My Review of Tyler Goodspeed's Recessions
Published in Works in Progress
I am delighted that Works in Progress have published my review of Tyler Goodspeed’s new book Recessions: The Real Reasons Economies Shrink and What to Do About It.
Here is a preview:
Goodspeed is not just interested in confronting the kinds of explanations for mania, crashes, and panics seen either in history books or in journalist accounts. He wants to see if the data supports theoretical accounts of recessions that locate the cause of the downturn in the preceding expansion. His antagonists are two celebrated Austrians: first Friedrich Hayek, introduced early in the book as a prospective restaurant dishwasher as a young man in New York and whose prominent account of business cycles rivaled Keynes’s in the 1930s; and second, Joseph Schumpeter, who saw in recessions the opportunity to sort out the mistakes and misallocations of the boom. Goodspeed’s main goal in the 200 or so pages of the book is to ask whether the data supports these theories, or their modern variants, or whether it is consistent with a much simpler story.
The short answer is no, and this is Goodspeed’s second main message. The spine of the book is data on quarterly output for the UK and US. The UK data comes from the work of Steve Broadberry and coauthors. The US data stems from the National Bureau of Economic Research but Goodspeed has extended it back to 1700 and applied a consistent methodology to provide a continuous business cycle series for both countries.
Goodspeed shows that British and American expansions do not resemble Dorian Gray, looking beautiful but hiding an inevitable accumulation of malinvestments (objectively bad investments that are destined to fail) and distorted decisions (mistaken economic decisions taken on the basis of bad regulation or flawed prices) that make a correction inevitable. If they did so, he argues, one would expect that as expansions get longer they get more and more likely to end. In his data, however, the relationship between the age of an expansion and the probability of death is essentially zero. Nor do measures of increased investment during the boom correlate with the severity of a downturn. Nor do longer expansions have longer recessions after them.
This is why recessions remain essentially unpredictable. Any perceived regularity is likely to be a statistical illusion. Goodspeed shows that attempts to forecast recessions such as inversions of the yield curve (where long-dated government bonds have lower interest rates than short-dated ones) or the Sahm rule (which says a recession is likely underway if the unemployment rate spikes high above its recent lows for three months) are overfitted to US data and don’t work for the UK. The same proved to be true of the Phillips Curve, a strong correlation between unemployment and inflation that existed in British data between 1860 and 1960, which broke down after governments attempted to target it and fine tune the economy in the 1960s.
The full review is available here.
The Schumpeter finding is the most consequential one here. If longer expansions don't produce more severe recessions — if the creative destruction mechanism doesn't actually clean up the misallocations from the boom — then the self-correcting assumption that underlies a lot of structural economic policy loses its empirical foundation. The implication worth drawing out is that structural problems don't resolve themselves through the cycle. They persist. Which means the gap between what an economy produces and what typical workers receive isn't a temporary distortion that the next recession will correct — it's a design condition that requires active structural intervention rather than cyclical patience. Goodspeed's data undermines the 'wait for the correction' argument more thoroughly than most readers will notice on first pass.