Fortune issue: February 21, 2000
First Principles
Is the Economy Recession-Proof?
By N. Gregory Mankiw
Break out the champagne. It's official: The current U.S. economic expansion, which began 107 months ago, is now the longest on record. This breaks the 106-month record set in December 1969, when the onset of a recession ended the economic boom of the 1960s. The official dates for the economy's peaks and troughs are set by the Business Cycle Dating Committee, a group of economics professors assembled by the National Bureau of Economic Research. One person who joined the group a few years ago told me it's the least demanding assignment he has ever had: The economy has been doing so well lately that the committee hasn't bothered to meet.
It hasn't always been so. According to the NBER's turning points, between 1854 and 1919 the average economic expansion lasted a mere 27 months. But after 1945 the average expansion rose to 50 months. (I omit the intervening years, when the Great Depression and World War II led to economic instability of a magnitude not seen before or since.)
Since 1982 the economy has been especially stable: The current record expansion comes on the heels of history's third-longest expansion, which lasted 92 months. Why are recessions less frequent now than they were a century ago? There are several reasons:
� DEPOSIT INSURANCE: If you have ever seen a banking panic, most likely it was in a movie, such as It's a Wonderful Life. In the 19th and early 20th centuries, banking panics caused frequent instability. Today, deposit insurance maintains public confidence in the banks, even in bad times. The policy has its costs--remember the savings and loan crisis of the 1980s--but it also has the benefit of eliminating one cause of recessions.
� AUTOMATIC STABILIZIERS: The U.S. government today is, as a percentage of GDP, about seven times its size at the turn of the last century. One byproduct of big government is economic stability. Whenever the economy slows, income taxes fall and spending on unemployment insurance and antipoverty programs rises--even without any deliberate policy change. This automatic fiscal stimulus mitigates the downturn.
� FED POLICY: Today, we look to Alan Greenspan to keep the economy on track. A century ago the economy was on a gold standard, and monetary policy as we know it did not exist. The Federal Reserve System wasn't even formed until 1914, and it wasn't until the 1950s that the Fed fully accepted its role as guardian of economic stability. Yet not until the 1980s, some argue, did the Fed figure out how best to fill that role.
Are these and the many other changes in the economy enough to make recessions a thing of the past? The question arises whenever the economy is doing well. During the last record-breaking expansion, a group of economists published a book called Is the Business Cycle Obsolete? (1969). The first chapter concluded; "It is important to remember that the economic system is dynamic and subject to almost continuous shock. Imperfect foresight and mistakes of judgment, the strains and stresses of the political process that so often lead to second-best solutions, and limited knowledge of the internal dynamics of the system suggest that even with the improvements in stabilization policy of the last six years, the United States has not seen its last recession." A prescient insight.
As the book was going to press, the Federal Reserve started worrying about inflation. It responded by raising interest rates to crack down on the overheated economy. The stock market lost a third of its value, and the boom promptly ended. Who said history doesn't repeat itself?
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N. GREGORY MANKIW is an economics professor at Harvard and the author of Principles of Economics.