As johnswentworth notes, recessions are way worse than what you’d get from a random walk. There is something to be explained.
To his list of theories, I would add Austrian business cycle theory (ABCT), which introduces the notion of the temporal structure of capital and explains e.g. why fluctuations in employment are larger in industries further up the capital pipeline/further away from end consumers (mining, refining) than in industries closer to the consumers (retail, hospitality).
According to ABCT, when the central bank lowers interest rates below the natural rate which clears supply (household savings) against demand (businesses seeking loans for investments), this causes overinvestment and undersaving. More specifically, the lower interest rate guides businesses to invest in capital further up the capital pipeline, with longer time to “maturation” (to being useful to the end consumer), e.g. oil tankers. The gap between savings and investment (which no longer matches) is covered by new money being put in circulation by banks.
As the new money keeps pouring in, inflation picks up, the central bank reacts by lifting the interest rates again, this makes the long-term investment projects (which were profitable) unprofitable again, this makes all the capital that was already put into them mis-allocated and much lower in value than before (if you have an unprofitable, half-built oil tanker, it’s not easy to convert it to some more useful form of capital, like cellphones).
Thus, real wealth has actually been lost throughout the economy (as opposed to Keynesian theory, where no value is actually lost, everyone is just caught in crowd psychosis, like a murmuration of sparrows following each other down the market).
The central bank reacts by monetary easing, dropping the interest rate to zero, thus preventing the healthy clearance of the built-up misallocation, and a new bubble can build on top of the previous one.
(In reality, I think, each recession will have slightly different causes and many theories will be partly right about particular recessions. There is always some element of the Keynesian “I will sell because everybody else is selling” etc.)
As johnswentworth notes, recessions are way worse than what you’d get from a random walk. There is something to be explained.
To his list of theories, I would add Austrian business cycle theory (ABCT), which introduces the notion of the temporal structure of capital and explains e.g. why fluctuations in employment are larger in industries further up the capital pipeline/further away from end consumers (mining, refining) than in industries closer to the consumers (retail, hospitality).
According to ABCT, when the central bank lowers interest rates below the natural rate which clears supply (household savings) against demand (businesses seeking loans for investments), this causes overinvestment and undersaving. More specifically, the lower interest rate guides businesses to invest in capital further up the capital pipeline, with longer time to “maturation” (to being useful to the end consumer), e.g. oil tankers. The gap between savings and investment (which no longer matches) is covered by new money being put in circulation by banks.
As the new money keeps pouring in, inflation picks up, the central bank reacts by lifting the interest rates again, this makes the long-term investment projects (which were profitable) unprofitable again, this makes all the capital that was already put into them mis-allocated and much lower in value than before (if you have an unprofitable, half-built oil tanker, it’s not easy to convert it to some more useful form of capital, like cellphones).
Thus, real wealth has actually been lost throughout the economy (as opposed to Keynesian theory, where no value is actually lost, everyone is just caught in crowd psychosis, like a murmuration of sparrows following each other down the market).
The central bank reacts by monetary easing, dropping the interest rate to zero, thus preventing the healthy clearance of the built-up misallocation, and a new bubble can build on top of the previous one.
(In reality, I think, each recession will have slightly different causes and many theories will be partly right about particular recessions. There is always some element of the Keynesian “I will sell because everybody else is selling” etc.)