by Cathy E. Minehan

Over the past several years we at the Federal Reserve Bank of Boston have used our annual economic conference to focus our own research, the research of other experts, and the thoughts of conference participants on issues related to economic growth and prosperity in this country and elsewhere. To that end, recently we have looked at technological change, and at changes in saving and investment—particularly as they might be encouraged by Social Security reform—as critical elements in long-run growth. This year we consider the short run—that undefined but vital period of time over which monetary policy can affect economic fluctuations. As Keynes quipped, “In the long run we are all dead.” Policymakers need to worry about the short run, and about how a combination of short runs can produce the optimal long run that has been the focus of some of our recent conferences.

The topic of our forty-second annual economic conference is one of the most important but perplexing issues in all of economics: What causes business cycles? Like many others, I have been asking this question more and more, lately. Several recent events—the aging economic expansion, financial crises in Asia, warning signs on the inflation front, and the surprising suggestion that we have conquered the business cycle—are putting increasing pressure on us to provide answers. As we have puzzled over this here at the Bank, we have realized that modern macroeconomics has trouble answering this question because of its widespread reliance on random, exogenous “shocks” as the cause of short-run economic fluctuations, or business cycles.

Business cycle theory suggests that unanticipated good or bad “shocks” occur periodically and create fluctuations around a long-run trend. Monetary and fiscal policy then must act to smooth the fluctuations. But I think most of us can agree that shocks are a less than fullysatisfying explanation of the business cycle. What economic behavior lies behind these shocks? What causes consumers to alternate between spending sprees and retrenchment? Why is investment spending so volatile, and what causes businesses to suddenly lay off large numbers of workers at a time, or even close down altogether? Do monetary and fiscal policies contribute to economic fluctuations?

Our inability to pin down the source of some of the most important events in economic history seems to me a gaping hole in the intellectual underpinnings of modern macroeconomics. More important, can the economic behavior behind shocks be identified, so that policymakers can anticipate an unsustainable boom, or an approaching downturn, before it happens rather than after? The ability to do that obviously relates to our biggest challenge of late, which has been trying to foresee anything that will upset the enviable success our economy currently enjoys.

My hope is that this conference has produced the beginnings of understandable, economic explanations of the sources of cyclical fluctuations—explanations that not only are more satisfying intellectually, but also are more practical for policymakers. I also hope that study of the papers and discussions will stimulate further research into the contentious issues raised and explored here.

Cathy E. Minehan
President and Chief Executive Officer
Federal Reserve Bank of Boston