The Causes of American Business Cycles: An Essay in Economic Historiography

THE CAUSES OF AMERICAN BUSINESS CYCLES:

AN ESSAY IN ECONOMIC HISTORIOGRAPHY

Sadia chaudhary

This paper surveys American business cycles over the past century.

Its task is to identify the causes of these cycles; other papers in this

collection address the nature of policy responses to these causes. This

paper can be seen as a test to discriminate between two views of the

American economy. The first is expressed in a characteristically vivid

statement by Dornbusch, who proclaimed recently: gNone of the U.S.

expansions of the past 40 years died in bed of old age; every one was

murdered by the Federal Reserveh (Dornbusch 1997). This stark view can

be contrasted with its opposite in the recent literature: g[N]one of the

popular candidates for observable shocks robustly accounts for the bulk

of business-cycle fluctuations in outputh (Cochrane 1994, p. 358).

I expand the time period to consider the past century, but it is easy

to distinguish the past 40 years, that is, the period since World War II. A

survey of business cycle causes over an entire century runs into several

problems, of which three seem noteworthy. First, it is not at all clear what

gcauseh means in this context. Second, the Great Depression was such a

large cycle that it cannot be seen as just another data point. Third, the

survey relies on the existing literature on business cycles, which is why I

have entitled it an essay in economic historiography. The paper proceeds

by discussing each of these problems in turn, then turning to the data,

and finally drawing some conclusions from the preceding efforts.

*Elisha Gray II Professor of Economics, Massachusetts Institute of Technology. The

author would like to thank Caroline Richards for research assistance. All errors remain the

authorfs alone.

BUSINESS CYCLES: DEFINITION AND ANALYSIS

The cause of a business cycle typically is taken to be a shock or

innovation to a relationship in the economy. Myriad relationships operate

in a complex economy like ours, and some way needs to be found to

impose order on the analysis of shocks. Order typically is imposed by

abstracting from the actual economy to an abstract model. A more

operational definition of cause, therefore, is a shock to a relationship in a

macroeconomic model. It follows that shocks may be specific to models,

which differ both in their level of detail and in their basic assumptions.

With differing levels of inclusiveness, one personfs shock may be

anotherfs movement of an endogenous variable. Government actions are

a case in point. Variation in government purchasing is taken to be

exogenous in many economic models, and it is eligible as a business cycle

cause in these models. But the growth of political economy has led people

to endogenize government actions. Only deviations from the rule then

would be admissible as a shock. Brown (1956) long ago looked for

Keynesian stimuli during the Great Depression. He sanitized government

spending to eliminate automatic stabilizers, that is, variations due to the

state of the economy, to find the high-employment surplus. Keynesian

stimuli then were changes in his calculated budget, not the actual budget.

As Brown recognized half a century ago, the stimulus.or shock.was

specific to the specification of the normal budgetary rule, that is, to the

correction used.

Actions by the Federal Reserve fall into the same category. The Fed

tries to respond to economic conditions. Are Fed actions endogenous or

exogenous? Various authors have tried to endogenize the Fed. Wheelock

(1991) and Toma (1997) have modeled the Fed in the interwar period.

Taylor and others have proposed monetary policy rules to analyze Fed

behavior since the Second World War (Taylor 1993a, 1993b). A typical

policy rule indicates that the Fed raises interest rates when inflation rises

and when the economy is operating above its trend level. Such Fed

actions would be considered endogenous in a model that treated the Fed

symmetrically with Brownfs treatment of the budget.

An example may make this distinction clear. OPEC countries raised

the price of oil sharply following the Yom Kippur War in the fall of 1973.

Prices began to rise in the United States as a result, and the Fed sharply

restricted monetary growth. A recession followed that Paul Samuelson

quipped had gMade in Washingtonh stamped on its bottom. Was the

recession gcausedh by the oil shock or by monetary policy?

The answer to this question depends on the model. If we are using a

model that regards Fed actions as exogenous (perhaps