Friday, February 15, 2013

Borio and Long Cycles

Borio writes of a financial cycle with a length on "the order of 16 to 20 years". He uses this estimate, it seems, only for contrast with ordinary "business-cycle frequencies". He is making the point that the financial cycle is not the same as the ordinary business cycle. I can accept that.

I don't see anything else in Borio's article that contradicts my view that the financial cycle is actually much longer than 16 to 20 years. But how long is this "longer" cycle?

My Debt-per-Dollar graph (from the linked post) peaks in 1933, and again in 2007. Philippon's graph of "financialization" shows comparable peaks, plus one in the late 1890s. But these peaks are endings of the "strong phase" of the financial cycle. The strong phase itself occurs before it ends, obviously.

Based on the acceleration points shown on Philippon's graph, I want to say the strong phases of the financial cycle began in the 1980s this time, in the 1920s last time, and in the 1890s the time before. And based on Min's observation, the cycle Lord Overstone saw probably began in the 1830s.

From the 1830s to the 1920s, two cycles in nine decades, average length 45 years.

From the 1890s to the 1980s, two cycles in nine decades, average length 45 years.

From the 1890s to the 1920s, as little as three decades.

From the 1830s to the 1980s, three cycles in fifteen decades, perhaps 50 years long.

The units are crude: decades, as opposed to years or quarters or months or days. Crude units are appropriate, I think. I deal in trends and tendencies, not in moments to buy and sell. Anyway, it's obvious that this cycle has a variable length. By Philippon's graph the strong phase of the 1890s lasted only about a decade, and that of the 1920s not much longer. But the strong phase that began in the 1980s lasted a full twenty years and more.

Probably has something to do with the flexibility that comes from not being on a gold standard. Flexibility, meaning they could increase the quantity of money whenever growing financialization made money tight (tight, relative to accumulating debt). In that case, one can think of the inflation since the 1960s as a policy response to growing financialization. Meaning that the problem goes back at least to the 1960s.

And again, as Borio writes, an incorrect policy response "can prolong weakness and delay a strong, self-sustaining recovery." There was less chance of that happening when we were on the gold standard. Today it is more important than ever to get policy right, to avoid prolonging problems and making things worse. Clearly, differences in length of the financial cycle can be attributed to the fact that the Federal Reserve has a finger in it.

Actually, from the 1920s to the 1980s is six decades -- long, in comparison to the cycle lengths ballparked above. That length also is an indication of the flexibility, and a consequence of the flexibility that comes from having the Federal Reserve manage our money. What I'm saying is, the strong phase of the financial cycle might have been ready to start before the 1980s. But it was undermined or counterbalanced by the Great Inflation. As Claudio Borio says,

the financial cycle depends critically on policy regimes.

Financial liberalisation weakens financing constraints... Not surprisingly, financial cycles have become twice as long since financial liberalisation in the early 1980s...

Obviously in my view, the correct policy response would have been to put limits on the growth of financialization. Instead, we took limits off. Why? Because we don't think in terms of long financial cycles. As Claudio Borio says, we cannot understand the economy if the financial cycle is ignored.

A four-part series on Claudio Borio's VOX article started on the 12th

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