Business Cycles and Economic Volatility ANIRVAN BANERJI DIRECTOR OF RESEARCH

The Importance of Business Cycles “Our greatest accomplishment of the twentieth century is that we have tamed the business cycle, at least in the industrialized countries of the west.” Sen. Daniel Patrick Moynihan

Turning Points are Difficult to Predict

Using Leading Indicators to Predict Cyclical Turns

The Goldilocks Economy l Luck AND Skill: Asynchronous expansions and Imported Disinflation l The porridge gets too hot: The Japanese expansion of

Errors in Judgment: The Persistence Bias l People (and models) expect past patterns to continue, resulting in recognition lag. l The case of Japan: Persistence bias on an international scale l The IT sector: Persistence bias blinds people to impact of old economy slowdowns

Errors in Judgment: The Attribution Bias l People take credit for good outcomes, but blame others or outside factors for bad outcomes l The productivity “miracle”: Attribution bias on national scale l Consequences: Stock price bubble, overbuilding of capacity

The IT Industry Grows Up l Infant industry: During earlier old economy downturns, IT industry was much smaller l By 2000, almost half of all U.S. capital investment was IT-related l Slowdowns cause profits to fall, which causes drop in investment -- ALWAYS

A Triple Whammy l Lagged effects of worldwide interest rate hikes of l Oil price spike of 2000 l Global IT bust l Result: First global recession in a generation. In terms of profits, there’s no place to hide.

IT Cycles and the Shoe, Leather, Hide Sequence l Shoe demand is cyclical, but shoe makers couldn’t predict cycles l Leather demand is more cyclical l Demand for hides is the most cyclical, but supply is insensitive to demand fluctuations, so hide prices are highly cyclical

IT Cyclicality l IT suppliers feel most cyclicality l IT capital equipment very cyclical l Rapid obsolescence magnifies IT cyclicality, spurs price wars l Rapid obsolescence sows seeds of rebound

The “I” of IT l “How ironic that the producers of the equipment that was to have eliminated the inventory cycle are themselves its foremost victims.” ---- Stephen Cecchetti, August 22, 2001

Early Warning l “Never in this expansion have the leading indicators been so close to forecasting a recession.” ---- U.S. Cyclical Outlook, September 2000

India: Liberalization and its Consequences l Impact of Market Reforms: Leadings indicators start working after early 1990s l Domestic Front: Business Cycles are Achilles’ Heel of market economies l Foreign Exposure: Key exports, including IT, are highly cyclical l Thus, Indian economy is likely to get more cyclical

Conclusions l Recessions are predictable l IT is highly cyclical l Indian economy is likely to get more cyclical l It is increasingly important to monitor leading indicators

Leading Indicators to Watch l Weekly Leading Index updated 10:30 a.m. each Friday at: l DSE-ECRI Indian Leading Index published in Economic Times every month.