Was the cause of the 1960 recession psychological? and now?

What caused the recession of 1960?

Here is an answer given at timerime.com.

“The recession of 1960-1961 was mainly due to the high inflation, high unemployment rates, and a bad gross national product rating. This recession lasted for 10 months and resulted in the second longest economic expansion in U.S. history. During Kennedy’s 1960 presidential campaign he sought to accelerate economic growth by increasing government spending and cutting taxes, and increased funds for education. The GDP of the United States during this period fell 1.6%, and the unemployment rate hit its peak at 7.1%. Kennedy knew that the economy was in big trouble so he sent congress an economic growth and recovery package consisting of twelve measures. They were an increase in the minimum wage from .00 to .25 per hour, an extension of the minimum wage to a greater pool of workers, an increase in unemployment compensation with an increased aid to children of unemployed workers, an increase in social security benefits to a larger pool of people, emergency relief for feed grain farmers, area redevelopment, vocational training for displaced workers, and federal funding for home building and slum eradication. JFK ended the recession by stimulating the economy ten days after taking office.”

Did inflation cause the recession of 1960?

inflation 1960

Link to graph #1.

There does not appear to be much inflation around 1960.

How about the stimulus package from Kennedy? Did it end the recession? How much did government expenditures change?

recession of 1960 1

Link to graph #2. (source BEA NIPA tables)

It does not appear as though the economic growth and recovery package by Kennedy was a big change from previous government spending.

So what caused the 1960 recession?

Investopedia said…

“This recession was also known as the “rolling adjustment” for many major U.S. industries, including the automotive industry. Americans shifted to buying compact and often foreign-made cars and industry drew down inventories. Gross national product (GNP) and product demand declined.”

So did imports increase around 1960 as a % of GDP?

recession of 1960 2

Link to graph #3.

OK… Imports were rising some from 1955 to 1960 and then stabilized after the 1960 recession. Does the stabilization of imports contradict the economic fact that international trade makes everyone better off?

How about inventories?

recession of 1960 4

Link to graph #4.

Inventories were still increasing before the recession.

How about monetary policy? Did the Fed tighten before the 1960 recession?

recession of 1960 3

Link to graph #5.

OK… now we see something. The Fed tightened before the 1958 and 1960 recessions. Why did the Fed tighten before 1960? Well, Christina Romer and David Romer tell us in their 2002 paper, “A Rehabilitation of Monetary Policy in the 1950’s“.

“Like central bankers of the 1990’s, monetary policy makers of the 1950’s had a deep-seated dislike of inflation and acted to control it. Their dislike of inflation was rooted in a model of the economy that emphasized the costs of inflation and the absence of a positive long-run trade-off between output and inflation. These Žfindings provide important insights into the performance of the economy in the 1950’s.”
There you have it. The 1960 recession was caused by the Federal Reserve being too fearful of inflation.
Here is a quote from the Romer and Romer paper…
“In the light of these threats to our economy, I am convinced that the time has come for a decisive signal from the Federal Reserve System’s determination to do its part to check inflationary trends.” (Vice Chairman Hayes, May 26, 1959)
But where was the inflationary trend in 1959? Looking back from 2013, the inflation of 1959 was very low. But to them it was not that low. They had seen high inflation after World War II and were overly preoccupied in letting it to creep back up.
The inflationary boom it seems was in the minds of members of the Federal Reserve. Psychologically, they perceived a threat from inflation that in retrospect was not there. And so we can wonder, is there a psychological worry or expectation in the minds of the current Federal Reserve members, that years from now will be seen as out of proportion? I think yes… The Federal Reserve does not know enough about the business cycle and how to measure the point at which a recession starts. Even Paul Krugman has recently mentioned that we need to know more about this. The end of this business cycle is an unknown to them. Even Bill Mcbride at Calculated Risk is having to wear shades because the future looks so bright. Yet, the shades may keep him from seeing something important.
The end of this business cycle expansion is closer than they all think. They see unemployment still high and lots of spare capacity and think we will simply have slow long-term growth back to potential. It’s not going to happen that way. The economy will hit the effective demand limit due to a lower labor share of income.

“Finally, it is not easy to predict the consequences of a decline in the labor share, and the corresponding increase in the capital share, of a sector of the economy as opposed to the labor share of the overall economy. Nevertheless, a decline in the share from almost 60% to less than 30% is significant and may have important consequences. An increase in the share of profits probably leads to an increase in investment early on. Simultaneously, a decrease in the share of labor over an extended period of time induces a decline in consumption or prevents consumption from increasing, even if the economy is growing. Sooner or later there is a mismatch between supply and demand as the increase in capacity caused by the increase in investment will not be matched by an increase in consumption demand. This is a problem of lack of demand, an under-consumption crisis. Capacity utilization will have to decline and along with it will come a decline in production, employment, investment, and demand.”

Economists do not think this describes the United States… yet. But it is this dynamic of low labor share that will bring about a limit on “production, employment, investment, and demand” before economists expect.  And the Federal Reserve says not one word about labor share. They are going to be blind-sided on this one. Psychologically, economists don’t have a comprehensive contextual perception of the effect of low labor share, as Federal Reserve members did not have a comprehensive contextual perception of inflation back in the 1950’s.

Here is the updated graph of the effective demand limit with the new numbers for real GDP (2009 dollars). We are close…

pot demand 6a

Link to graph #6.

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