The Economy -- Revisiting The Juglar Cycle

Including the immediate post World War II conversion and the latest downturn, the U.S. economy has suffered through 10 recessions over the last 55 years, although admittedly they have become less frequent in recent decades. However, back when respectable economists still talked about business-cycle theory, they often distinguished between Kitchin cycles, which averaged three to four years and were dominated by swings in inventory investment, and Juglar cycles, which covered about one decade and were dominated by long-term shifts in capital spending patterns. With the 2001 recession well under way, it has become apparent that a Juglar-like pattern remains part and parcel of the U.S. economy, and therefore we can expect several years of sluggish growth. Over the last half-century, the U.S. economy has generally had periods of five to eight years of strong growth [even if punctuated by brief recessions] followed by periods of sluggish growth that have averaged about four years. These periods of sluggish growth were 1958-61, when real GDP rose an average of 2.4%; 1970-75, up 2.3%; 1979-82, up 0.8%; and 1990-93, up 1.8%. During these periods the unemployment rate averaged 6.8%, compared with an average of just less than 5% for the rest of the post World War II period. In all of these cases, the economy either fell back into recession after only about a one-year recovery, or the upturn was unusually sluggish. The periods immediately preceding the sluggish years were generally ones of exuberance and "limitless" expansion plans, accompanied by the belief that the boom could continue indefinitely -- similar to what happened in the '90s. In planning for the future, firms overcommitted resources for the present. Thus when the inevitable unexpected downturn in sales and economic activity occurred, it took firms several years to work off the excess costs in terms of employees and capital spending. Companies first trimmed discretionary expenditures-advertising, travel and entertainment, and consulting services. These actions lead to layoffs that worsened the unemployment rate and, because those former employees generally received above-average salaries, caused unusually sluggish growth in real disposable income and consumption. We are seeing this now, and this pattern is expected to remain in place for the next two to three years. Thus one major factor that will keep the economy from roaring back late next year, when the recovery finally does start, will be a relatively low level of profits. Furthermore, that will be accompanied by a sluggish rebound in the stock market. Generally the stock market bounces back 50% or more in the first year of recovery, but there is very little chance that will occur this time for a basic reason: Stocks are still relatively highly priced, with a P/E ratio of about 25. Even if the P/E stays at this relatively rarefied level, and profits rise 25% from their trough in mid-2002 to mid-2003, which at the moment seems optimistic, gains in the stock market will probably not outperform that increase. Indeed, it is more likely that the P/E ratio will decline because of the return of the Federal budget deficit. The deficit, which is now expected to rise to $50 billion to $60 billion in FY 2002, may well create fears of higher inflation in the future and increase the stock market's risk premium, which had declined during the 1990s precisely because of lowered inflationary expectations and the emergence of the budget surplus. Even though many of the additional programs voted on will be "one-time" expenditures, the historical record indicates how difficult it is to return to surplus: the Federal budget remained in deficit for 28 consecutive years, from FY 1970 through FY 1997. Thus far from stimulating the economy, the higher deficit is likely to result in smaller gains in profits and stock prices, offsetting the additional money funneled to consumers and businesses. As a result, the recovery, when it does start, is likely to be anemic, and accompanied by a further rise in the unemployment rate, which is now expected to climb to 7% by the end of next year. Michael K. Evans is chief economist for American Economics Group, Washington, and president of the Evans Group, an economics consulting firm in Boca Raton, Florida.