By Dr Frank Shostak
Is it possible to ascertain the state of the economy by looking at the data? Most economists are of the view that by looking at the data one can establish the state of economic conditions.
The so-called data that analysts are looking at is however a display of historical information. In The Ultimate Foundation of Economic Science p. 74, Mises argued that,
What we can “observe” is always only complex phenomena. What economic history, observation, or experience can tell us is facts like these: Over a definite period of the past the miner John in the coal mines of the X company in the village of Y earned p dollars for a working day of n hours. There is no way that would lead from the assemblage of such and similar data to any theory concerning the factors determining the height of wage rates.
During the 1930’s the National Bureau of Economic Research (NBER) introduced the economic indicators approach to ascertain business cycles. A research team led by W.C. Mitchell and Arthur F. Burns studied about 487 economic data in order to establish what business cycles are all about.
Mitchell and Burns have concluded that,
Business cycles are a type of fluctuation found in the aggregate economic activity of nations….a cycle consists of expansion occurring at about the same time in many economic activities, followed by similarly general recessions, contractions, and revivals which merge into the expansion phase of the next cycle; this sequence of changes is recurrent but not periodic.
Furthermore, according to the NBER research team because the causes of business cycles are complex and not properly understood it is much better to focus on the outcome of these causes as manifested through the data.
It is held that a careful inspection of the data makes it possible to establish peaks and troughs in general economic activity. The NBER methodology was designed to be as impartial as possible in order to be seen as purely scientific. On the NBER methodology Murray Rothbard wrote,
Its numerous books and monographs are very long on statistics, short on text or interpretation. Its proclaimed methodology is Baconian: that is, it trumpets the claim that it has no theories, that it collects myriads of facts and statistics, and that its cautiously worded conclusions arise solely, Phoenix-like, out of the data themselves. Hence, its conclusions are accepted as unquestioned holy “scientific” writ.
The importance of defining the subject of investigation
By stating that business cycles are about swings in the data, the NBER says nothing about what business cycles are all about. One only describes fluctuations in the data. One however, does not explain these fluctuations. In order to ascertain what business cycles are, one requires to identify the essence – the driving force behind these cycles.
The key in the analysis of the data is to establish the subject of analysis. Once the subject is established, the next step is to form the essence the definition of the subject.
To establish the definition of the boom-bust cycles we must ascertain how this phenomenon had emerged.
To establish the definition, it is helpful to go back as far as one can at the point of time when a particular thing had emerged.
According to Murray Rothbard,
Before the Industrial Revolution in approximately the late 18th century, there were no regularly recurring booms and depressions. There would be a sudden economic crisis whenever some king made war or confiscated the property of his subjects; but there was no sign of the peculiarly modern phenomena of general and fairly regular swings in business fortunes, of expansions and contractions.
The boom-bust cycle phenomenon is somehow linked to the modern world with the establishment of central banks. The source of the recurrent boom-bust cycle turns out to be the alleged “protector” of the economy — the central bank itself. The central bank’s ongoing policies that are aimed at fixing the unintended consequences that arise from its earlier attempts at stabilizing the so-called economy are key factors behind the recurrent boom-bust cycles.
These responses to the effects of previous policies on economic data give rise to the fluctuations in the growth rate of the money supply and in turn to the recurrent boom-bust cycles.
Observe that the central bank easy monetary policy, which results in an expansion of money supply, sets in motion an exchange of nothing for something, which amounts to a diversion of wealth from wealth-generating activities to non-wealth-generating activities.
In the process, this diversion weakens wealth generators, and this in turn weakens their ability to grow the overall pool of wealth. The emergence of activities on the back of easy monetary policy is what an economic “boom” is all about – observe that these activities cannot stand on their “own feet”. These activities are also characterized as bubble activities.
Once however, the central bank tightens its monetary stance, this slows down the diversion of wealth to bubble activities. Bubble activities are now getting less support; they fall into trouble — an economic bust emerges. Hence, the more of such activities that were generated during the economic boom, the greater the cleansing of such activities is required in order to revitalize the economy – consequently the greater the economic recession is going to be.
Observe that bad business conditions emerge when least expected — just when all businesses are holding the view that a new age of steady and rapid progress has emerged. An economic slump emerges without much warning and in the midst of “good news”.
Note when the central bank changes its monetary policy the effect of the new stance does not assert itself instantaneously – it takes time. The effect starts at a particular point and shifts gradually from one market to another market. Consequently, the previous monetary stance may dominate the scene for many months to come before the new stance begins to assert itself.
Economic slowdown versus Recession
Contrary to popular thinking, recessions are not about declines in various economic indicators as such – they are about the liquidation of business errors brought about by previous loose monetary policies. They are about the liquidation of activities that sprang up on the back of previous loose monetary policy. The ensuing adjustment of production may or may not manifest itself through a negative GDP growth rate.
As a rule, the symptoms of a recession emerge once the central bank tightens its monetary stance. What determines whether an economy falls into a recession or just suffers an ordinary economic slowdown is the state of the pool of real savings. As long as this pool is still expanding, a tighter central bank monetary policy is likely to culminate in an economic slowdown. Notwithstanding that various non-wealth, generating activities are likely to suffer; overall, economic growth is likely to be positive. The reason being because there are more wealth generators versus non-wealth generators. This is reflected by the expanding pool of real savings.
As long as the pool of real savings is expanding, the central bank and government officials can give the impression that they have the power to prevent a recession by means of the monetary pumping and the artificial lowering of interest rates. In reality, however, these actions only slow or arrest the liquidation of activities that emerged on the back of an easy monetary policy, thereby continuing to divert real savings from wealth generators to wealth consumers. (Note, that what in fact gives rise to a growth rate in economic activity is not the monetary pumping but the fact that the pool of real savings is actually growing).
The illusion that through the monetary pumping it is possible to keep the economy going is shattered once the pool of real savings begins to decline. Once this happens, the economy begins its downward plunge, i.e., the economy falls into a recession. The most aggressive loosening of money will not reverse the plunge. In fact, rather than reversing the plunge, loose monetary policy is going to further undermine the flow of real savings thereby further weakening the structure of production and thus the production of goods and services.
Summary and conclusion
According to the NBER, given the complex nature of economic cycles it is much better to deal with the symptoms of the disease rather than trying to identify causes, which for the time being are of a mysterious nature. We suggest that without establishing the underlying causes of boom-bust cycles, employing policies in response to changes in the data to counter economic cycles is likely to destabilize the economy. We hold that a major cause of boom-bust cycles is the institution that supposedly “defends us” against this menace. This institution is the central bank itself.