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What Causes Recessions? A Physicists’ Complex Systems Model

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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

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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.

What Causes Recessions? A Physicists’ Complex Systems ModelThis predictor is seven for seven. Though: there are two recent false positives — shortly following the 2001 and 2008 recessions.

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.

Dan Crawford
aka Rdan owns, designs, moderates, and manages Angry Bear since 2007. Dan is the fourth ‘owner’.

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