by Steve Roth
What Causes Recessions? A Physicists’ Complex Systems Model
I received some very interesting comments from Yaneer Bar-Yam to my recent Evonomics post— “Capital’s Share of Income is Far Higher than You Think.” He pointed me to his very interesting paper, “Preliminary steps toward a universal economic dynamics for monetary and fiscal policy.”
I’m using this space to reply with with some stuff that can’t display in that comments space.
I haven’t gotten to the full-boat, multipart reply that I have floating in my head, but wanted to get back on two items for the nonce, a question plus a response on recession prediction:
1. What is the function in this model that “causes” capital gains? This always strikes me as the core problem in a complete SFC model where flows (including holding gain “flows”) balance to and fully explain (change in) net worth: if you can write a reaction function that predicts asset-price changes, you’re a very rich person… 😉
2. The recession-prediction based on investment/consumption ratio misses a bunch of recessions (false negatives). Contrasted here with a personal favorite: every recession since 1970 has been preceded by a year-over-year decline in real household total assets/net worth. (Including liabilities to arrive at net worth instead of just using assets adds no predictive value). Click for FRED.
The investment:consumption ratio bruited as a predictor/cause in the paper is four for seven, and even there: the first year of decline in this ratio seems late in each case (as opposed to the measure’s peak) to suggest it as a cause:
|Investment:Consumption ratio peak/first year of decline||Year-over-year declines in real household net worth (CPI-adjusted; base year 82–84)||Quarters of real YOY net worth decline – YOY % decline in first declining quarter – NW decline peak-to-trough %||Beginning of NBER-dated recession|
|Q4 1969 – Q4 1970||4 – 3.9 – 5.6||Q1 1970|
|Q4 1973 – Q1 1975||6 – 3.8 – 9.9||Q1 1974|
|Q1 1980 – Q2 1980||2 – 1.5 – 1.4||Q1 1980|
|1981/1982||Q3 1981 – Q2 1982||4 – 1.8 – 1.0||Q3 1981|
|1989/1990||Q3 1990 – Q2 1991||4 – 3.2 – 1.9||Q3 1990|
|2000/2001||Q4 2000 – Q4 2001||5 – 2.0 – 8.1||Q1 2001|
|Q2 2002 – Q1 2003||4 – 1.8 – 5.2|
|2007/2008||Q4 2007 – Q3 2009||8 – 3.8 – 19.3||Q1 2008|
|Q3 2011 – Q4 2011|
I have various ideas and explanations for all this, but apologies, haven’t found time to write them all up.