Chasing the Business Cycle

Is the Business Cycle a Necessity or Nuisance? 


Listener: 15 April, 1995. 


Keywords: Macroeconomics & Money; 


A recent editorial in the London Economist mused on the death of the business cycle. Economists have been able to track cycles of upswings and downswings for over two centuries. The fluctuations are not a precise sinusoid. Each business cycle is unique, but all show regularities in the underlying mechanics. Typically the cycle is about a growing trend, so the upswing is stronger than the downswing, and each cycle ends at a higher level of economic activity. 


While some economists see the cycle as an unnecessary nuisance, others see it as an integral part of the growth process. For at least fifty years some of the former group have been claiming that business cycle have been abolished by good (i.e. their recommended) management. Cycleless the economy would grow indefinitely. 


For fifty years such predictions have been voided by the world economy going into a cyclical downswing. Ironically the claims of the death of the cycle tend to be at their strongest, just as the boom peaks. The Economist editorial is concerned that there is then a tendency to relax economic management, which exacerbates the downswing. This loosening applies to governments, to business and, of course, to economic commentators. 


It would be foolish, although characteristic, to claim that New Zealand has magically abolished the business cycle, while much better managed economies have failed to do so. It is true that the fluctuations of the late 1980s were not as pronounced as in the past. This was partly because the world economy was in a long boom, partly because we were so struggling with stagnation and restructuring that oscillations were less evident. However since mid 1991 the New Zealand economies has been in one of its longest upswings, as is apparent from manufacturer’s capacity utilization index. The Institute of Economic Research, who compile the figure, will be announcing the April figure soon. We should not be surprised if the new level is lower than the December one. 


Indeed more thoughtful analysts worry about high capacity utilization, which is associated with inflationary pressures – hence the Reserve Bank trying to restrain economic growth by raising interest rates and holding them at high levels. But as The Economist perceptively observes “many economists now put their trust in monetary policy to arrange a `soft landing’ rather than a crash. But monetary policy is blunt: there are long and changing delays between alterations in interest rates and any effect on economic activity; even then the size of the impact is uncertain.” The editorial argues for other measures including fiscal policy. Although not directly addressing New Zealand, it would support the current budget surplus. 


While inflationary pressures are an important part of the top of the cycle, in the past the New Zealand downswing has been more hostage to a balance of payments crisis. Imports surge relative to exports, draining the economy of spending, while the government has to take measures to protect the current account. This is the prospect which faces Australia, with the expectation of a harsh budget next month. It would be surprising if New Zealand escaped the same fate. 


In the past the crisis has often been precipitated by a collapse in overseas prices for pastoral exports. Today these are a smaller part of the totality of export effort. Even so part of the strength of the upswing has been from their improvement. But suppose there is some price weakening, while the Australian economy slows down. Our manufactured exports would also slow down, and there would be less tourists from across the Tasman. Meanwhile imports would continue to boom. 

A not widely noticed discussion in the latest Reserve Bank Economic Forecasts observes that our import penetration ratio has risen from around 23 percent in 1984 to 29 percent in 1991, and is expected to go above 35 percent next year. The exact figures do not matter as much as the evident truth that imports as a share of spending are rising rapidly, so that exports as a share of production have to rise to pay for them. 


Unfortunately the monetary policies restraining inflation are exacerbating the threat of a balance of payments crisis. High interest rates push up our exchange rate, making imports cheaper and more attractive to purchase. Meanwhile the return on exports is depressed, making it harder to pay for the imports. Thus measures to ease inflationary pressures encourage importing, discourage exporting, and heighten the threat of an external collapse. 


This seems a far cry from the sort of economics prospects recently presented to the public. These assume a soft landing scenario, with the economy in a long run growth situation similar to the rich economies. They could be right, but one would have more confidence in the forecasts if the commentators were to stop assuming the death of the business cycle, and to explain why they think this time the end of the upswing will be different. As Mark Twain said after reading his obituary, the reports of the death are greatly exaggerated.