Download 100 years of business cycle analysis at the Kiel Institute 89th Kieler

100 years of business cycle
analysis at the Kiel Institute
89th Kieler Konjunkturgespräch
March 17/18, 2014
Joachim Scheide
1
The early years: Top research until 1933
• During the first years after 1914, business cycle research did
not play much of a role. The focus was more on producing a
statistical basis for the analysis of the world economy.
• But it really started in 1926.
• The “Astwik” department was in place with many researchers.
Among them were Colm, Neisser, Marschak and later also
Leontief.
• It was the first group in Germany to analyze international
business cycles, and it contributed to the progress of empirical
research.
• The group soon got an excellent reputation. Observers
compared its quality with that of the NBER (founded in 1920).
And the works of Mitchell and the Bureau were seen as an
example where Kiel could be heading.
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Adolph Löwe, at the Kiel Institute
between 1926 and 1930
Bernhard Harms had met Adolph Löwe
during a research visit at the Kiel Institute.
He offered Löwe a professorship and
asked him to establish a department with
the focus on international business
cycles.
The department was called “Astwik”:
“Abteilung für statistische
Weltwirtschaftskunde und
internationale Konjunkturforschung”
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Gerhard Colm and Wassily Leontief
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The early years: Top research until 1933
• The research of the group covered a variety of business cycle
theories. Several papers were published in the
“Weltwirtschaftliches Archiv” and in other journals or books.
• A fundamental piece was the thesis by Löwe (1926):
“How is business cycle theory at all possible?”
• Here, he criticized Mitchell’s work in the sense that it was
plainly a “descriptive analysis” and could not be – as Mitchell
claimed – a “theory of the business cycle”.
• Löwe’s approach was very modern:
- A business cycle theory would have to explain the
co-movements of important variables such as prices,
production, interest rates, investment, wages and profits.
- And the reference point should be some kind of equilibrium.
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The early years: Top research until 1933
• Based on that, Löwe criticized existing theories because they
often started from a situation which itself was not explained.
• For example, one starting point was the “undercapitalization
during a depression”. BUT: How did we get there?
• Or: Low interest rates would help to overcome a depression,
and a boom may be the result. BUT: How can the depression
be explained?
• Therefore, the equilibrium – not in a static sense – was a
useful reference point.
• Then Löwe mentioned a variety of disturbances (today:
“shocks”) which may produce the business cycles we observe.
• There was no consensus at the time of what the relevant
shocks were, but Löwe was an optimist hoping that such a
consensus was not too far away – but he was not right.
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The early years: Top research until 1933
• The events at that time had an impact on the research, and
members of the group also had a voice in the public debate.
• One big achievement on the basis of the analyses was the
understanding that the economic downturn starting in 1929
was far more synchronous than all the previous ones.
• As far as economic policy was concerned, the members of
group were often labeled as “Pre-Keynesians”.
• For example, they were advocating active fiscal policies,
based also on Colm’s work on the effects of fiscal
expenditures on economic activity.
• So they criticized the policy in Germany under Brüning.
But sadly, it all ended when the Nazis took over in 1933.
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The early years: Top research until 1933
• All in all, it may not be appropriate to speak of a
“Kiel School” because the work was too diversified.
• But the members were very much recognized. For example:
- Hayek was influenced by Löwe and others.
- Keynes received a lot of impact from Neisser and called
him one of the leading figures of the neo-Wicksellian school
next to Hayek and van Mises.
• And the members of the Astwik group were later very
successful in other positions. For example:
- Colm became an advisor for Truman, and he was one of
the architects of the German currency reform in 1948.
- Marschak was the thesis advisor of Franco Modigliani and
Don Patinkin, and he was the President Elect of the AEA.
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After 1945: A slow start for business
cycle analysis and policy advice
• The members of the Astwik group rarely returned to Kiel, and
their achievements were hardly recognized – quite a disgrace!
• One exception: Gerhard Colm was the first person to receive
the Bernhard Harms Prize in 1964.
• Fritz Baade (director 1948-1961) was not very much devoted
to business cycle analysis. But he started “Die Weltwirtschaft”,
the Kiel Institute’s journal in which regular reports on individual
countries, on raw material markets etc. were published. And it
offered a large data base.
• But the Kiel Institute was relatively silent in the public debate
for a while as far as business cycles and macroeconomic
policies were concerned.
• This did not change much under Erich Schneider (19611969), although he brought the Keynesian ideas to Germany.
9
The giant leap: Herbert Giersch –
President between 1969 and 1989
“The Age of Herbert Giersch”: Work on
Economic policy for Europe. Full
employment and stability. Openness for
prosperity. Free trade. Exchange rate
flexibility. The future of the world economy.
Economic policy in the age of Schumpeter.
Eurosclerosis. Index clauses. Employment
and macroeconomic policy. European
parallel currency. Rules for faster growth in
the world economy. Monetary policy and
independence. Growth and structural
change. Space and growth. International
competition. IMF surveillance. New world
economic order. Transition to a market
economy. Macroeconomic stability.
Macroeconomic policies for Germany.
And so on …
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The late 1960s and the 1970s:
A great challenge for the policy advisor
• The first years were as turbulent as they could possibly be:
- Monetary instability, inflation was high and volatile.
- Oil prices were exploding.
- Wages were exploding, too.
- Unemployment surged.
- The system of fixed exchange rates blew up.
• Already at the end of the 1960s, there was upward pressure
on the D-Mark leading to big controversies (election!).
• Giersch was in the forefront of those advocating a free float.
• In May 1971, he sent a letter with this proposal to Karl Schiller.
It was signed by several German professors (including Otmar
Issing). And he got the support from Friedman, Haberler,
Johnson, Machlup, Okun, Samuelson, Tobin and others.
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The late 1960s and the 1970s:
A great challenge for the policy advisor
• Giersch was devoted to the role of a policy advisor, also to
the German government and the public (“Bringschuld”).
• As far as the macro economy was concerned, he like nobody
else stressed the distinction between long-term growth
and the short-term business cycle – difficult as it may be in
theory or empirically. His textbook is still the reference.
• One of the leading questions: How can the supposed conflict
between price level stability and other targets be solved?
• Monetarism had the answer to the inflation problem. And only
flexible exchange rates gave the central bank the power to
control inflation – this is obvious now, but it seemed
revolutionary in the early 1970s.
• While Giersch was certainly not a monetarist, he used the
convincing theories for the policy strategy he proposed.
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The late 1960s and the 1970s:
A great challenge for the policy advisor
• The problems the German economy (other countries, too, of
course) was facing seemed insolvable.
• With high and rising inflation, wages went out of control. When
inflation was brought down, unemployment rose even more.
• The Kiel proposal looked like this:
1. The central bank announces an “inflation target” which is
communicated with the government and the social
partners who should adjust their expectations accordingly
(“Vorfahrt für die Bundesbank!”).
2. Given this, unions and employers are responsible for
employment when they fix wages.
• In general, the “assignment problem” of economic policy
was solved by assigning the instrument with the comparative
advantage to the respective policy target.
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The assignment of policy goals and
instruments – the Kiel solution
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Responsibility
Target
Monetary policy
Price level stability
Fiscal policy
(deregulation, tax policy, …)
Long-term growth
Social partners
Employment
Exchange rate
External balance
Basic research with a focus on policy
relevance over the decades
• Needless to say, many policymakers did not like the ideas,
they had “other things to do” (like winning an election).
• This was also true under Horst Siebert (President 19892003) who also was a member of the German Expert Council.
• But the research at the Kiel Institute has continued to focus on
topics relevant for macro policies.
• Over the years, it became, of course, more and more difficult
to be at the frontier because macro is done “everywhere“
(universities, central banks, international organizations, …).
• Currently, one focus of the Kiel Institute is on business cycle
models with labor market frictions which may explain the
behavior of unemployment over the cycle better than
alternative models. The implications for the strategies of
monetary and possibly of fiscal policy are demonstrated.
15
Finally: A few examples of our
forecasting work
• Paul Samuelson: “Stock markets predicted nine of the past
five recessions.”
• Economists usually do not (like to?) predict recessions – and
they also hesitate to predict strong recoveries.
• But the IfW forecasters predicted two of those recessions, and
they were heavily criticized for that!
• „Legendary“ forecast in 1981: Today everybody would predict
a recession, but at that time we were called “dogmatic
monetarists” (or something worse!).
• What happened? Because of the boom and rising inflation, the
Bundesbank had raised interest rates by 600 basis points in
about one year.
• According to our model, the economy had to crash, and it did!
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Real GDP in Germany:
Deviations from a trend
Percent
5
4
3
3
2
5
Five recessions since 1970
1
4
2
1
0
-1
-2
-3
-4
-5
1970 1973 1976 1979 1982 1985 1988 1991 1994 1997 2000 2003 2006 2009 2012
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Our very simple model:
The “monetarist” equation
Source: Die Weltwirtschaft (1975), Band 2.
18
Why we predicted a recession in 1981:
Sharp deceleration of money growth
Money
growth M1
Source: Die Weltwirtschaft (1981), Band 1.
19
Recent work relevant for the forecasts
and for policy advice
• The financial crisis has made it clear: Financial market
variables are extremely important. We developed indicators
for financial market stress which help to explain the cycle.
• Our studies show that recoveries after severe crises are
less dynamic than after normal recessions. This has been one
reason why we have been not very optimistic in our forecasts.
• In addition, uncertainty about economic policy can be a
dampening factor for economic activity. This may explain the
relatively modest recovery of investment in this cycle.
• Since interest rates have been much too low for Germany –
and will remain to be too low for some time – there is a risk of
a boom. This has important implications for economic policy.
• Current economic policy in Germany is likely to dampen
potential output growth (minimum wage, early retirement).
20
Forecasts based on models with large
datasets: Big uncertainty!
Source: I. Pirschel and M.H. Wolters (2013).
21
Critical question: Why have forecast
errors not become smaller over time?
• In recent decades, there has been tremendous progress in
developing theoretical models for the macro economy.
• In addition, empirical methods have become much more
sophisticated, also thanks to computers.
• However, the forecast errors have not become smaller, and
this is not due to the fact that there have been more or bigger
shocks.
• One reason: Forecasting models are not stable over time.
For example: Money growth was a good indicator in the
1970s, but not any more today.
• Another reason: Our knowledge about the “true structure” of
the economy is limited which is one argument against “fine
tuning” (Milton Friedman).
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