Let us say this much for Trump. The economy has prospered under his watch. I am not convinced it has prospered because of tax cuts or gutting regulations, but simply because an extended recovery has been gathering steam. So the obvious question is, how long will it continue. Any time before, the sort of conditions we are seeing today would be a sign that we are nearing the peak of the business cycle and that recession cannot be far away. Is that still the case?
I will begin by digressing and pointing out that there has not been any significant change in the condition of the economy since the 2016 election. The general trajectory was one of improvement before the election and it has continued since the election. The stock market has grown faster since the election, no doubt in part as a result of enthusiasm over lower taxes and less regulation, but the stock market is not the real economy and is subject to "irrational exuberance."
Pre-election, Trump presented this as a false prosperity headed for certain disaster. If the stock market was surging, it was because of a bubble which was about to burst. If the economy seemed prosperous, it was a sham prosperity buoyed up by low interest rates and bound to end when rates were inevitably raised. And if unemployment was only 4.2%, it was because labor statistics undercounted unemployment, excluding discouraged workers and involuntary part-time workers. The real number was closer to 10% or 15%. Trump even said 42%, although this was generally agreed to be just crazy. Certainly my boss -- a Republican, although Trump was his last choice on the Republican side -- was caught up in the sense of gloom and doom and said (when defeat for the Republicans seemed certain) that it was for the best because then when inevitable disaster struck, everyone would understand the Democrats were to blame.
And then a funny thing happened when Trump won the election. All those statements about impending disaster -- well, apparently all it took was an election to dispel them. Overnight the bubble in the stock market filled in and all growth became solid. After just one day, false prosperity became real. And all those fake statistics about unemployment became genuine next time they came out. Apparently unemployment fell from 42% the month before Trump was elected to 4.2% the month after, a 90% drop in record time!
In all seriousness, what is one to make of all this? Well, for one thing, the economy continues to add jobs at an incredible clip, with no significant decline in the headline unemployment rate (I think it fell from 4.2% to 4.1%), without significant wage increases, and with no sign of inflationary pressure. All this is a sign that there really was considerable slack in the economy, that unemployment was much higher than the headline figure because of the large number of discouraged workers. The discouraged workers are coming back, so there is still significant room for growth by eliminating slack. Other signs of economic slack have been large business cash reserves going uninvested and persistently low long term interest rates.
How much slack? Time alone will tell. But eventually we will run out of slack in the economy and then what? Time was when it meant we had reached the peak of the business cycle and there would be a recession. Is that still the case? At least some theories suggest no.
To understand why, the first thing to understand is that there are at least two types of recession. One occurs when central banks tighten monetary policy to stop inflation and a recession results. Since the recession is induced, recovery is rapid when central banks relax monetary policy. During the Great Moderation from the 1980's to the latest financial crisis, this sort of recession appeared to end, possibly because central banks had figured out how to fight inflation without causing recessions.
But this did not mean that recessions ceased, merely that they became less frequent. A second kind of recession continued to occur, the kind that follows a bubble bursting and an overhang of bad debts. Recovery from this type of recession is slower than than from a recession induced to fight inflation. So, less frequent recessions and longer expansions were paid for by slower recoveries. But the first two recessions under the Great Moderation (circa 1991 and 2001) were mild ones. Then with the 2008 financial crisis a really bad recession occurred, followed by a slow and painful recovery.
So the real question is whether the economic crisis produced some sort of change in the economy that means the business cycle has finally ceased. There are some theories that suggest it is so, although they differ as to why.
One suggestion is that a really bad financial crisis has finally scared sense into the banking industry and will keep it from ever creating a bubble again. Pardon me if I am skeptical. In the 19th century, serious financial crises happened every 20 years or so, and banks never learned a thing. And, indeed, banks seem eager to engage in reckless behavior any time they get the change.
The other theory is that stringent financial regulations will prevent any more bubbles from forming. If that is the case, Trump and the Republicans (with significant assist from Democrats) are working on it. Nonetheless, I will concede that we aren't seeing signs of a bubble at least so far. So maybe our economy really will reach capacity and just stay there for years and years until the next bubble strikes.
But I am inclined to believe that business cycles are still with us, and that once our economy reaches capacity, a recession will follow as it always has before.
I just have no idea when that will be.
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