Friday, November 04, 2005

Propagation, Katrina, and the waves of business cycles 

The jobs report came out this morning, and most observers are disappointed. The BLS report states that there are no direct effects from Hurricanes Katrina or Rita in the data anymore (though it's worth noting that BLS had to do a fair amount of revising of the previous numbers), and so people are concerned. What's going on?

Many years ago I thought about writing a book on business cycles and forecasting, since I teach a course by that name at SCSU. There are plenty of books on business forecasting, but ones that tie that to business cycle analysis are very few. The one that was out there was in its eighth edition and the original author getting quite old (now deceased). I never did publish the work I began, because midway through I decided there wasn't enough of a market. But it did get me to read a great deal of old business cycle literature, and today's report reminds me of something I wrote about then. I wrote this in 1990:

A theory of business cycles must contain two elements in order to explain real world phenomenon. The first of these is an impulse mechanism, which describes how an economy at equilibrium can be disturbed from that equilibrium. The second is a propagation mechanism that shows how the impulse imparts cycles on the economy that bring it back to equilibrium, since we do not observe that our economy diverges from equilibrium.[1] Knut Wicksell gives the example of a wooden rocking-horse being struck by a club. The club makes a strong single blow directly downward on the back of the rocking horse. It is the impulse that starts the rocking horse moving. But it is the bent wooden slats that give the horse its rocking motion. That motion is different from the motion of the club. Likewise in an economy, shocks themselves do not create cycles. They do not come in regular waves and do not have a similar influence on the economy at each wave. Some waves are much more pronounced than others, and some last longer than others. It is the impulse that generates the energy by which cycles are created. But it also requires a theory of market interconnections to describe how those shocks are transmitted into the economy.

[1]I have seen this story in many places, including the work of Ragnar Frisch. But my reading of it came from Gottfried Haberler, Prosperity and Depression. Geneva: League of Nations; 1937.

Could this be what we're seeing now with Katrina? Some are arguing that there are "indirect effects", but this quite misses the concept of propagation mechanisms. In short, the disruption of production and employment caused by the shock or impulse of a hurricane causes reactions in the relationships between these areas and those elsewhere in the economy with which they do business. It is imaginable that successive waves occur, though most likely these are smaller as time passes. But I think it unlikely this will be the last one.