The Interaction of Cycles

But there is no ground to believe that there should be just one wave-like movement pervading economic life.

-- Joseph A. Schumpeter

Wandering through Google results for unemployment historical data the other day turned up The Natural Rate of Unemployment, a PDF by David Brauer of the Congressional Budget Office. (16 pages, lots of pictures.)

The paper is from April, 2007 -- shortly before the crisis. Brauer's Figure 2 shows a prediction based on pre-crisis thinking:

Brauer's Figure 2: Demographics and the Natural Rate of Unemployment

David Brauer writes:

In its summer 2006 forecast, CBO reduced its estimate of the current natural rate from 5.2 percent to 5.0 percent, reflecting a decline since the mid-to-late 1990s in the share of the labor force that is below the age of 25. That decline is attributable not to a change in the age mix of the general population, but to an unexpected sharp and sustained drop in the labor force participation rate of teens and young adults, most likely because of higher rates of school enrollment.

Weird science:

1. People can't find work.
2. People go to school to improve their chances of finding work.
3. The "labor force participation rate" falls because people are in school.
4. The "natural rate of unemployment" falls.

It's sort of like: People can't afford so much steak, so they switch to pasta. And then steak is taken out of the "basket of goods" used to figure inflation, and pasta is put in. Because of this change, the inflation rate number is less. This is sick-puppy arithmetic, all of it. And bad economics.

But that's not why I called this meeting.


I think it's a little funny that the projected rate is five point oh! percent. The number wants to convey more accuracy than it can hold, I think. And once that trend line hits 5.0, it is rock-solid. A straight-line projection out to 2015 and beyond. Laughable.

I also think it's a little funny that in 2006 when CBO reduced its projection to 5.0 percent, apparently they reduced it all the way back to the year 2000.

We have always been at war with Eastasia. But that's not why I called this meeting.


Here is the opening sentence from the Abstract of Brauer's paper:

This paper assesses the natural rate of unemployment—the unemployment rate that arises from all sources other than fluctuations in demand associated with business cycles.

A simple definition. Unemployment arising from all sources other than business cycles. And that brings us to today's agenda: the fluctuations that are associated with business cycles.


In his Kondratieff rejection piece, Murray Rothbard wrote:

... the market is a seamless web. All facets of the market are interconnected through the price system, and the profit-and-loss motive. Booms and busts spread throughout the system; that is precisely why they are important. It is absurd to think that one part of the economy can peg along on a nine-year cycle, another on a three-year cycle, and still another on a 25-year cycle, with each of these cycles barreling along on a hermetically sealed track, not influencing and modifying each other. In fact, there can only be one real cycle going on in the economy at anyone time.

Rothbard is right:  It *IS* absurd to imagine completely separate cycles existing with absolutely no influence on each other. On the other hand, it is not absurd to imagine that more than one cycle might arise from economic forces generated by concurrent economic activity of billions of people spread over the face of a planet. Nor is it absurd to imagine such cycles themselves in continuous interaction.

It is, however, absurd to invent the notion of the non-interaction of cycles, pretend that others invented the notion, and then reject the work of others by saying that the non-interaction of cycles is absurd.


In Business Cycles (PDF, 385 pages apparently), on page 209 Schumpeter attempts to present an extremely simplified or "clean" version of the interaction of business cycles. He limits his presentation to three cycles only, "for the sake of simplicity". He eliminates not only other cycles but also "external disturbances" and also "Seasonals and Growth". And he makes his three cycles as regular and unvarying as possible by using "three sine curves the amplitudes of which are proportional to their duration".

Schumpeter warns that this is a great simplification: "Of course, we do not, as a matter of principle, postulate either internal regularity or sine form...

...we may look upon the charts as an illustration of all the boldest assumptions which it is possible, and to some extent permissible, to make in order to simplify description and to construct an ideal schema with which to compare observations. In particular, all cycles have four phases of equal length, amplitudes of plus and minus excursions are equal and constant, periods are also constant, and each of the two higher cycles consists of an integral and constant number of units of the next lower movement."

And then Schumpeter provides Chart 1, showing the interaction of cycles:

Take three extremely regular wave-patterns and add them together, and you get a surprisingly complex shape.

Schumpeter:

For the stranger to statistical technique the fact alone that extreme regularity of but three components may result in so very irregular-looking a composite should be instructive.

Schumpeter argues that the cycles *DO* interact.

I didn't find the reference, but Schumpeter also argues that if time and chance should bring the lows of various cycles together, the combined low would be deeper than any of the individual lows alone. You can see this behavior on his chart.

Schumpeter said this concurrence could explain the severity of the Great Depression. I don't necessarily buy that explanation of the Great Depression. But I certainly buy that such a thing could happen. So I have to reject Rothbard's assertion that "there can only be one" cycle.