Wednesday, October 7, 2015

The Business Cycle and the Current State of the Economy (Part 2)

By Robert Wenzel

In part 1 of The Business Cycle and the Current State of the Economy, I discussed the fundamental nature of the business cycle and that it was incorrect to think that the Fed can not re-ignite a new boom phase.

That said, there are factors that can prolong the bust phase. I discussed some of these factors in Part 1, but I want to put more emphasis on them here and also identify other factors that may cause shifts in employment and the economy that have nothing to do with the business cycle itself, that is, nothing to do with the boom-bust itself or a prolongation of the bust phase.

The chief way by which the bust phase is prolonged is by government regulations, subsidies etc. that have nothing to do with the Federal Reserve, the creator of the boom-bust cycle.

For example, "unemployment insurance" prolongs the high unemployment situation because the government for all practical purposes is paying people not to work. Without unemployment insurance, people, if they have no savings, would either have to find new work or starve. It is not likely that many would choose starvation. Further, markets clear. Thus, it is not a legitimate argument to say "There are no jobs." Unless government is restricting hiring in some manner, say by minimum wage laws or licensing restrictions, jobs will be available on a free market. The only spike in unemployment will be transitory unemployment as workers are laid off from the capital goods sector and find work in different  less capital intensive areas, including consumer goods sectors.

Another method that can cause a prolongation of the recession is government education loans or education subsidies of one type or another, If a government provides student loans, say, to laid-off workers then those workers can be considered part of those that are part of the labor force but not participating and part of a prolongation of the recession non-employment situation, if these student loan recipients would have otherwise sought employment.

There are, however, other economic factors that may change at the same time (or different times) as a boom-bust period and have nothing to do with the period.

Murray Rothbard touched upon this briefly in his book America's Great Depression, when he wrote (emphasis in original except for blue highlight which is mine):
It is important, first, to distinguish between business cycles and ordinary business fluctuations...Changes, then, take place continually in all spheres of the economy. Consumer tatsets shift:time preferences and consequent promotions of investment and consumption change;the labor force changes in quantity, quality and location...All these changes are typical features of any economic system. In fact, we couild not truly concieve of a changeless society, in which everyone did exactly the same things day after day, and no economic data ever changed.
Thus, it is entirely conceivable from Rothbard's perspective to picture changes in the labor force participation rate that have nothing to do with the boom-bust cycle or an extended recession.

This appears to be the case with regard to the current decline in the labor force participation rate. From an Austrian School Business Cycle Theory perspective, it appears we are in the boom phase. That is, the Fed is aggressively pumping money (for the most part) and capital goods prices are climbing (for the most part), e.g. the stock market and housing prices, and unemployment is falling.

Here are the charts on this data since the 2008 financial crisis:

This is classic recovery/boom phase activity (with slightly different trends for different sectors).

But what about the labor force participation rate? It is collapsing:

There are various factors contributing to the falling participation rate, as I have already notedA report from the Bureau of Labor Statistics issued in November 2006 studied those in the not-working part of the labor force participation category and found they generally fell into three categories:
1) The aging of baby boomers. A lower percentage of older Americans choose to work than those who are middle-aged. And so as baby boomers approach retirement age, it lowers the labor force participation rate.
2) A decline in working women. The labor force participation rate for men has been declining since the 1950s. But for a couple decades, a rapid rise in working women more than offset that dip. Women’s labor force participation exploded from nearly 34 percent in 1950 to its peak of 60 percent in 1999. But since then, women’s participation rate has been “displaying a pattern of slow decline.”
3) More young people are going to college. As BLS noted, “Because students are less likely to participate in the labor force, increases in school attendance at the secondary and college levels and, especially, increases in school attendance during the summer, significantly reduce the labor force participation rate of youths.”
The number of young people going to college can be argued is the result of easier government funding since the financial crisis, and thus this participation rate factor must be considered a prolongation of the recession.

The decline in women working appears to be more of a secular trend, though it has intensified at the start of the financial crisis but can not be blamed, at this point, on the bust of 2008.

Most significant are the findings of Shigeru Fujita at the Federal Reserve Bank of Philadelphia, who has written:
Almost all of the decline (80 percent) in the participation rate since the first quarter of 2012 is accounted for by the increase in nonparticipation due to retirement. This implies that the decline in the unemployment rate since 2012 is not due to more discouraged workers dropping out of the labor force.

This, of course, fits in with the theory that the decline in the participation rate is not connected to the 2008 recession and should not be considered and indication of  "a serious ongoing bust" dating back to the 2008 financial crisis that the Fed has been unable to reverse, but rather the type of  economic phenomena that Rothbard discussed as potentially very real but outside of the boom-bust cone.

It is extremely dangerous to jump on every piece of "negative" data to argue that the Fed can never create a new boom phase. When a boom phase becomes clear, then those wanting to attack business cycle theory can point to the incorrect view held by those who argue that the Fed can "never" reverse the bust.

To be sure, the Fed is a bad actor in the economy and we would be much better without it. But we must properly understand the threats it creates at different times. The Fed does create the malicious  boom-bust cycle, but it is also generally flirting with accelerating price inflation. In recent years, a combination of the desire by individuals to hold larger cash balances in the shadow of the 2008 financial crisis and gains in productivity  (See the oil sector) have dampened the price inflation, but that is not likely to be a long-term phenomenon. Accelerating price inflation will be back soon enough, which of course when it does occur, should be blamed directly on the Fed. And, yes, eventually, we will have another bust phase, we are just not in one mow.

 Robert Wenzel is Editor & Publisher at and at Target Liberty. He is also author of The Fed Flunks: My Speech at the New York Federal Reserve Bank. Follow him on twitter:@wenzeleconomics


  1. This is a well written piece RW, I hope it lands on LRC.

  2. In Rothbard's essay "From Hoover to Roosevelt: The Federal Reserve and the Financial Elites" ...

    "The Fed, under Meyer, did its mightiest to inflate the money supply -- yet despite its efforts, total bank reserves only rose by $212 million, while the total money supply fell by $3 billion. How could this be?

    "The answer to the mystery is that the inflationary policies of Hoover and Meyer proved to be counterproductive. American citizens lost confidence in banks and demanded cash ... while foreigners lost confidence in the dollar and demanded gold ...

    "In addition, the banks for the first time, did not fully lend out their new reserves, and accumulated excess reserves ... banks can always use their excess reserves to buy existing securities; they don't have to wait for new loan requests. Why didn't they do so? ...

    "[Just] at the time when bank loans were becoming risky, the cheap money policy of the Fed had driven down interest returns from bank loans, thus weakening banks' incentive to bear risk"

    Some things never change. Though, unlike Meyer, the Ben Bernanke was able to increase the money supply despite peoples' desire to increase their cash holdings and the banks' accumulation of excess reserves.

  3. The business cycle is not a predictable one year after year and can even be rather surprising on some instances as well. Nevertheless, market practitioners still put in efforts to somehow try and gauge what is to come next in order to better prepare themselves for the worst case scenario. Though the potential of surprises still remains, but they are always willing to take on that risk.