51, NO. 9, SEPTEMBER 2001
The Economy is Cyclical?–It
Just Ain’t So!
Roger W. Garrison
According to a memorable title, “Business Cycles
Aren’t What They Used to Be–and Never Were” (Gerald Sirkin, Lloyd’s Bank
Review, v. 104, 1972). In today’s political and economic environment, we
need to be clear about which characteristics endure and which ones can
and do change over time. We might begin with a reminder about characteristics
that have never been justifiably associated with the business cycle. The
term itself suggests a rhythmic variation of business activity. But despite
the once-popular notion of a built-in fifty-five year cycle dreamed up
by Russian economist Nicolai Kondratieff, no such econo-rhythms have any
claim on our attention. Neither Kondratieff’s long wave nor any of its
shorter-wave cousins are any part of our actual experience.
The “cycle” as applied to twentieth-century fluctuations–and as applied
to twenty-first century worries–is better described as a boom-bust sequence.
It is a whipsaw effect with no necessary recurrence implied. The economy
is somehow set off on an unsustainable growth path–a path on which market
forces are pitted against one another. Eventually and inevitably, the trade-off
between maintaining an excessively high growth rate and accommodating people’s
current demands for consumables is made in favor of the latter. When resources
are finally diverted away from the future-oriented investment projects,
jobs are lost and a period of liquidation ensues. While there is no instant
fix for an economy that has experienced such a bust, ordinary market forces
operating throughout the economy can put the economy back on a sustainable
The most conspicuous enduring characteristic of the boom-bust sequence
is revealed by investigating the originating “somehow.” The origin of this
macroeconomic misstep must have an essential element of centrality about
it. A fully decentralized economic system cannot “somehow” set itself off
on an unsustainable growth path. Such a systematic distortion suggests
central decisionmaking, and the central element of note in our economic
system is, of course, the central bank.
Credit expansion by the Federal Reserve orchestrates a boom. Abundant credit
at artificially low rates of interest encourages more investment activity
than can be carried through to completion. Entrepreneurs borrow the new
money and buy resources. If the central bank had the power to print more
resources, too, the boom would be sustainable. But neither the Federal
Reserve nor any other governmental institution has such powers. Hence,
the boom is artificial and leads to a bust.
Beyond its origins in ill-conceived or politically motivated monetary policy,
the boom-bust sequences has other enduring characteristics, such as excessive
investment in long-term projects and dramatic movements in the prices of
interest-sensitive and highly speculative assets. One curiously enduring
complement of a maturing boom is the widely held belief that business cycles
are a thing of the past. In the 1920s, Irving Fisher believed we had reached
a new plateau of prosperity. References in today’s financial press to the
“new economy” should be seen as dark reminders of Fisher’s plateau. Editorials
sounding related themes (“Conquering the Business Cycle”; “Have the Laws
of the Cycle Been Repealed?”; “An Era of Cycle-Free Growth”) should be
read as old hat rather than new era.
Even the reasons offered for believing that we’ve entered a new economy,
while different in their details, are tellingly similar. The expansion
of the 1990s actually involved real economic growth–attributable in part
to the internet, the digital revolution, and just-in-time inventory management.
True enough, but the expansion of the 1920s also involved real economic
growth–attributable in part to technological advancements in automobiles,
home appliances, and food processing.
In both periods, the real growth, which in the absence of credit expansion
would have been accompanied by price reductions, helped keep price inflation
in check. That is, increases in the money supply and the ongoing real economic
growth had largely offsetting effects on the overall level of prices. F.
A. Hayek described this circumstance as artificial price-level stabilization–a
term that could only be puzzling to Irving Fisher and modern-day monetarists,
who take price-level stability as the hallmark of macroeconomic health.
But Hayek demonstrated that the absence (or slightness) of price inflation
is of little comfort in a period when cheap credit is stimulating investment
beyond people’s willingness to save. Price-level constancy does not equal
Business cycles aren’t what they used to be if only because some people–and
policymakers–make judgments and take actions on the basis of their experience
with previous booms and busts. The history of the art of “Fed watching”
illustrates the point. During the early years of the Federal Reserve, there
were no Fed watchers. In fact, there was precious little that one could
have watched. Data on the monetary aggregates and credit conditions were
simply not available–a circumstance that helps explain how the boom (the
monetary deception) could be so long-lasting.
During the 1960s and 1970s, the availability of data on the monetary base
and on the key money-supply aggregates allowed Fed watchers to monitor
the Federal Reserve’s efforts to manipulate credit conditions. And in the
early 1980s, when money-growth targeting replaced interest-rate targeting,
those same aggregates allowed Fed watchers to compare track records to
intentions and to make predictions about the Fed’s habitual overshooting.
This was a period of relatively short business cycles.
In today’s environment, the monetary aggregates have lost the meaning they
once had. The much-watched M1 and M2 derived their significance from two
vital links: (1) the ability of the Federal Reserve to control those aggregates
by adjusting the monetary base and (2) the near constancy of the velocity
of money, which maintained a near constant ratio between the money supply
and the price level. After extensive banking reforms of the Carter and
Reagan administrations severely weakened both links, the Federal Reserve
returned to interest-rate targeting. Present day Fed watchers can only
watch and wonder. The monetary aggregates are readily available but are
not very helpful. M1 is essentially the same as it was a year ago. Over
that same period, M2 has risen by eight percent; the new MZM by 13 percent.
(The “ZM,” which stands for zero maturity, indicates all financial instruments
payable at par on demand.) Unfortunately, none of these measures of money
are both readily controllable and strongly correlated with the price level
or any other macroeconomic variable.
Currently, there is timely information about the Federal Reserve’s changing
interest-rate target. Both the administered discount rate and the targeted
federal funds rate are publicly announced within a couple of hours after
each decision to change them. What is not known, however, is the interest
rate that would prevail in the absence of credit-market management by the
Federal Reserve. The all-important “natural rate of interest”–like the
“natural rate of unemployment”–becomes unobservable in a Fed-dominated
Our suspicions of political motivation–along with the 13 percent MZM growth–suggest
that the managed rates (of interest and unemployment) are somewhere below
the respective natural rates. If so, the resulting pattern of investments
is unsustainable; the economy is living on borrowed time. It’s a familiar
story. The internet and MZM notwithstanding, business cycles are what they
used to be: The central bank has whipsawed the economy once again.