Can Economic Data Explain the Timing and Causes of Recessions?
Most economists are of the view that through the inspection of economic data it is possible to identify early warning signs regarding boom bust cycles. What is the rationale behind this way of thinking?
During the 1930s the National Bureau of Economic Research (NBER) introduced the economic indicators approach to ascertain business cycles. A research team led by W.C. Mitchell and Arthur F. Burns studied about 487 economic data points in order to establish what business cycles are all about. Mitchell and Burns had concluded that
[b]usiness cycles are a type of fluctuation found in the aggregate economic activity of nations…. a cycle consists of expansion occurring at about the same time in many economic activities, followed by similarly general recessions, contractions, and revivals which merge into the expansion phase of the next cycle; this sequence of changes is recurrent but not periodic.1
In this way of thinking, business cycles are seen as broad swings in overall economic activity. The NBER research team concluded that because the causes of business cycles are complex and not properly understood it is much better to focus on the outcome of these causes as manifested through the economic data.
It is held that a careful inspection of the data makes it possible to establish peaks and troughs in general economic activity. The peaks and troughs identified by the NBER serve as a point of reference to classify various individual data as leading, coinciding, or lagging. Once the data is classified, it can be assembled into the leading, the coincident, and the lagging groups, known as the leading, coincident, and lagging indices.
These indices are seen as economic signposts that are expected to alert analysts and policymakers regarding the state of a business cycle. When the leading index starts to display signs of weakening, this is seen as a possible indication of weakness in economic activity in the months ahead.
The coincident index confirms that the peak of the cycle may have been reached, while the lagging index provides the final confirmation. Hence by means of these three indicators, it is held, the stage of a business cycle can be ascertained.
The indicators approach that was inspired by the NBER methodology was designed to be as impartial as possible in order to be seen as purely scientific. Murray Rothbard had the following comment on the NBER methodology,
Its numerous books and monographs are very long on statistics, short on text or interpretation. Its proclaimed methodology is Baconian: that is, it trumpets the claim that it has no theories, that it collects myriads of facts and statistics, and that its cautiously worded conclusions arise solely, Phoenix-like, out of the data themselves. Hence, its conclusions are accepted as unquestioned holy “scientific” writ.2
Establishing the Essence of Boom-Bust Cycles
Should we regard any decline in the leading index as a precursor for a future economic decline? For how many months must the index decline before we can be certain of an upcoming economic recession?
In addition, if one is to wait for the leading index signal to be confirmed by the coincident index, then what is the point of having the leading index? After all, it is supposed to alert policymakers
Article from Mises Wire