Wednesday, February 17, 2010

Exam 1 Comment 2: Is Growth Just a Positive Average of Business Cycles?

I know – my title is kludgy.

One way to think about growth is to build it up from business cycles. So, you might assume that expansions and contractions/recessions are mirror images of each other. But, if expansions are longer (they are, on average, about 3 times as long) then on average the economy will grow.

This is not correct. And, it can lead to the presumption that the way to get an economy to grow is to encourage expansions and discourage contractions – that’s the Keynesian idea.

Instead, we need to recognize that the baseline is growth. The business cycles are then the deviations from that baseline.

This view is consistent with how the math of compounding works – and thus the use of natural logs and differences to help visualize the data. It also leads us to trying to explain the baseline first, and the fluctuations second.

When was the last time you heard a politician or pundit argue that we need to increase baseline growth, even by a tenth of a percentage point? You don’t hear that, but you should: it would make our children richer.

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