Given the recent (official) announcement that the U.S. has been in recession since December 2007, I decided to look at the record of business cycles compiled by the National Bureau of Economic Research. The following graphs depict the length of expansions and contractions (and the trends in both), before and since the creation of the Federal Reserve System in 1913.

Source: “Business Cycle Expansions and Contractions,” National Bureau of Economic Research.

It seems that the creation of the Fed might have had a stabilizing effect on business cycles. (How much of an effect is impossible to tell, given the many other variables at work.)

But…the graphs don’t depict the relative severity of the various contractions. It is worth noting that the worst of them all — the Great Depression — occurred after the creation of the Fed and, in part, because of actions taken by the Fed. (A note to the history-challenged: The Great Depression began in September 1929 and ended only because of America’s entry into World War II.)

In any event, the long-run cost of economic stability has been high. (See this and this, for example.)

From a post at my old blog, dated January 16, 2008:

On November 14, 2007, I wrote:

Is it possible that the current bull market reached a temporary peak in May of this year, and is now descending toward a secondary bottom that it will not reach for a few years?

This was my tentative answer, then:

A reversal that lasts a year or two seems entirely possible to me.

My less tentative answer, now, is that the stock market (as measured by the Dow Jones Wilshire 5000 Composite Index) has crossed into “bear country.” That is, it has met the two conditions which indicate a “correction” or bear market that will last for months or years:

• the index has dropped below its 250-trading-day average, and

• the 250-day average is moving downward (if imperceptibly)….

P.S. [added March 12, 2008] By my reckoning, every downturn in the 250-day average since 1970 has signaled every recession since 1970.

It’s been obvious for months that we’re in a bear market. It’s now also obvious (to the National Bureau of Economic Research) that we’re in a recession and have been since January of this year (a “peak” in economic activity having occurred in December 2007).

Macroeconomics (the study of aggregate economic activity), in most expositions of it that I have seen, fails on two counts. First, macroeconomics usually ignores or accounts inadequately for microeconomic behavior, that is, the behavior of individual persons and firms. Second, it aggregates that which cannot be aggregated, namely, disparate forms of economic activity performed by disparate actors.

Regarding the first point, macro without micro is meaningless. Macroeconomic aggregates have no independent existence.

Secondly, an aggregate is meaningless if it represents disparate phenomena. A foot (measure of distance) is a meaningful measure only if it represents a collection of inches (or fractions thereof); a pound (measure of weight) is meaningful only if it represents a collection of ounces (or fractions thereof); and so on. But a foot is a foot, and a pound is a pound; the two cannot be aggregated because they measure different things. (Yes, there is in physics a measure of force known as the foot-pound, which “is the amount of energy expended when a force of one pound acts through a distance of one foot along the direction of the force.” But “foot-pound” is something distinct from “foot” and “pound”; it is a measure of force, not a way of making length and weight commensurate.)

This post illustrates both points. Consider A and B, who have discovered, through trial and error, that each can have more clothing and more food if they specialize: A in the manufacture of clothing, B in the production of food.

Our primitive pair also has discovered a “just right” balance in the amount and allocation of clothing and food that they make and consume. Through voluntary exchange (bargaining), they have found a jointly satisfactory balance of production and consumption. A makes “just enough” clothing so that he can cover himself adequately, keep some clothing on hand for emergencies, trade the balance to B for “just enough” food, and enjoy “just enough” leisure. B does likewise with food. Both A and B might like to have more clothing and/or food, but both are doing as well as they can do in a voluntary relationship.

A and B’s respective decisions and actions are microeconomic; the sum of their decisions, macroeconomic. The microeconomic picture might look like this:

• A produces 10 units of clothing a week, 5 of which he trades to B for 5 units of food a week, 4 of which he uses each week, and 1 of which he saves for an emergency.

• B, like A, uses 4 units of clothing each week and saves 1 for an emergency.

• B produces 10 units of food a week, 5 of which she trades to A for 5 units of clothing a week, 4 of which she consumes each week, and 1 of which she saves for an emergency.

• A, like B, consumes 4 units of food each week and saves 1 for an emergency.

Given the microeconomic picture, it is trivial to depict the macroeconomic situation:

• Gross weekly output = 10 units of clothing and 10 units of food

• Weekly consumption = 8 units of clothing and 8 units of food

• Weekly saving = 2 units of clothing and 2 units of food

You will note that the macroeconomic metrics add no useful information; they merely summarize the salient facts of A and B’s economic lives — though not the essential facts of their lives, which include (but are far from limited to) the degree of satisfaction that A and B derive from their economic activities.

The customary way of getting around the aggregation problem is to sum the dollar value of microeconomic activity. But this method simply masks the aggregation problem by assuming that it is possible to add the marginal valuations (i.e., prices) of disparate products and services being bought and sold at disparate moments in time by disparate individuals and firms for disparate purposes. One might as well add two bananas to two apples and call the result four bapples. The essential problem is that A, B, and everyone else will derive different types and levels of enjoyment from clothing and food (both of which come in many forms), not to mention the vast array of other kinds of goods and services that are bought and sold. (For a long disquisition on this point, go here.)

In sum, macroeconomic concepts (e.g., aggregate demand) are not exogenous entities that exist independently of microeconomic activity. At best, they are ambiguous, qualitative proxies for a host of disparate microeconomic activities.

In future installments I will cover such topics as recession and fiscal policy.

…of the Laffer Curve, when you can have the real thing? The author of the first-linked item suggests that the amount of income remaining in private hands is maximized at an overall tax rate of 25 percent. My empirically-based estimate (second link) puts the private-income maximizing tax rate at 15 percent. The latter figure is a practical minimum:

The normal peacetime burden of government spending between the end of the Civil War and the eve of the Great Depression ranged from 5 to 10 percent of GDP,¹ enough to maintain law and order and to provide minimal “social services.” To that I would add 5 to 10 percent for the kind of defense that we need in these parlous times. (See this post, for example.)

You can’t have a vibrant economy without law, order, and defense from foreign enemies.

As measured by the Dow Jones Wilshire 5000 Composite Index, the price of U.S. stocks has declined about 45 percent from the peak of about a year ago. That drop rivals the crash of 1929, when the value of the Dow Jones Industrial Average lost 48 percent of its value from the peak on September 1 to an initial bottom on November 13. (After recovering for a while, the Dow continued to slide, reaching its final bottom on July 8, 1932 — 89 percent below its peak value.)

My objective isn’t to spread panic but, rather, to chastise those who sell in panic. The resources that produce real goods and services haven’t vanished suddenly; the economies of the U.S. and other developed countries can still produce all that they have been producing; and they can continue to grow as they have done for centuries and millenia.

In sum, the current panic has nothing to do with the state of the “real” economy. It is an over-reaction to a credit “crunch” that involves a relatively small portion of the world’s financial markets. Those who sell stocks in the current panic will, in a few months or years, regret having done so as credit markets stabilize and the economy returns to full production and normal growth.

If you are ready to panic, just take a deep breath and consider the big picture:

And just remember this: You haven’t lost money in the stock market until you actually sell stock for less than your purchase price. Up to that point the quoted price of a stock is nothing more than a guess as to its current value. Sure, you can sell at a loss and (maybe) claim the loss as a deduction on your tax return, but the value of a deduction is always less (usually far less) than the loss. And you can sell at a loss and put the money into something else — like a 3-percent savings account (whoopee!) — and then miss the turnaround in stock prices.

Yes, we are in a bear market, as I foresaw here and confirmed here. But let’s put the downturn in perspective:

Even with today’s significant drop (4.55 percent), the market is high by historical standards. (For example, the Wilshire 5000 Full-Cap Index, a broad measure of U.S. stock prices, is still higher than it was at any time before the “bubble” of the late 1990s, even after the index is adjusted for inflation.) Moreover, the decline from March 2000 to October 2002 — which somehow seems to be a distant memory for today’s headline writers — was far steeper and deeper than the slide that began last October. There may be a time to panic, but it hasn’t yet arrived.

I present, without comment, a petite histoire graphique of the unemployment rate in the United States. The median is 5.5 percent.

Sources: Statistical Abstracts of the United States: Colonial Times to 1970, Series D85-D86 (http://www2.census.gov/prod2/statcomp/documents/CT1970p1-05.pdf) and Bureau of Labor Statistics, Employment Status of the Civilian Noninstitutional Population, 1942 to date (ftp://ftp.bls.gov/pub/special.requests/lf/aat1.txt). Rate for July 2008 used as the average for 2008.

Guest commentary by Postmodern Conservative.

The coverage at The American Spectator is generally good. But everyone’s entitled to say something stupid at least once and awhile. In this case it’s G. Tracy Mehan, III (“This Bud’s Not for You“) waxing nostalgic about his hometown company, Anheuser-Busch, which has just been bought out by the Belgian mega-brewer, InBev. In his desperation Mr. Mehan says he’s willing to abandon his “free-market, free-trade principles” all because of “an American brand.” I’m just as nostalgic as anyone else at times, but when push comes to shove, A-B is an overrated producer of stale suds. So if InBev buys out a US brewery, what’s the upshot? I imagine that most of the jobs will stay and, heck…. maybe the beer will get better! After all, the Japanese gave America better cars. That’s what the market is all about.

Justin Wolfers (Freakonomics blog) has completed a series of six posts about the economics of happiness (here, here, here, here, here, and here). The bottom line, according to Wolfers:

1) Rich people are happier than poor people.
2) Richer countries are happier than poorer countries.
3) As countries get richer, they tend to get happier.

All of which should come as no surprise to anyone, without the benefit of “happiness research.” Regarding which, I agree with Arnold Kling, who says:

My view is that happiness research implies Nothing. Zero. Zilch. Nada. I believe that you do not learn about economic behavior by watching what people say in response to a survey.

You learn about economic behavior by watching what people actually do.

And…you consult your “priors.” It is axiomatic that individuals prefer more to less; that is, more income yields more satisfaction because it affords access to goods and services of greater variety and higher quality. Moreover, income and the wealth that flows from it are valued for their own sake by most individuals. (That they might be valued because they enable philanthropic endeavors is a case in point.)

It is reasonable to conclude, therefore, that the “law” of diminishing marginal utility, which may apply to particular goods and services, does not generally apply to income or wealth in the aggregate. But, in any event, given that Wolfers’s first conclusion is self-evidently true, the second and third conclusions follow. And they follow logically, not from “happiness research.”

Mark Perry discusses House Resolution 5800, introduced by Rep. Paul Kanjorski (D-PA), the “Consumer Reasonable Energy Price Protection Act of 2008,” which would:

• Tax the oil industries’ “windfall profits.”
• Set up a “Reasonable Profits Board” to determine when the oil companies’ profits are in excess, and then tax them on those windfall profits.
• As oil and gas companies’ windfall profits increase, so would the tax rate for those companies.

…Kanjorski said “his legislation will encourage oil companies to lower prices to prevent them from receiving higher tax rates.”

A few Questions/Comments:

1. Oil companies don’t set oil and gas prices, global market forces do. The fact that oil and gas prices change daily demonstrate very clearly that oil companies are at the mercy of market forces of supply and demand.

2. If you tax something (oil), you get less of it. If you get less of something (oil), prices go up, not down.

3. How does Rep. Kanjorski know what “reasonable profits” are?….

Well, Rep. Kanjorski is a typical member of Congress, whose members’ economic views reflect their constituents’ economic illiteracy.

Those constituents, I am sure, would reject slavery out of hand. But they favor measures like Kanjorski’s because they want to buy a given amount of a good or service (gas, health care, etc.) at a lower price. But the only way to get the same amount of anything at a lower price is through greater productivity (which can’t be legislated) or by forcing people to produce more of it, that is, by making slaves of them.

(For more about economic illiteracy, follow these links. Relatedly, some links about irrational voters are here.)

Cross-temporal comparisons of incomes by percentile are meaningless, as Arnold Kling and Russell Roberts explain. The bottom line: the persons included in a particular income range (e.g., bottom decile or quintile) in one year are not the same persons who were included in that income range five, ten, twenty, or thirty years earlier. Moreover, real (inflation-adjusted) income has grown steadily across the board: at the bottom and all the way to the top.

Those persons who are (temporarily) at the top do not take away anything from those who are at the bottom or in between. Those at the top earn because more they produce things of commensurate value. (I exclude politicians, lobbyists, and the beneficiaries of economically restrictive regulation.) Those in the middle and at the bottom earn what they earn because they produce things of less value. (Teachers, for example, earn less than baseball players because there are so many more persons who are able to be teachers than there are persons who are able to be major league ballplayers. It’s that fact — not “social injustice” — which accounts for the fact that teachers, firemen, policemen, etc., don’t make as much as ballplayers.) There’s no other way for an economic system to generate more for all than to allow it to reward producers according to the market value of what they produce.

Income inequality is a bogus issue. It is exploited by economic illiterates, do-gooders, and politicians to advance various forms of welfare, which necessarily involves income redistribution. The result, of course, is to make almost everyone worse off. The only beneficiaries of income redistribution are the welfare bureaucracy, vote-grabbing politicians, and perennial parasites. The rest of us pay via higher taxes and slower economic growth.

Related posts:
“Why Class Warfare Is Bad for Everyone” (21 Sep 2004)
“Fighting Myths with Facts” (27 Sep 2004)
“Debunking More Myths of Income Inequality” (13 Oct 2004)
“The Destruction of Wealth and Income by the State” (01 Jan 2005)
“Ten Commandments of Economics” (02 Dec 2005)
“More Commandments of Economics” (06 Dec 2005)
“Zero-Sum Thinking” (29 Dec 2005)
“On Income Inequality” (09 Mar 2006)
“The Causes of Economic Growth” (08 Apr 2006)
“The Last(?) Word about Income Inequality” (21 Jul 2006)
“Your Labor Day Reading” (04 Sep 2006)
“Status, Spite, Envy, and Income Redistribution” (04 Sep 2006)
“Things to Come” (27 Jun 2007)
“The Poor Get Richer” (06 Feb 2008)

Guest post:

Is Chevron Corporation another example of changing perceptions about “overpopulation.” According to its recent print ad, appearing in many and news magazines:

With our planet’s population continuing to increase, and the quality of life for millions in the developing world improving daily, our demand for energy is also growing. And to meet everyone’s needs 25 years from now may take 50% more energy than we use today.

Finding and developing all the fuel and power we need for our homes, businesses and vehicles, while protecting the environment, could be one of the greatest challenges our generation will face. The key to ensuring success is found in the same place that created this need: humanity itself. When the unique spirit we all possess is allowed to flourish, mankind has proven its ability to take on, and overcome, any issue. It’s a spirit of hard work, ingenuity, drive, courage and no small measure of commitment. To success, to each other, to the planet. The problem…becomes the solution.

This is very much in line with the analysis of Donald Boudreaux (Cafe Hayek) about unduly panicky UN population growth predictions, as cited in an earlier post. The new perception of many people, including Chevron, is that a growing population — with the right political and economic resources — can more than support itself.

Donald Boudreaux explains, in about one thousand words, what this chart depicts:

Source: Liberty Corner, “The Population Mystery” (02 Mar 2005)