CHRISTOPHER DOW ON MAJOR RECESSIONS [*].
Artis, Michael ; Flemming, John ; Matthews, Robin 等
The National Institute had planned a seminar to mark the launch of
Christopher Dow's new book Major Recessions. The seminar had to be
cancelled, because Christopher Dow died a few days before it was due to
be held. As some kind of substitute, the CLARE Group decided to publish
this review article. The sections of the article have different authors,
but they have been designed to be complementary in scope and the authors
have discussed them with each other and with other members of the Group,
especially A.J.C. Britton, W.J. Carlin, C.A.E. Goodhart, P.M.
Oppenheimer, M.V. Posner and J.R. Sargent. The Review is pleased to give
hospitality to GLARE Group articles, but is not necessarily in agreement
with the views expressed.
Robin Matthews starts with some comments on the style in which, and
background from which, Dow wrote this work and which concentrates on
five major British recessions of the 20th century. He presents five of
Dow's more general conclusions with comments. This section is
followed by a review by Mike Artis of Dow's analysis of the five
major recessions (1920-1, 1929-33, 1973-5, 1979-82 and 1989-92) regarded
as episodes in economic history. One of Dow's main theses is that
major recessions permanently reduce productive capacity. Martin Weale
examines statistically his suggestion that they reduce demand by
consumers whose income expectations adjust in that way -- for which he
finds little support. John Flemming addresses the 25 'golden'
postwar years without a major recession presenting a critical analysis
of Dow's method of distinguishing between major and minor
recessions. Matthews and Flemming consider his treatment of the question
whether major recessions are inevitable, how they might be avoided, and
how thei r effects might be mitigated. While hankering for postwar
controls Dow's Keynesianism is subtle. Finally Matthews suggests an
analogy with Schumpeter's Business Cycles which survived a critical
review by Kuznets, Dow's treatment of his data being much more
thoughtful than Schumpeter's even if some parts of his model seem
rather shaky.
Introduction: Robin Matthews
Some general characteristics of the book
Christopher Dow did not start work on the book until he was over
70, and he was approaching his 82nd birthday by the time it was
completed. The style is entirely characteristic of the author and gives
no hint of declining powers. Those who knew him will be able to hear his
voice on every page. He is very conscious of the difficulty of the
subject and the intractability of the material ("on some big
questions I have changed my mind several times"). This does not
prevent him from writing with serene self-assurance.
He is unconcerned by many prevailing fashions of thought. He is not
ignorant of them, though perhaps he has not felt an obligation to
acquaint himself comprehensively with writings that are based (in his
opinion) on fundamentally erroneous premises. Real Business Cycle theory
gets short shrift; so does Ricardian equivalence. As to econometrics,
since there were only five major recessions in the UK to consider since
World War I, "it is not possible to undertake the rigorous testing
to which econometrics aspires ... It is not clear how great this loss
is. Econometric procedures have proved much less valuable than most of
us hoped a generation ago". His own preferred method is
"quantitative-historical": the book contains a large number of
well-designed charts and tables, and a strong admixture of theory.
Christopher Dow's career before he retired was predominantly
in the public service -- in the Treasury, at the OECD, and in the Bank
of England. He was close to the processes of public decision-making for
much of the post-World War II period. Although he was one of the
country's most eminent macroeconomists, he never held a university
appointment. This background is reflected in the purposes that he sets
himself in this book. He seeks to reach conclusions that are at the same
time intellectually defensible and practically useful. This may
sometimes mean making the best of a bad job, given the nature of the
subject and the evidence available. He is not interested in deductive model-building as an end in itself.
A review article like this cannot cover all the rich contents of
the book's 446 pages. We hope that we may stimulate readers to read
the book itself. They must be prepared to find much greater emphasis
than is customary in modern macroeconomics writing on demand-side
explanations of the level and trend of real GDP, though the effects of
demand are represented as working largely through their effect on the
supply side. Readers must also be prepared for some other differences
from the way that most economists are accustomed to address professional
colleagues nowadays. Dow does not find it surprising that there should
be large differences between individual major recessions and between
countries. He allows himself a flexibility in interpretation that may be
historically defensible but does sometimes come near to obscuring the
central message.
It would be a poor tribute to a serious scholar to review his work
entirely en couleur de rose. What follows includes a number of
criticisms. These should not be taken to imply a negative view of the
work as a whole.
The reference to the "five major recessions" indicates a
couple of characteristics of the book.
World War I and World War II between them lasted ten years; but
political historians may for many purposes find it convenient to treat
them as two episodes, rather than ten. In the same way Dow is in general
disposed to think of the five major recessions as five episodes,
although he does have quite a lot to say about some individual years. He
certainly does not view each year, let alone each quarter, as a sample
drawn at random from some supposed universe of years or quarters. This
partly explains why he finds econometrics unhelpful.
The reference to the five major recessions also indicates a
limitation of the book. Its subtitle is "Britain and the
World". But it is mainly a book about the UK. It does contain an
extensive treatment of the Great Depression in America in the 1930s, and
it also has some interesting summary charts and tables relating to other
industrial countries. These countries are not neglected, but they are
not treated on at all the same scale as the UK. There is not much
discussion about the characteristics of major recessions in individual
Continental countries or Japan. This is a little disappointing, in view
of the author's experience as chief economist at the OECD. The
treatment of the pre-World War I period is even more summary. The
book's orientation towards the UK since World War I limits the
generality of its conclusions on major recessions. Of course, it is easy
to see that to have done otherwise would have increased the book's
scope intolerably.
Five leading conclusions, and comments on them
In what follows, the passages in italics are intended to describe
Dow's own views.
Conclusion 1. Major recessions, defined for practical purposes as
occasions when there was a sizeable absolute fall in output measured
from one calendar year to the next, have occurred at irregular
intervals, not in any cyclical or other regular pattern. In the UK there
have been five since World War I: 1920-1, 1929-33, 1973-5, 1979-82,
1989-92. Smaller recessions occurred between World War II and 1973 and
also before World War I. In the period between 1856 (when UK national
income statistics begin) and World War I, only the years 1891-93 and
1908 might just qualify as major recessions.
It is not only in severity that major recessions differ from
smaller ones. In the first place, major recessions have no tendency to
be self-correcting in the absence of upward shocks. Thus the level of
unemployment remained much higher in 1929 than in 1920 or 1913; it
likewise remained much higher in 1989 than in 1979. In the second place,
the duration of the period between the bottom of a major recession and
the peak of the next boom has typically been much longer than the
duration of the preceding downswing, making the whole "cycle"
from peak to peak much longer than in minor fluctuations.
Comments on Conclusion 1. Both the latter two points
(non-self-correction and asymmetrical duration) will become clearer
after we have discussed Conclusion 4.
It seems rather surprising that all recessions should be capable of
being categorised without hesitation as major or minor. Such a sharp
dichotomy has not been part of standard business cycle literature. It
corresponds well to British experience since World War I, especially the
period since World War II. It was obviously designed to fit it. It is
not so obvious that it would hold more generally.
A certain amount depends on the definition of "major recession
We are accustomed nowadays to think of business cycles in terms of
GDP at constant prices. It is true that 19th century business cycles
were manifested more in the price level and in profits than in output.
But there were large movements in output in at least some sectors. When
Jevons was writing in the 1870s, the number of bricks produced was one
of his criteria. In any case, it is difficult to believe that the fairly
regular commercial fluctuations that are observable back to at least the
1820s were not a horse of the same colour.
Questions of definition arise even if we confine ourselves to GDP
at constant prices. Dow's definition cited above was in terms of an
absolute fall in national output over at least a year. But this is
intended by Dow as no more than a convenient approximation. The true
measure of the magnitude of a recession must, as he recognises [p.2],
[1] be the extent of the shortfall at the trough of actual output below
its trend. It is therefore affected by what the trend rate of growth is.
To take an example at random: it would be absurd to deny that it would
have constituted a major setback if Japan had experienced two years in a
row with stationary output in the 1960s, since its trend growth rate at
that time was over 10 per cent per year. Moreover, it is not only
between countries that there have been differences in trend rates of
growth. There have also been differences between periods in individual
countries, including the UK. In the light of the high average growth
rate enjoyed by this country in 1950-73, maybe t he amplitude of the
minor recessions then was not so trivial. (The measure of the amplitude
of recessions in that period might be further increased if one measured
the trend growth rate in the way preferred by Dow (see below), namely by
the rate of growth of capacity during the upswing, instead of by more
conventional measures.)
Conclusion 2. Major recessions are caused by unexpected shocks on
the demand side, amplified to an important extent by resulting changes
in the confidence of firms and consumers (Dow prefers the term
"confidence" to "expectations", in recognition that
the expectations of economic agents are vague and not single-valued).
"Shocks" refers to identifiable major disturbances, capable of
being given a name, not to a multiplicity of small random influences
capable of sustaining fluctuations that would otherwise be antidamped or
even non-existent, in the manner of Slutsky. Possible sources of
identifiable major shocks are changes in the demand for exports or in
the terms of trade and changes in government fiscal or monetary policy.
Changes in confidence can even be a prime mover, not just a source of
amplification. Wars are a special kind of shock: they have been
important historically, but the level of capacity after a major war is
difficult to judge.
Comments on Conclusion 2. Lack of confidence in the future level of
demand would normally be thought of as amplification of the
multiplier-accelerator interaction.
However Dow does not make such a distinction between the behaviour
of firms and of households as the distinction between multiplier and
acceleration principle would suggest. He is unsympathetic to the
acceleration principle or to any reformulation of it that would make
investment a function of the relation between demand and the capital
stock. Confidence about the future, rather than memory of the past, is
what matters, and the size of the stock of capital inherited from the
past is not of prime importance, since much of it will be old and out of
date. Hence investment and consumption both end up as functions simply
of the level of confidence (though not necessarily with the same
coefficients). The one exception allowed is that Dow agrees that
investment in real property has on a number of occasions been depressed
by the overhang of property inherited from a past over-optimistic
construction boom, especially in the case of office buildings. It is not
entirely clear why Dow repudiates the idea that similar eff ects might
follow from past high investment in other sectors, e.g. the utilities
sector in 1950-73. [2]
Major depressions, according to Dow, are more likely than other
downturns to be characterised not only by severe shocks but also by
severe loss of confidence, in the minds of both producers and consumers.
The third section of this review offers one way of testing this
hypothesis insofar as it relates to consumers. The conclusions are not
very favourable, but the methods used are not exactly in the Dow spirit,
and he might not have accepted them.
Conclusion 3. This conclusion is put forward more tentatively, but
it is important. It provides the link between demand and supply.
Major recessions bring about not only an immediate fall in output
but also a permanent downward shift in the level of capacity. Capacity
output (equivalent to productive potential in other writers'
language) may be understood as the maximum amount that can be produced
in the Marshallian short period (my phrasing, nor Dow's). The
growth of capacity incorporates the effects of both capital investment
and innovation. It can be measured by the growth of output between two
dates, minus any part that needs to be credited to increased employment.
Major recessions reduce capacity through the premature scrapping of
capital, the rusting of skills, and the destruction of the internal and
external organisational capital of businesses, which is likely to have
taken time and trouble to build up. [3]
Comment on Conclusion 3. Dow is not the first writer to postulate that demand affects supply.
The idea is obviously reminiscent of the literature on downward
ratchets and hysteresis, though that literature has usually been more
concerned with the labour market and inflation than with productive
capacity. One peculiarity of Dow's treatment is his belief that in
minor recessions the effect is not felt at all (as opposed to being felt
to a smaller extent).
Another analogous belief, to which Dow does not subscribe, is that
unusually strong demand has a permanent effect in raising the growth
rate. This doctrine was put forward by Kaldor (1966, 1967) a generation
ago, on the basis of the observation, dubbed by him Verdoorn's law,
that there is a correlation between the rate of growth of production and
the rate of growth of productivity. Kaldor regarded the rate of growth
of production (determined by demand) as the independent variable in this
relationship, the opposite of what would be the more usual view. Kaldor
was thinking of a steady, perhaps linear, effect of demand pressure on
the rate of growth of capacity, rather than of a once-for-all jump.
Dow prefers his own formulation to these and other al ternatives,
not mainly on a priori grounds, but because he thinks it corresponds
better to experience in the period he is studying.
Conclusion 4. Dow categorises years into three classes: they may
show recession, trend growth, or fast growth (i.e. above trend). His
assignment of historical years to these categories is shown in Table 1.
The supposed sequence of events through which this comes about, and the
effect of major recessions on long-term growth, may be seen from Chart
1. This is adapted from Dow (1998, p. 375) and it gives a schematic
representation of the effects of two imaginary successive major
recessions. The dashed line denotes actual output; the solid line
capacity (productive potential), and the dotted lines the hypothetical
trends of capacity in the absence respectively of the first major
recession and of the second one. The vertical axis is on a log scale.
A demand-side shock and the associated blow to confidence cause
output to fall (say, from A to B'). This leads to a fall in
productive potential, for the reasons given under Conclusion 3. The fall
in productive potential is rather smaller than the fall in actual output
(the difference in Chart 1 being the distance from B to B'). There
is a tendency for productive potential and also demand to rise at the
trend rate (indicated in Chart 1 by the slope of BC). Once the recession
is over, there will be a tendency for growth to be resumed at this rate.
But there will be no tendency for the ground lost by the loss of
productive potential to be made up. Nor will there be any automatic
tendency for growth to take place at the higher rate required to
eliminate the non-utilisation or underutilisation of resources created
by the recession. However it is likely that there will gradually be a
recovery in confidence, and when that happens it will permit output for
a while to grow at faster than the trend rate. There is no u niformity
about when this recovery of confidence will take place: early, late,
continuously or not at all (compare Table 1). Moreover the economy may
or may not reach full utilisation of potential before another major
recession arrives. (Some of these different possibilities are
illustrated by the differences between the aftermaths of the two
recessions in Chart 1.)
The trend rate of growth (in Chart 1 the slope of BC or DE) is
somewhat lower than the rate of growth of actual output over the
cyclical upswings. On the other hand it is higher than conventional
measures of the trend rate of growth, such as the peak-to-peak, because
the latter is depressed by the once-for-all contraction in capacity
(between A and B). The occurrence of a major recession has a permanently
depressing effect on the level of capacity and hence on the rate of
growth of output: demand affects supply. The effects of one single major
recession on the long-run growth rate will be watered down by the
passage of time. But repeated major recessions will have a permanently
damaging effect on the long-run growth rate that is actually achieved.
Comments on Conclusion 4. The notion that the economy would move
along the trend line if left to itself is perhaps the most surprising
feature of the model, in view of the emphasis that Dow elsewhere places
on demand. It is a little redolent of Say's Law, qualified by the
recognition of the periodical downward displacements of supply that
arise from demand in major recessions.
Dow is not seeking to set up an integrated model of growth and
fluctuations. He therefore does not commit himself on the question
whether in the absence of major disturbances capacity and output could
actually go on indefinitely growing along the trend line as he defines
it (BC). Possibly it would ultimately slow down as the result of an
encounter with some kind of ceiling [p. 100]. Nor does he postulate that
a major recession would alter the trend rate of growth (BC or DE) one
way or the other. It is sufficient for his purpose to establish that a
major depression pushes the economy permanently off course.
Turning to some of Dow's data, it is at first sight rather
surprising to find that, whereas all major industrial countries
experienced trend retardation after the early 1970s, only the UK and
Italy (of the eight countries listed in Table 2.10, p. 33) experienced
larger deviations from trend in 1973-90 than in 1950-73. The tendency in
the other six countries was actually in the opposite direction. However,
this does not necessarily mean that they became less subject to major
recessions in the sense of Dow. The deviations just referred to are
deviations from a fitted trend, not downward displacements of the trend
line. Germany is shown in Dow's chart as having had two substantial
downward displacements of trend in the later period. On the other hand
the displacements shown from France and Japan are very modest, yet they
too underwent large retardations. Thus Dow's data do not support
the hypothesis that the famous retardation after the early 1970s was
everywhere due to increased incidence of major recessions. T o do Dow
justice, he only hints at such a hypothesis. He says that major
recessions cause retardation, not that all retardations are due to major
recessions. It would nonetheless be a little disappointing if the same
general explanation did not hold for a phenomenon that was so obviously
worldwide.
Conclusion 5. It is a matter of high importance for governments to
adopt policies that will prevent or at least mitigate major recessions.
This will not be easy, and it would be wrong to be too optimistic about
the prospects of success. In responding to external shocks, government
faces many of the same difficulties as the private sector does. However
government policy itself has been a significant source of shocks, and
that at least is something that it should be possible to avoid.
In discussing Conclusion 5 later in this review, we shall pay
particular attention to the periods when major recessions were avoided.
The above five conclusions are by no means Dow's only ones.
Some of the others will be referred to in connection with his historical
survey, to which we now proceed.
The case studies: Michael Artis
About one half of Dow's book is devoted to the five case
studies of major recession that he detects between the end of World War
I and the mid-1990s. Three of those recessions occur after the end of
World War II, the first of them dated 1973-5. The other two are dated
1920-1 and 1929-32; in between there is the recovery of the mid- to
late-1930s, World War II and its aftermath, a period in which no major
recessions intervened.
The account that Dow gives of the first of these recessions, that
of 1920-1, commences with a point of which too little -- arguably -- is
subsequently made. This is that there was at that time a remarkable
decline in hours of work. Matthews et al. (1982) discuss this remarkable
phenomenon at some length (it was a phenomenon common to a number of
European countries). Thus the observed decline in output was due in part
to a straightforward decline in supply. Dow admits that this was
probably to some extent still the case even in 1921 (and was certainly
the driving force behind the earlier output falls in 1919 and 1920). But
in that year there occurred a sharp fall in employment which Dow
attributes to a demand decline. This might have been associated with the
previous fall in working hours since the wage bill did not fall, and
real wages and the share of wages in total factor income had
consequently increased. An explanation hinging on "excessive real
wages" might be a starter, but it is not Dow's explanation.
Instead he points to a decline in world demand (there was a big drop in
UK exports) and a negative fiscal policy impact as triggers for a
decline in confidence. This recession is reasonably described as
"very odd" - it certainly contains some unusual and confusing
features, most notably the hours of work adjustment which left total
output in 1920 some 5 per cent below its pre-World War I level.
When he comes to the second big interwar recession, Dow's
argument points to the principal proximate cause as having been that of
the Great Depression in the United States. That depression indirectly
reduced the demand for UK exports (principally by depressing primary
producers' demand). This effect in itself (amounting to a decline
of some 4 per cent of GDP between 1929 and 1932) was, however,
substantially modified by the accompanying favourable movement in the
terms of trade. This movement supported consumers' expenditure
which, Dow points out, actually rose throughout the recession, yielding
a net negative impact of about 2 per cent. Relative to the conventional
wisdom (new as well as old) that adherence to the Gold Standard had a
lot to do with the recession, Dow argues robustly that the Gold Standard
did not constrain the United States and that the fall in output there
was extremely large relative both to the past experience of the United
States itself and to the contemporary experience of other industr
ialised countries. Unless it can be shown that a lack of gold was a key
determinant of restrictive monetary policy in the United States itself,
by far the largest gold holder in the world at the time and the centre
country of the system, Dow's point seems a good one and the
correction of perspective overdue. Even so, the subsequent contribution
to the recovery in the UK of the devaluation and the turnaround in
fiscal policy are testimony to the prior restrictiveness of adherence to
the Gold Standard and the associated stringency in financial policy. Dow
has little room for explanations based on "excessively high real
wages", basically on the grounds that real wages are not the direct
object of wage settlement and prices are fixed by manufacturers. This
argument can be queried when wage negotiators explicitly aim at real
(product) wages but this is unusual and was not the case at this time (a
rare earlier exception is provided by the sliding scale that related
miners' wages to the price of coal in the late 19t h century).
Given the centrality of the US depression as the leading and
exogenous factor driving the UK into recession, Dow spends several pages
discussing the causes of that depression. He attributes major importance
to the amplification of initial causes due to the wave of bank failures.
But the reader should not suppose that this is the same line of
reasoning as that of Friedman and Schwarz who, famously, indict Federal
Reserve policy for not seeing to it that bank reserves and money supply
did not fall. Dow accuses them of ignoring the endogeneity of the bank
reserves and the stock of money and, essentially, of getting the
causation wrong. Bank failures reflected a lack of demand for bank loans
and structural weaknesses in the US banking system of the time. All this
is well argued, persuasive and important even if from the point of view
of treating UK history it is necessarily something of a detour.
Dow's view about the two recessions 1973-5 and 1979-82 is
relatively conventional. In both he ascribes a major role to the
exogenous event of the oil price increase. The deflationary impact of
the increases is described in terms of the Keynesian "indirect tax
increase" analogy. As with an indirect tax increase there is a
price-raising demand-reducing effect. In the case of the first oil price
shock the revenue proceeds were initially largely saved by the OPEC countries so that a redistribution of world income was accompanied by a
deflationary shock. In the second case - despite the fact that the UK
was by then a net exporter of oil - the analysis is much the same, for
the UK government, to which a large proportion of the increased revenues
accrued, was bent on a tight fiscal policy. The reason why the shocks
were so hard to deal with is also crisply acknowledged: the reduction in
the disposable income equivalent of output means that real incomes must
inevitably fall. Resistance to this implies inflationary pr essure. Dow
remarks, without enthusiasm, that "The case for a restrictive
policy is that it will encourage acceptance of the inevitable, and thus
lessen and shorten the scale of inflation". He is sceptical that as
much had been learnt about how to deal with oil price shocks by 1979 as
some observers claim: mainly, it was just that the shock was smaller.
But where he parts company most notably with at least some other
analysts is in downplaying the supply side effects of the oil shocks,
especially the first and larger one. Here the main issue is why it was
that after the first oil shock there was such a large fall in
productivity and, afterwards, when growth was resumed, why the growth
rate was so much lower than before. These phenomena have given rise to a
number of competing explanations. One argument is that this productivity
growth break was due to the exhaustion of opportunities for
'catchup' (of the US by other industrialised countries). This
is only coincidentally related to the oil shock per se. Other arguments
are more closely related to it. For example, one school of thought
argued that the oil shocks left real wages too high and another that the
effective capital stock was drastically lowered by the shock to energy
prices (as if it had been bombed out of existence). The profession came
to no compelling consensus on the merits of these rival exp lanations.
Dow contributes two important points to the debate. First, he notes that
much the same phenomena regarding productivity were found in the
aftermath of the 1929 slump u and prefers, in this light, to attribute
the productivity phenomena to the collapse in demand per se. Second, he
makes some points on the possible scope of the supply side effect which
seem quite telling, all the more so for being simple (e.g. he points out
that two-thirds of the capital stock is embodied in dwellings, buildings
and such whilst The annual return on the remaining third might ... be
put at around 10 per cent of GDP ... Suppose the proportion of that
third rendered smaller by dearer energy was somewhere between 1 and 10
percent... The extent to which potential total supply will ... have been
reduced would then be between 0.1 and 1 per cent of GDP. Even the larger
figure is only a fraction of the actual total loss of productivity [p.
287, italics supplied].
The most recent recession (1989u93) is clearly a different matter
altogether. Most observers will be prepared to accept that the first two
major postwar recessions can be traced in large part to the oil shocks,
themselves reasonably treated as exogenous events. The third major
postwar recession, on the other hand, equally unforeseen by the
principal forecasting organisations, is another matter. There do not
appear to be any clearcut exogenous 'events' that can be
'blamed' in the way that the oil price shocks can be blamed
for the earlier recessions and no straightforward way to excuse the
forecasters for what appears to be a major error.
An econometric analysis of consumption in recessions: Martin Weale
Dow's explanation is that the recession was largely due to the
after-effects of a preceding "wave of optimism". This view in
itself is eminently plausible, though Dow finds reason to contrast it
with what he regards as the chief rival explanation, which is that the
recession resulted from prior excesses due to "financial
deregulation". He picks as the chief proponent of this view
ex-Chancellor Lawson. It is nor too difficult to find fault with what
seems to be an overly nit-picking approach to the main issues here. The
central issue surely is whether a deregulated environment gives more
scope for waves of optimism to build (and crash) or whether deregulation
allows the economy's self-regulating mechanisms to come into play.
Then there is the logically separate issue concerning learning about the
new environment. Most of our ideas about how a financially deregulated
economy can regulate itself presume a fully-learned, well-informed set
of actors. Even then, on many accounts imperfect information makes
herdin g behaviour endemic, leading to the likelihood that waves of
optimism (and pessimism) will result from time to time. The extreme form
of this is in speculative 'mania', on which a large literature
exists. The problems of information are more acute, it seems reasonable
to suggest, when an act of deregulation itself opens up new
opportunities (note the word 'new'), and indeed there is a
history of deregulation leading to over-lending and crisis. Had the
western economies not already been greatly deregulated, it seems quite
likely that the wave of optimism would not have had the scope to build.
Dow identifies a number of ways in which large recessions differ
from small ones. This section looks at one of the points he makes about
the influence of recessions on consumption.
"The reason why large recessions are large seems to be partly
that the initial shock is larger; but also partly because the processes
by which an initial shock gets amplified are then more powerful. The
effect on consumption is larger because consumers' expectations of
future income, and thus also their spending, fall more in response to a
large shock." [p.3]
"A large recession may reduce consumers' life-time income
expectations; the change in planned savings will then be more radical.
If it lowers the rate of increase of expected income over their
lifetime, that . . . could reduce spending by more than income has
fallen." [p. 90]
"Consumers are likely to reduce spending in anticipation of
any fall in income..." [p. 90]
These remarks have to be read in the context of his view that
recessions lead to permanent falls of output, a basic proposition which
is, unfortunately, very difficult to examine statistically because the
various tests for structural breaks (Andrews, 1993) have low power.
Looking at the period 1920-95, such tests might be able to identify one
or two breaks, but it is very unlikely that they would be able to
identify breaks associated with each of the five recessions which Dow
discusses. On the other hand, one can examine the behaviour of
consumption/ saving during the recessions, in order to examine how far
consumption movements had the effect that Dow suggests.
The savings rote and the big recessions
An underlying framework which leads broadly to Dow's
conclusion is an informal form of the life-cycle/permanent income model
in conjunction with a neo-classical view of production. In this model, a
representative forward-looking consumer will choose a consumption path
on which the planned rate of growth of consumption is proportionate to
the difference between the real rate of interest and the discount rate.
If the real rate of interest is expected to remain constant at the
discount rate, then each consumer will plan for constant future
consumption. It follows that, if there is a fall in the level of output
which is expected to be permanent, in that trend growth is resumed from
a new, lower, level, then the savings ratio will be unaffected. On the
other hand, the appropriate response to a temporary fall in income is to
maintain consumption. If the fall of income is unanticipated, then, at
the same time as the savings ratio declines, there will be modest
permanent fall in consumption; the temporary fall in inc ome reduces the
lifetime resources available to consumers.
Chart 2 shows the national savings ratio, calculated by adding
together household and public consumption and national saving measured
net of stock appreciation and depreciation of capital. Consumption is
measured at market prices rather than factor cost and the underlying
measure of national income (consumption plus saving) therefore differs
from the accounting standard. [4] The conventional consumption figures
are also redefined so that the depreciation of consumer durables is
treated as consumption, while net increases in the stock of durables are
regarded as financed by saving. Since the stock of durables tends to
grow over time, this has the effect of raising saving and reducing
consumption; it does not affect the measure of national income which
remains the sum of the returns to labour and (net of depreciation) to
the capital stock. [5]
The savings ratio is calculated from personal and public
consumption aggregated and measured relative to national income rather
than, as is usual in analyses of the consumption function, from personal
saving measured relative to personal disposable income. This is because
the intention of this study is to look specifically at the role of
consumption movements in aggravating recessions; to do this it makes
sense to look at movements in personal consumption after allowing for
the offsetting effects of any movements in public consumption. Should
personal consumption fall at the start of each recession, in the manner
that Dow suggests, but that movement be offset by a rise in public
consumption, it would be difficult to argue that movements in
consumption are a factor intensifying the recession even if what is said
in the quotation on the previous page is true.
It might be argued that a fall of personal consumption, even if
offset by a rise in public consumption, was consistent with a view that
households reduced their consumption in the light of a permanent
expected reduction in income, as suggested by the second quotation at
the start of this section. In order to study that question, as opposed
to the more general one about consumption movements intensifying
recessions, it would be necessary to estimate a full consumption
function. Here we limit ourselves to the first issue which is better
addressed with the consolidated consumption data.
Dow identifies recessions in 1920u21, 1929u32, 1973u 5, 1979u82 and
1989u93. The first year of each recession represents an output peak;
thus it is not itself a recessionary year. Apart from World War II, the
chart shows troughs in the savings ratio in 1921, 1931u3, 1975u7 and
1991u3, with a less obvious trough in 1981u2. There are also troughs
associated with the General Strike and in 1952u4 with other less marked
dips in other years.
Looking at Chart 2, one might be able to entertain the view that,
in 1975u7 and 1981u2 the savings ratio remained at normal levels. The
situation in the mid-i 970s is confused by the fact that the savings
ratio was sharply lower after 1974 than before; it averaged 4.95 per
cent between 1920 and 1938, 11.18 per cent between 1950 and 1974 and
7.10 per cent between 1975 and 1995. Thus the savings rate in 1975u7 can
be regarded either as low by comparison with the period from 1950u74 or
as normal for the period 1975u95. A similar point can be made for
1981u2. The trough exists because saving was abnormally high between
1978 and 1980 rather than because it was unusually low during the
recession. On the other hand saving in 1991u3 was low in the context of
the period in which the recession took place.
This chart then suggests that in 1921, and in the recessions of the
1930s and 1990s, saving was unusually low, failing to support the notion
that consumption movements intensified other movements in demand. In the
1970s and 1980s, howevet savings behaviour is more compatible with the
notion that the recessions were ex pected to have a permanent effect on
output and thus with Dow's hypothesis. There is not very much
evidence of saving rising in advance of a recession (saving up for a
rainy day) although there are local peaks in the savings rate in 1920,
1979 and 1989; it could be argued that these were motivated in this way.
However, this visual analysis is not completely satisfactory. It is
generally found that consumption is excessively sensitive to movements
in income, meaning that consumption changes by more, and therefore the
savings ratio changes by less than the life-cycle model predicts in
response to a temporary change to income. Without trying, in any sense
to fit a consumption function, we can shed more light on part of
Dow's argument by looking at the relationship between income and
the savings rate in greater detail.
This is done by estimating the statistical relationship between the
national savings rate and the change in the logarithm of national
incomeA The relationship is meant to summarise the data rather than to
provide a coherent behavioural model (for which one would need to
examine various forward-looking models). The savings rate is related to
its own lagged values and current and lagged values of the growth of
real income. The lag lengths are determined using the Schwarz Inequality
Criterion (Schwarz, 1978). Using this method it is impossible to say
anything about the 1921 recession; it comes hard on the heels of the
Great War and there are no satisfactory lagged data with which to start
the model. However, we can look at the other four recessions by putting
dummy variables into the equation. If the data are to provide evidence
that consumption movements intensified the recessions, then in these
recessions the savings ratio should be higher than the summary of the
rest of the data period suggests. In view of th e visual evidence that
the effects of the recessions appeared only after a year into the
recessions, and that saving remained low in the first recovery year,
dummies were set for 1931u3, 1975 and 1976, 1981 and 1982 and 1991u3. A
preliminary analysis also suggested that the savings rate was on average
higher between 1950 and 1973 than between 1974 and 1995, and this
difference could not be accounted for simply by the change in income
growth. Accordingly another dummy was introduced for this period.
The results of the regression equations are shown in Table 2, for
the prewar and in Table 3 postwar. Of the four recessions examined, the
savings ratio is unusually low, not unusually high in three of them; in
two of these (1931-3 and 1991-3) the difference from the basic model is
statistically significant at a 5 per cent level, and in the third case
(1975-6) the p-value is 8 per cent. In the recession of the early 1980s
saving was very slightly higher than the basic structure suggests, but
the difference is so small that it would be quite wrong to give any
importance to this.
There remains the question whether the picture has been affected by
the treatment of the first year of each recession. It has been assumed
that people took some time to adjust to the recession, which was why
saving held up. The alternative, of course, is that saving held up
because they knew that the recession was going to have a permanent
effect on output and there was no offsetting movement in public
consumption. In 1930 saving was lower than the fitted value, by 0.44 per
cent of national income; the standard error of the equation was 0.8 per
cent of income. In 1974 and in 1980 the saving rate was higher, by 0.56
per cent and by 0.34 per cent than the model suggests. In 1990, on the
other hand, it was lower by 0.95 per cent. The standard error of the
equation was 0.58 per cent. The figures for 1974 and 1980 might give
tentative support to the view that the output falls which occurred in
these years were aggravated by falls of consumption, while the
subsequent falls were perceived as temporary; but the evide nce in
favour of this view could hardly be described as convincing.
Study of four of the five recessions considered by Dow suggests
that, even if they did have a permanent effect on output, the savings
rate does not reflect this. Far from the national savings rate holding
up, or even rising during recessions, it tends to fall by an unusually
large extent; movements in national saving have tended to offset rather
than exaggerate recessionary forces.
Of course these arguments do not necessarily extend to the
components of national saving. It is perfectly possible that household
consumption has indeed behaved in the manner suggested by Dow, with the
effect being offset by movements in public consumption. It is an open
question whether these three should be regarded as completely
independent or, as is implicitly assumed here, the outcome of a
consolidated decision process. But even if the consumption decisions by
the different sectors are considered independently, their aggregate
outcome remains that described here: even if household consumption has
tended to aggravate recessions in the manner Dow suggests, its effects
have been offset by the behaviour of public sector consumption.
The long interval without major recessions 1945-73: John Flemming
The twenty-five years following World War II are now conventionally
seen as a golden age. Keynesian policies delivered both full employment
and unprecedented real growth. Admittedly other European countries grew
even faster (having more wartime damage to recover from), policy was
dominated by successive balance of payments crises and was characterised
as stop-go. Matthews (1968) questioned the attribution of full
employment to Keynesian policies.
The questions to ask here are whether this was truly a period free
of the costs of recession, and, if so, what lessons one might learn as
to how to avoid them -- the subject of the next section.
If a major recession is defined as involving high unemployment, it
is clear that none occurred in the UK between 1945 and 1975. But one of
Dow's reasons for focussing on major recessions is the cost they
represent, particularly in foregone output, as, on his account, they
permanently displace the path of capacity output.
Dow identifies five UK "mini cycles" between 1947 and
1973. They are certainly "mini" in their implications for
unemployment, which, until 1970, oscillated between 1 and 2 per cent and
never exceeded 3 per cent. But does this imply that there were no costs
comparable to those associated with longer recessions?
Growth in upswings in this period consistently reached 4 per cent
per annum, while the trend growth rate rose from 13/4 per cent per annum
to 21/2 per cent per annum for an average of 21/4 per cent per annum.
Although growth was rarely less than 1 per cent per annum, downswings
were typically longer than upsprings (Chart 3) so that the average
growth rate was less than 2 1/2 per cent per annum. Should the
"mini cycles" be held responsible for the difference between 4
per cent and 21/2 per cent annual growth over 25 years - as large a
cumulative total as that of the few later recessions? Dow clearly does
not think so, for which he gives two reasons - one more explicit than
the other.
In chapter 7 he argues that these mini cycles were less
"stop-go" than "go-stop" as clumsy use of the fiscal
accelerator encountered a balance of payments con-straint -- in an era
of capital controls - and precipitated equally heavy footed braking.
Thus the 4 per cent growth rate was artificially induced, unsustainable
and did not represent true capacity growth. There have, however, been
economists, such as Kaldor, cited above, who advocated just such
policies as means of raising the trend rate of growth. This line of
defence is not entirely convincing, although these mini-cycles,
including their upswings, were dominated by stockbuilding.
There is, however, another basis for distinguishing between major
and minor recessions. Dow is rightly interested in some concept of
capacity or productive potential. For reasons discussed earlier he is
reluctant to put any weight on investment or capital stock data,
preferring to use unemployment rates (despite the well known loose
relationship between changes in employment and unemployment).
He defines "constant employment GDP" at time t as
[GDP.sub.t] =(1 + [u.sub.t] - [u.sub.s,v]) where s [less than] t [less
than] v are the ends of a subperiod over which [u.sub.s,v] is the
average rate of unemployment. Deviations of GDP from "constant
employment GDP", GDP, are plotted in Chart 4 [fig. 2.1] which also
indicates by shading the five major recessions. It will be seen that
different trend rates of growth of GDP are indicated on the chart for
each inter-recessional period (also allowing a break for World War II).
As has been indicated in the Introduction the five recessions
appear to have been selected initially by reference to a year-to-year
drop in GDP and a plunge in employment raising unemployment to a (new)
high level. The most interesting part of Dow's theories, however,
requires that major recessions not merely mark changing slopes in trend
growth of GDP but actual displacements of the trend line. Such
displacements are indeed suggested by Chart 4 [fig. 2.1] and are
illustrated more explicitly for the post-war period in Chart 5 [fig.
2.6].
It seems that Dow used informal methods to identify the major
recessions and then fitted trends with breaks in level and slope at
these points. Is this a legitimate procedure? It certainly looks
somewhat casual. Could it be reformulated more formally and would that
produce the same results?
Given a definition of constant employment GDP, which enables one to
abstract from cyclical effects, there are well known, though not
entirely definitive, techniques -- also discussed earlier by Weale --
for identifying intercept and slope changes at particular levels of
significance. Such tests would also help to pin down major recessions,
which could then be defined as downward displacements of trend constant
employment GDP (and perhaps also of actual GDP from that trend).
A question to which Dow devotes more time is the appropriateness of
his simple employment adjustment. He is well aware that Okun's law
associates a rise in GDP relative to capacity with a much less than
proportionate increase in employment (or the corresponding change in
unemployment). He suggests [p. 22] that "at times of major
recession ... employment (and unemployment) reacts more fully to output
changes than in average year-to-year fluctuation as reflected in
Okun's Law".
It seems that this is not a statement (only) about the reaction to
recession-inducing shocks but to the whole of a period of a major
recession and the subsequent recovery. Thus he regresses [delta]u on
[delta]y separately for 1920- 38, 1950-73 and 1973-92 (when he
substitutes [delta][y.sub.-1] for [delta]y). The first and last periods
are characterised by major recessions (1920 and 1930; 1973, 1980, and
1990). In these periods the coefficient is about (-) 0.40 or 0.45
whereas the middle period without major recessions has a coefficient
smaller than (-) 0.2.
Using the reciprocal of the relevant coefficient to make the
constant employment adjustment to GDP (Method B) produces no downward
displacements of the trend of GDP in the postwar period. Thus quite a
lot of Dow's thesis rides on a defence of his choice of Method A -
generating constant employment GDP as defined above.
He lists three reasons for preferring it on page 22:
(1) His first reason has already been quoted. He does give evidence
of a significantly larger and more rapid (un)employment response in the
periods of major recession, but the coefficient is still less than 0.5
(in absolute magnitude) and its reciprocal (at 2.25) is not much closer
to the unity of Method A than the 5 of Method B (as applied to the
period 1950-73). One is tempted to think that Dow might have argued that
if 5.0 characterised a period without major recessions and 2.25 a long
period with two or three such recessions, a major recession itself might
be characterised by a coefficient of unity. But if that was his thought,
to how long a sub-period could such a coefficient properly be applied?
Not, presumably, the 20-year periods to which he applies Method A.
(2) Method B generates implausibly large (10 per cent or more)
shortfalls of output from capacity output.
This is illustrated in Dow's figure 11.1 [p. 386] (reproduced
here as Chart 6). Extrapolating the pre-1973 average GDP growth rate of
2.9 per cent to 1992 suggests a 23 per cent shortfall of actual from
potential GDP. Dow reduces this to a 7 per cent shortfall of constant
employment GDP from its capacity level in 1992 by adding back the 7 per
cent point rise in unemployment and comparing it with a trend line
displaced by 2.2 per cent in 1973 and 5.4 per cent in 1981.
(3) One should "expect that major recessions will damage
economic capacity" so that a method revealing this is to be
preferred.
All of these suggest that while Method A exemplifies a postulated mechanism it does nothing to substantiate its operation. In particular
some of Dow's difficulties might be due to his reluctance to use
any measure of the natural rate of unemployment (or the NAIRU) (see [p.
424]). If such indicators trended upwards over a period, and should be
taken as reflecting a constraint on "full (or constant) employment
GDP", then actual output is likely to diverge cumulatively from a
trend of capacity GDP calculated without taking this factor into
account. The procedure would then need downward displacement of the
trend line in order to keep things on track as at (2) above. Thus
Dow's procedure is particularly likely to locate "major
recessions in such periods, and to attribute to them a retardation of
growth more appropriately attributed to the determinants of the NAIRU.
Of course Dow's distaste for that concept is understandable,
and on a hysteresis model (major) recessions may account for apparent
increases in the NAIRU. Thus the debate is not closed -- but that may
serve to reinforce the view that a rather more thorough statistical, if
not econometric, approach would have been in order to pin down the
mechanism and pattern of causation.
Given Dow's view that no major recessions occurred between
1945 and 1973 either in the sense of a large rise in unemployment or in
the sense of a costly displacement of trend growth, how does he believe
that that was achieved? A question given added point by the evident
failure to avoid recession after World War I. He does compare the
aftermath of the two world wars, and acknowledges that the later policy
makers were influenced by their knowledge of the earlier episode in
managing demand, but by fiscal and micro regulation. Demand was buoyant
and Dow explicitly endorses a "bootstraps" argument that it
stayed up because output income and demand remained so buoyant [[ss]7.2,
p. 247].
All of this is fairly plausible -- with the post-World War I 1920/1
recession not recurring because the immediate postwar boom was contained
both by formal rationing -- not only of consumer goods -- and, he
suggests (or implies), the less formal rationing implied by stickier
prices in the late 1940s than early 1920s.
One difficulty with this account is to square its emphasis on the
consumer confidence supporting demand with the interpretation of
subsequent labour market developments. Only after 1969 did unemployment
persistently exceed 2 per cent and inflation was equally low as late as
1966. In 1976 I inferred that the natural rate of unemployment in the
1950-65 period seemed to lie between 13/4 and 2 per cent. It
subsequently rose enormously -- on some accounts to a peak of about 10
per cent. As mentioned, Dow was never enamoured of NAIRU or natural rate
concepts -- seeing the relevant relationship as being "of a
sociological sort, reflecting many aspects of group behaviour ... it may
... easily change ... as a result of experience [including that] of
inflation" [p. 424] -- or, one might add, recession. One account of
the adverse shifts of the Phillips curve at the end of the golden age
(and later) relates to the fading of memories of prewar unemployment --
and the passing of the generation that experienced it. As we ha ve seen,
an upward trend of this kind might be thought to undermine Dow's
approach unless it could be attributed to the experience of recession --
which is not plausible for this particular period.
The questions that this sort of (implicit?) approach raises for his
account is the coherence of an explanation of strong consumer demand
based on apparently high (and growing) confidence at the same time as
wage restraint was based on apparently high (but waning) insecurity. The
combination should have led to an earlier and more rapid shift in the
Phillips curve than in fact occurred. Dow's emphasis on confidence
rather than expectation is very much in the spirit of Keynes. It may be
that consumer demand and confidence was not on its own so consistently
strong as a first reading suggests that Dow maintains. Both in
discussing the early post-World War II period, and in discussing
remedies for recession, Dow displays a now unfashionable yearning for
credit and consumer controls. If consumer demand, based on a moderate
level of confidence, was pressing against these limits, and thus
deferred into periods in which it might otherwise have slackened, its
persistent strength relative to supply should not be mistaken for
spontaneous and stable strength in any absolute sense. On this view
there are other problems, if consumer demand was being restrained why
was investment demand so strong? Here the role of reconstruction (and
exports) must be crucial with consequences for employment and income
that contribute to maintaining consumer demand pressure on capacity and
control constraints.
A third surprise is the ease with which demobilised labour could be
absorbed into civil production at the same time as workers at home were
released from wartime production, although the continuation of National
Service for fifteen years meant that demobilisation was less complete
than after World War I. This may have its parallel in fighting a
recession following a sustained boom and bubble such as characterised
Japan in the 1980s. In the boom-and-bubble-economy labour is
disproportionately employed in investment, construction and luxury
services. If unemployment were to be avoided in its aftermath many of
the workers in these sectors would have to find jobs in cooperation with
the limited capital stock devoted to producing more basic consumer goods
(or exports) which would depress the (market clearing) real consumption
wage -- possibly quite sharply. If it is hard to imagine this working
after a bubble, so that redeployment could not avert unemployment, how
did it work so well after the war? This is not a q uestion addressed by
Dow in this work; nor indeed by authors such as Wilson (1952) and Wright
(1979), whose accounts of demand pressing against administrative
constraints parallel Dow's.
Are recurrent major recessions inevitable? John Flemming and Robin
Matthews
This is the title of the book's concluding chapter. It is a
more tentative chapter than the earlier ones. "Full answers to
these questions would require another book.. what follows is a
semi-reasoned statement of belief, or a series of essays intended to
give an idea of the considerations that led to my conclusions" [p.
414].
Dow's general approach implies that the answer to the question
in the title must depend on the answers to two sub-questions:
(1) are recurrent unforeseen major shocks inevitable?
(2) is it inevitable that government policy will be unable to
prevent those shocks from creating major recessions?
It is obvious what the answer will be to the first of these
questions. Historically, shocks have come from a variety of sources and
have varied in their timing and in their severity to a major degree.
They have not been well foreseen by private agents, nor by governments.
There is every reason to suppose that they will persist.
So we come to the second question. Not surprisingly, in view of
Dow's emphasis on the diversity of past experience, he finds it
difficult to make contributions that are both new and of major general
importance. And like authors of all books on practical macroeconomic policy, it is in a few places overtaken by events in consequence of
unavoidable publication lag. However, he does make some interesting
points that are not commonplace.
It is easy to make fun of Panglossian models in which perfect
knowledge of present and future are imputed to private economic agents.
A more serious question, as Dow recognises, is whether governments are
on balance better informed and/or better motivated than the sum of
individuals. Here is one possible example of democratic malfunction,
different from the ones that are usually cited. Dow suggests that
democracy (rather than the sinister machinations of financiers) may be
what causes macroeconomic policy to be biased in a deflationary
direction. The reason is that inflation affects nearly all voters,
whereas unemployment affects only a small minority (though it affects
those more severely than inflation affects the generality). Politicians
in search of votes favour the large battalions.
That is a general point. Dow also makes a number of suggestions
about faults in policy in past periods that may well be valid in the
light of hindsight but are not very helpful for the future (his views on
the causes of the five major recessions are conveniently summarised in
the box on [pp. 411-2]). Another example already briefly touched on
relates to the years immediately after World War II. The experience of
the post-World War I recession, as well as the memories of the 1930s
unemployment, made the government then lean towards excess demand. In
retrospect Dow thinks this was pushed too far. At the time it was
possible to pursue such a policy without causing undue inflation,
because many direct controls inherited from the war were still in place
-- things were not so different, in that respect, from the centrally
planned economies of Eastern and Central Europe at that time. However,
it would hardly be feasible technically or psychologically to reinstate those controls now.
Dow does not generally favour the various attempts that have been
made to shortcut the task of the policymaker by seeking stability in a
single variable, such as the money supply or the exchange rate. He
frowns on the more fashionable policy of targeting the inflation rate,
not only because price stability is not the only objective of policy but
also because experience shows that the relationship between trends in
the price level and trends in other variables is far from regular. His
book went to press too soon for him to be able to comment on the recent
bouleversement of the task placed on the Bank of England's Monetary
Policy Committee, by which the inflation target has been made in
principle a minimum as well as a maximum, thus treating unusually low
inflation as a proxy for demand deficiency. One may conjecture that he
might have thought it an improvement on what went before, but he would
have regarded it as subject to the same objection as that just stated,
namely that historically there has been a quite irregular relationship
between price trends and trends in activity (in the golden age 1950-73,
for example, prices generally rose less rapidly in cyclica l upswings
than in cyclical downswings).
Anyone who thinks of Dow as an unregenerate Keynesian is in for
some surprises. In an interesting section on the national debt, he
points out first that historically there have been very large changes in
the ratio of national debt to GDP unconnected with budget deficits and
surpluses as usually defined. At the same time he does take the size of
the national debt as a serious constraint on fiscal policy, at least in
some circumstances. In particular, sudden increases in the national debt
will cause financial markets, reasonably, to suspect that the government
is letting things get out of control. Apart from that [p. 433]
"countries with debt-GDP ratios much above the average are, I
think, bound to take steps to limit any further rise in the ratio, and
probably to reduce it. Conversely, governments not in this position need
to take care not to get into it, but otherwise need not be so actively
concerned about the ratio" -- which rather alters things for the
British reader. This is perhaps one of a number of pla ces in the book
where Dow's many years spent drafting the Bank of England Quarterly
Bulletin have influenced his style. "He writes as a banker does,
saying only the needful", said Sir Walter Scott. One might nowadays
substitute "he writes as a central banker does, for reading between
the lines".
Although Dow is thus not really too worried in the British context
about increases in the national debt (which are in any case likely to be
only temporary as recovery resumes), he does have sympathy with the
conventional hostility of Finance Ministries to the use of fiscal policy
for stabilisation purposes, because of the danger that it will undermine
discipline in spending departments. This should nor apply to the
automatic stabilisers, which are of limited extent and are well
understood; these should be kept in place. For the rest, he suggests
various ways in which public policy might affect private spending
demand. Some of these are reminiscent of Swedish schemes fashionable in
the 1960s and 1970s -- but Dow concentrates on the government as leasing
facilities commissioned from private contractors, as under the British
'Private Finance Initiative', or stimulating now privatised,
but regulated, public utilities into countercyclical patterns of
investment. This would have the advantage of lying outside the b udget
and so not causing the threat mentioned to financial discipline. Dow
recognises but perhaps does not sufficiently emphasise the timing
problems and the dangers of counterproductive effects on confidence in
the private sector.
In this context public works run two risks. They may be seen as too
little too late and thus as a signal from above that things are worse
than has been realised -- thus stimulating private saving. This has
happened in Japan, with successive unsuccessful attempts to prime the
pump of domestic demand. The problem is the impossibility of judging
what will prove 'enough' to resuscitate a depressed economy.
If one cannot credibly say one has done enough, what reaction should one
expect from private agents? On the other hand a tax cut to be held until
GDP recovers to a pre-set level does provide a boost to disposable
income, bridging until earnings recover, which consumers should be
willing to spend; in principle it is no more threatening to fiscal
discipline than the automatic stabilisers.
Dow's treatment of monetary and fiscal policy is contrary to
what is widely regarded as Keynesian orthodoxy in another respect. He
emphasises the prime importance of avoiding excessive booms, as a means
of avoiding major recessions -- just as Marshall and other 19th century
authors emphasised the importance of preventing 'overtrading'.
The Barber boom and the Lawson boom figure largely in Dow's list of
past avoidable errors.
In discussing monetary policy, Dow recognises the dilemma created
by the influence of interest rate on exchange rates. At the same time
there is here what seems to us to be the greatest weakness in his
chapter on policy. Globalisation is acknowledged, but it is nor put at
the centre of the stage, as many observers would be inclined to think it
ought to be. How far are the limitations of government stabilisation
policy the limitations of the powers of the government of a single
stare, operating in a world where the private sector is not subject to a
similar limitation? There is an interesting brief discussion and
footnote [on p. 436] about blocs of nations. But, not surprisingly, he
does not address the basic dilemma of how to reconcile the need for
transnational stabilisation policy with national democracy. The
experience of Japan (and more recently, perhaps, of Eire) suggest that
national stabilisation policy may still have its uses.
Dow's own account of the causes of major recessions suggests
another aspect of policymaking which it might have been interesting to
pursue. Suppose it is true, as he postulates, that major recessions are
characterised by once-for-all loss of capacity. Is this loss of capacity
in all cases really irrevocable? If not, policy can be directed towards
the retrieval of the capacity that has been lost. The extent to which
this is feasible is likely to depend on which of the various possible
causes enumerated by Dow was responsible on any particular occasion for
the loss of capacity. It is also likely to be affected by the length of
time that has elapsed since the capacity was lost.
Concluding comment: Robin Matthews
When Joseph Schumpeter's Business Cycles was published in
1939, it received an adverse review from archempiricist Simon Kuznets.
Kuznets's criticism was that, although the book contained dozens of
charts and hundreds of pages of narrative, all this empirical material
did not really establish much of a case for Schumpeter's model.
Yet what is now remembered and come to form part of the lore of
economics is Schumpeter's model, not Kuznets's criticism.
Can this be taken as a likely precedent for Dow's Major
Recessions? The two cases differ in important ways.
On the one hand, Dow's stated objectives have a much narrower
scope than the "magnificent dynamics" of Schumpeter. On the
other hand, Dow's thoughtful analysis of the data is quite unlike
Schumpeter's undoubtedly slapdash procedures. So historians of the
particular episodes studied by Dow will learn much from his book,
whereas the historical portions of Business Cycles are not now much read
-- and to tell the truth never have been. It was thinking about the data
that led Dow to his conclusions, instead of the model coming first and
the examination of the data second, as with Schumpeter (and many more
recent economists too).
Yet there remain certain parallels. Dow's model is broadly
compatible with the course of these historical events. But by its
nature, his way of analysing the data is not likely to establish sharp
general conclusions convincingly. He would probably have replied that
this is an unavoidable feature of the subject and that more ambitious
claims are bogus. Not all will agree, and some parts of his model may
prove shaky in the light of further empirical analysis. Whether this is
so or not, we are not likely to forget his general picture of the
irregularly occurring major recessions, greatly affected by confidence,
which lead to permanent downward shifts in the growth path of the
economy, though not to its irretrievable collapse.
Dow, J.C.R. (1998), Major Recessions: Britain and the World,
1920-1995. Oxford, Oxford University Press (paperback forthcoming Autumn
2000). Charts 3-6 reproduced by kind permission of Oxford University
Press.
NOTES
(1.) References in square brackets refer to page nos in Major
Recessions.
(2.) Perhaps the reason is that office blocks and dwellings are
more likely to have become objects of speculation in the boom than power
stations. Alternatively the reason is perhaps that they have a longer
life than most forms of capital. It has long been recognised, of course,
that building is subject to fluctuations that may be longer and have a
different timing from fluctuations in general activity. In the UK,
building booms before World War II occurred in the 1870s, in the late
1890s and early 1900s, and in the 1930s, and their effects are still
visible in our towns. In more recent times there have been notoriously
violent recessions in the building industry in the mid 1970s and the
early 1990s.
(3.) The last point is another very Marshallian idea (though Dow
does not credit it to Marshall). It is exemplified in the unusual title
of Book IV of the Principles: "The Agents of Production: Land,
Labour Capital, and Organization" (italics added).
(4.) The savings and consumption figures are taken from Sefton and
Weale (1995), extended using the 1996 Blue Book beyond 1990. The
estimates of durable goods' depreciation are derived from the
calculations performed by Solomou and Weale (1997) to calculate holdings
of durable goods shown in the personal sector balance sheet.
(5.) Although, if an income were imputed to the stock of consumer
durables, then the measure of aggregate income would differ further from
its conventional value. Income is either consumed or saved and we
calculate it by adding together consumption (public and private) and
saving as conventionally measured (net of depreciation and stock
appreciation). However, we then add to the consumption estimate our
estimate of the depreciation of the stock of capital goods and deduct
from it the value of purchases of capital goods, making an offsetting
adjustment to saving so as to leave income unchanged.
(6.) Having established that the savings rate is 1(0) while the log
of real income appears to be 1(1).
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