a Keynesian demand shock. He notes that the U.S. recession of the 1870s had no counterpart in Britain. If booms cause busts, then recessions should have been seen in both countries.

Keynes’ view was that recessions are usually triggered by swings of capital spending, which depend on “animal spirits.” The booms are characterized by optimism and the busts characterized by fear. This gets little attention from Goodspeed. Although Keynes oversold this theory, it has been at work sometimes. The housing construction boom of 2003-05 saw construction of over 70 new housing units for every 100 additional residents. We typically need about 40 units per 100 people, so the country was massively overbuilding. Then new construction fell by 73% over four years. The Great Recession of 2008, in my view, was driven by prior overbuilding combined with an unstable financial system. Goodspeed may be right that supply shocks are a major issue, but swings in capital spending are also sometimes at work.

Politics has influenced some economic theories. Keynes believed in activist government policy and developed a theory that justified activism. He was usually the smartest person in any room he entered and believed that putting smart people—like himself—in charge would yield good outcomes. Friedman was skeptical of government. Though he himself was exceptionally smart, he doubted that government policies could be made wisely. He developed both theory and evidence that government efforts to smooth the economy tended to be counterproductive. Subsequent economic studies have often aligned with the researchers’ political beliefs. Thus, the academic study of recessions may have been hurt by personal political preferences.

Using Recession’s insights may be difficult in practice. If a succession of small events can cause a recession, we’ll have to watch for the shocks. That approaches what has been called “factoid economics.” A person latches onto some random facts: a locust infestation here, a labor strike there, a ship gone sideways in a canal. There are always myriad small problems reported by the press, and we cannot go crying recession every time we see two or more of them.

However, those whose businesses are sensitive to the economy should keep in mind one lesson from the book: The economy is fairly resilient. It usually handles shocks pretty well, without falling into recession. Most of the things happening in the economy that people worry about never trigger widespread declines in economic activity. We should mostly chill.

Recession was published as war was being fought in the Middle East and the Strait of Hormuz was closed, so Goodspeed’s focus on supply shocks is timely. As I wrote on Forbes recently, continued disruption of the flow of oil (and oil-derived products such as fertilizer) may well trigger a global recession. Even though the economy is resilient with regard to many small shocks, contingency planning for a recession remains vital for business survival.