Noah Smith provoked a conversation here at Angry Bear by wondering what causes recessions. Recessions are not such a mystery when you see the interaction between effective demand and such things as productivity.
The conversation took place in the comments section of a previous post on Productivity’s role as a cause of recession. The issue is whether increasing productivity causes recessions, as opposed to tight money policy or something else.
Truly, a recession is caused by a blend of factors, including monetary policy, effective demand, vulnerable profits and pressures in the economy from an urge to increase productivity. Yet, here I want to show a graph of productivity gains since 1967. I will use a graph previously posted. (link) The graph shows real GDP on y-axis, and utilization of labor and capital on x-axis to represent expansions and contractions of the business cycle.
In this graph, we see how real GDP jumps to a new attractor level after a recession. (Recessions are seen when the plot goes to the left.) Each new attractor level points toward a higher and identifiable productive capacity. Surely, productivity needs to increase in order for the economy to jump to new levels, right? Well, we can visualize when productivity jumps in this process of jumping up to higher and higher levels of productive capacity.
For each data point of real GDP, I change its size to represent the productivity growth over the preceding year.
What do we need to see here? The larger bubbles show larger increases in productivity. You will notice that the larger bubbles primarily appear during those recessionary transition periods. (between the lines & to the left)
So are productivity gains “causing” recessions? Well, they are part of the dynamics that cause recessions.
Many people are concerned about low productivity at the moment. Yet, we can expect productivity to increase through the next economic contraction. Is that saying that pent up productivity will cause the next recession? Well, pent up productivity gains are part of the pressures that cause recessions, in combination with the changes of the effective demand limit. Pent up productivity gains are released through the recession process after effective demand expands. (see article below)
When effective demand (blue line) increases during an economic contraction, productivity (red line) increases with a bit of a lag. The times when productivity growth is low or zero, coincide with a tightening of effective demand. Basically, effective demand can be seen as a leading indicator of productivity changes.
Lambert, Edward. Relax DeLong & Krugman… Productivity advances will appear when there is demand space. Effective Demand blog. December 3, 2013.