Many pundits view financial crises as exogenous shocks that impact the business cycle. I’ve argued that most financial crises are actually endogenous, caused by the business cycle. There is very little evidence that financial crises have much effect on output, except when bank failures lead to currency hoarding that a central bank cannot fully accommodate due to a gold price peg. The banking crisis of the 1930s was a result of a depression that began in 1929, and the post-Lehman crisis of late 2008 was the result of a recession that began in December 2007.
Steven Kelly has a tweet pointing out that the recent banking problems in the US occurred on the West Coast, which is the worst performing region of the country (suffering from tech layoffs.)
Sudden bank runs are too often characterized as spontaneous fits of irrational panic. But what we see is that they’re very much tied to the business cycle. In 2023, West Coast bank runs have followed a West Coast business cycle that has very much turned.
When the banking problems developed back in March, the press was full of stories that the long awaited recession (which was already expected due to the Fed’s 2022 “tight money” policy) would now begin. After all, the recession of 2008 seemed to get much worse immediately after Lehman failed. (Actually, it got much worse before Lehman, but due to data lags this was not known until a few months later.)
Three months later we are still waiting for the recession.
People continue to make bad predictions because they have the wrong model. High interest rates do not indicate tight money. Financial turmoil is mostly the effect of a weak economy, not the cause.
Eventually, the US will experience a recession. But as long as the Fed continues to try to prevent recessions, the exact timing of recessions will be largely unforecastable.
READER COMMENTS
Casual Observer
Jun 14 2023 at 1:10am
I’ve learned a lot from your posts, but still find a lot of conflicting information out there. I am curious what your thoughts are on this blog post by a fellow “freshwater” economists (he got his phd from U of MN). At the end of the day, I agree with your conclusion that we need to be careful with macro indicators and that business cycles/recessions are unpredictable, but that begs the question: but then what? Do we just “wing” it? G
Scott Sumner
Jun 14 2023 at 9:11am
“I am curious what your thoughts are on this blog post”
Which post? Can you summarize the argument?
Casual Observer
Jun 14 2023 at 12:21pm
Still figuring out comment. Lets see if this works: https://earlyretirementnow.com/2023/05/17/may-2023-market-musings-monetary-policy-and-inflation/
Don Geddis
Jun 14 2023 at 1:47pm
Price stickiness does not cause inflation. Continual inflation requires continual monetary stimulus. Price stickiness causes delays in price adjustments. If anything, it prevents inflation (which is a change in the price level).
Everyone knows the difference between price levels, vs. price growth rates (“inflation”). “Transitory” vs. “permanent” inflation is about about whether the growth rates are sticky, not whether the price level is sticky. The (false) theory is that past inflation sets expectations for future inflation, in a kind of “wage-price spiral”. This isn’t actually how inflation works, but it is a commonly held theory of inflation. But it has nothing to do with whether you recover the previous price level.
Thomas Hutcheson
Jun 14 2023 at 4:38pm
Asymmetrically downward price stickiness in the presence of continuous shocks that require continuous changes in relative prices requires a continuous rise in the average price level (inflation) for markets to clear (no unemployment of resources to occur). Optimal monetary policy is to permit that amount of inflation and no more.
Scott Sumner
Jun 15 2023 at 9:48am
I’d rely on market indicators, which are the least bad option.
Thomas Hutcheson
Jun 15 2023 at 6:05pm
Market indicators can indicate when outcomes deviate from targets, not what the target should be.
spencer
Jun 14 2023 at 10:10am
Business cycle theories are fictitious. Monetarism has never been tried. Volcker targeted nonborrowed reserves, not total reserves. And disintermediation only applies to the nonbanks since 1933.
The economic problem is the Keynesian economic persuasion that maintains a commercial bank is a financial intermediary. The utilization of bank credit to finance real investment or government deficits does not constitute a utilization of savings, since bank financing is accomplished through the creation of new money. Savings are not synonymous with the money supply.
Dr. Philip George’s “The Riddle of Money Finally Solved” corroborates this. Banks don’t lend deposits. Deposits are the result of lending/investing. All bank-held savings are unused and unspent.
Since we don’t have a valid velocity figure, bank debits to deposit accounts, we must fall back on the ratio of transaction accounts to savings/investment type accounts. Greenspan discontinued the transaction concept of money velocity in Sept. 1996.
The fall in the “demand for money” (inverse of Vt) is historic.
Shadow stats refers to this as: “The most-liquid “Basic M1” (currency plus Demand Deposits) held 118.1% above its Pre-Pandemic Level and is increasing year-to-year, versus the Aggregate M2 Money Supply holding up by 30.0%, but declining year-to-year”.
M2/GDP is still too high.
M2/Gross Domestic Product | FRED | St. Louis Fed (stlouisfed.org)
Link: Calafia Beach Pundit: A soft landing thanks to surplus M2 (scottgrannis.blogspot.com)
Grand Rapids Mike
Jun 19 2023 at 4:04pm
The Fed really ramped up M2 by almost 40% from March 2020 to Dec 2021. Since then the decline of M2 seems to about 5%. So there is a lot of money slashing around to keep inflation going.
spencer
Jun 14 2023 at 10:16am
Targeting N-gDp makes economic cycles self-correcting (like before the GD).
Thomas Hutcheson
Jun 14 2023 at 4:46pm
Yes, but it requires the right target given a) the degree of asymmetrically downward price stickiness and b) the magnitude of the shocks and hence the magnitude of the required changes in relative prices.
spencer
Jun 14 2023 at 6:56pm
N-gDp targeting would work like Friedman’s K percent rule.
Knut P. Heen
Jun 21 2023 at 10:51am
That is the standard interpretation of Modigliani-Miller. Trouble occurs because the pizza is small, not because we have promised the creditor a large slice.
I think the reason people still talk about finance as a cause of business cycles is the old misinterpretation of the Great Depression. The stock market crashed in 1929 before the depression set in. The idea that rational expectations imply that the stock market should crash before a great depression sets in came much later. When I read history in high school, I read the following timeline: stock market crash, then depression, and the conclusion was that the evil stock market caused the depression. The history book was not written by someone who had heard about rational expectations.
I think the lack of demand story for business cycles also is wrong. Why did they resort to soup kitchens during the 1930s if the lack of demand meant that there was a lot of unsold meat laying around?
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