The Death Of A Business Cycle

How do business cycles end? In the US, conventional wisdom is that they are murdered by the Federal Reserve. It is too slow to raise rates and then goes too quickly. This view is espoused by numerous well-respected economists and policymakers. President Trump's criticism of the Federal Reserve is anchored by such views.  

America's ambivalence toward a central bank is around 200-year old. It was the Panic of 1893 that swung the banking community around to support a modern central bank. It is notable that the economic crisis of 1893 was called a panic. The jargon changed in the late1920's with the Great Depression. Subsequently, the word recession was used to denote the end of a business cycle to avoid the connotation of the word depression, which was associated with the calamity of the 1920s and 1930s. 

The business cycle existed before the Federal Reserve. Therefore it seems incongruous to blame it for the business cycle, though of that does not prevent it from making policy mistakes that could exacerbate the downturn. Earlier business cycles seemed to reflect the agriculture cycle. However, by the start of the 20th century, economists and policymakers had begun recognizing an industrial business cycle. 

Some, for example, linked it to the lag time between breaking ground for a new factory and the time that factory came on-line. Others saw the rise of fixed costs relative to variable costs as posing new challenges. It provided an incentive to continue to produce even at a loss rather than cease production, like the abstract models of the day suggested. There are also some that saw the problem as a function of the creation of national markets.  The US, Germany, Italy, for example, were united in around the middle of the 19th century.  

In the US, after the Civil War, a shoe manufacturer in Boston now would compete with a shoemaker in Chicago. The birth of national economy exposed excess capacity and redundant investment, and what many at the time called "ruinous competition". It is not coincidental then that the US experiences its first large-scale merger wave after 1893 Panic. Mergers and acquisitions (horizontal) are industry's attempt self-regulate and get rid excess capacity. Think of US Steel, which when created out of ultimately nearly a dozen steel companies, early in the 20th century. Indeed, the "Trust Question" was one of the issues that dominated national politics for around a quarter of a century before WWI.  

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Read more by Marc on his site Marc to Market.

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Gary Anderson 1 year ago Contributor's comment

If investors are fearful of investing, late in the cycle, when all prices are relatively inflated, the Fed must kick start investment. The Fed must slow the economy or it will slow itself violently, as GDP will drop, as in 2007-8. Unfortunately, the Fed sometimes jumps the gun, because of fear of the zero lower bound, and then only helps bigger business in a recovery. It should help everyone it breaks.