Do Economic Expansions Die of Old Age?
The United States is approaching its 100th month of economic expansion, which is already the 3rd longest economic expansion in US history. Recessions are remarkably difficult to forecast and the extended length of this expansion has left many asking whether we’re close to the next recession. Many expect a downturn simply because enough time has passed since the prior recession and “we’re due.” While there are some elements of truth to this statement, it is also very possible that this expansion will be the longest in US history.
Janet Yellen has commented publicly on the idea of whether expansions “die of old age.” In December 2015, Chair Yellen said,
“I think it’s a myth that expansions die of old age. I do not think that they die of old age. So the fact that this has been quite a long expansion doesn’t lead me to believe that…its days are numbered.”
Economists have long argued each side of this debate dating into the early 1900s when it was more widely thought that expansions died of old age. Since World War II, the thinking has gradually shifted and the Federal Reserve has more recently argued that duration does not equate to increased risk of recession, including in multiple published papers. The argument that expansions do not die of age was supported by a San Francisco Fed paper from February 2016. Unfortunately, their argument based on the post-World War II era is based on only a limited number of recessions at a time when the length of expansions has increased dramatically. Moreover, how many of those expansions even reached maturity? When shocks come to an economy and lead to a recession, the economy may not have had the opportunity to mature so the thesis that it may have become vulnerable based on its length is difficult to assess. Complicating the issue further is the fact that expansions have grown significantly in length based on improved economic and monetary management as well as a shift from a manufacturing to a service-based economy. Fifty years ago a mature expansion lasted only 4 years. Today, the most recent 4 expansionary periods were 4 of the 6 longest in US history.
There are reasonable arguments on each side. Those that argue in favor of economic weakness based on the length of the recovery suggest that as an expansion matures it becomes more vulnerable to shocks. Various industries mature and their growth rates slow. With no sector exhibiting strong growth, the overall economy becomes more vulnerable to negative shocks. In addition, as an expansion matures and the unemployment rate drops to low levels, such as those experienced in the economy today, the quality of each additional hire declines. Imagine a company which is having a difficult time finding an employee to fill a vacant position. The position will go unfilled or eventually it may settle for a lower quality candidate in order to fill the position, but the lower quality candidate isn’t likely to be as productive. This helps to stall the recovery further until the next recession at which time these less productive employees are purged from a firm’s payroll leaving the firm leaner and with a more productive set of remaining employees.
In the post-World War II era, expansions have lasted far longer, but when an economy turns negative it still turns very quickly.
Historically, the unemployment rate has rarely stayed at any one level for any period of time. Indeed, the unemployment rate is in constant motion either climbing or declining, but rarely staying the same. Thus, while the current unemployment rate is falling and is also already at very low levels, there is a significant likelihood that it will decline further. If sideways movement is very difficult to achieve, the only other direction at some point is higher.
The problem with this analysis and others is that it is all fairly conjectural and not based on data because we just don’t have a large enough sample of recession-recovery events, especially for an economy that structurally changes over decades.
Regardless, the current US economic climate continues to show slow and steady GDP growth with somewhat slowing, but steady, job growth. Economic conditions remain positive with no obvious weakness or bubble. Nothing we see over the next 6 months suggests a recession is near. If this continues for a little over 2 years, the expansion will officially be the longest in US history, although in order to reach this milestone we’ll likely need to have an unemployment rate that holds achieves a historically low level. Perhaps the US economy will experience several years of steady job growth where new jobs created are absorbed equally by new people entering the workforce resulting in a sideways unemployment rate. History suggests this is very unlikely, but it may be necessary in order to reach the longest expansion in US history.
San Francisco Fed Paper, February 2016: http://www.frbsf.org/economic-research/publications/economic-letter/2016/february/will-economic-recovery-die-of-old-age/
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