Why Most Recessions Are Completely Misunderstood ft. Tyler Goodspeed

[00:00:01] Tyler

That’s the kind of shock that reminds me of some of the past energy supply shocks, or some steel shocks, or cotton, on these essential products, the supply disruption of which can really have spillover effects into other parts of the economy.

[00:00:20] Intro

Welcome to Top Traders Unplugged. In markets success doesn’t come from predicting what happens next, it comes from being prepared for what you can’t predict.

In each episode we go deep with some of the world’s most thoughtful minds in investing, economics, and beyond to understand how they think, how they prepare, and how they decide, and the experiences that shaped how they see the world. No noise, no short-cuts, just real conversations to help you think better and invest with confidence.

[00:00:53] Kevin

Welcome, everyone, to Top Traders Unplugged. My name is Kevin Coldiron, and I’m host of the Ideas Lab series where we talk with authors of new books that help us understand the global economy. Okay, so think about these ideas. Economic busts do not follow economic booms. Economic expansions do not simply die of old age. And recessions don’t cleanse the system of previous excess.

If you find those ideas surprising, well, stay tuned because our guest today is going to explain why, after studying four centuries of data, he believes all those conclusions are correct. Our guest is Tyler Goodspeed.

Tyler is the Chief Economist of ExxonMobil, and previously he chaired the Council of Economic Advisors in the first Trump administration. And he’s joining us today to talk about his fascinating new book, Recession: The Real Reasons Economies Shrink and What to Do About It.

Tyler, thanks for joining us and welcome to the show.

[00:02:00] Tyler

Thanks. Great to be with you, Kevin.

[00:02:02] Kevin

Okay, so I want to start off with a couple just sort of background questions. I mean, in the book, you work through explanations for what causes recessions. You explain the logic, and then you provide evidence to show mostly that the explanations we’ve been given don’t work. But I guess my question is, did you go into the project thinking, hey, I really would like to just kind of systematically go through and test all these ideas and see if they really hold, or was it more, I don’t think these ideas are correct based on my own work and my own experience, and I want to provide a way to convince others that that’s the case?

[00:02:47] Tyler

So, part of me had a contrarian motivation but, to be honest, when I first started the project, it was in the aftermath of the 2020 pandemic recession that we’d all just experienced, which was one of the sharpest, deepest, albeit also shortest recessions in US and, indeed, UK history. And I began the project thinking that recession was unique.

That unlike in, say, 2008, this was sort of the narrative in my mind. Unlike in 2008, there had been no great excess, no imbalance, no misallocation that needed to be remedied. This was a purely exogenous shock.

And as I got further into the project, the more I realized that while the 2020 pandemic recession (like, in fact, every recession) was unique, it actually wasn’t as dissimilar as I thought. Because when I extended the sample, so to speak, from not just the United States, but also to the United Kingdom, and extended the sample back in time all the way to 1700, the more I realized that actually, typically, there is no error or excess or misallocation at the end of an economic expansion to which recession is the inevitable or even necessary remedy.

[00:04:14] Kevin

Okay, so you were… I guess you kind of… Did you start the project with an idea that you were going to do that level of historic research, or was it really more initially focused on what happened during the pandemic and then you kind of expanded it?

[00:04:32] Tyler

It started with a set of questions to which I realized the 12 US recessions, since 1945, were inadequate to the task because most analysis of economic recessions is confined to the 12 US recessions since 1945, for the simple reason that it was only after about 1947 that the relevant data became readily available at quarterly or monthly frequency. But the reality is, you think that with quarterly or monthly data, you have all these statistical degrees of freedom, but you really only have 12. And not to sound too much like an econometrician, but with the slope and intercepts, you’ve already chewed through two of those degrees of freedom.

[00:05:15] Kevin

Yeah, that was going to be my second question, really, which is the research challenges seem pretty tricky to me. Right? Because as you say, the sample size is small. If we go back to 1970s, there’s only been five recessions in the US in over half a century. And you mentioned the famous Tolstoy quote, right? All happy families are alike, but each unhappy family is unhappy in its own way. And your take is that, well, each recession is unhappy in its own way. So, those are pretty big challenges to me. Right? One, you don’t have that many data points. There’s not that many recessions to look at. And all the data points you have, or the data points that you do have, seem really different. So, could you just sort of elaborate a little bit on how you thought about dealing with those problems, those challenges?

[00:06:05] Tyler

So, one of the ways I dealt with the challenge was to simply extend the standard recession chronology for the United States back in time all the way to 1700. So, fortunately, the National Bureau of Economic Research has a series at quarterly frequency going back to 1854 and then an annual frequency back to 1790. Other scholars, your colleague at Berkeley, Christina Romer, Davis, did a very good alternative recession chronology because the NBER series tends to overstate the frequency and duration of pre-1927 US recessions. And then I did a lot of work to extend the chronology back to 1700 using Colonial American statistics.

And then also I extended the sample across the Atlantic to the United Kingdom. And what’s interesting there is that here you have two very large advanced economies that have long been deeply financially and economically integrated, similar legal institutions. And yet when I compared the two, despite all those similarities, despite that integration, they’ve actually had very dissimilar recessionary experiences over the past 200 years.

[00:07:23] Kevin

Yeah, that was surprising to me how the level of correlation between the timings and the length of the recessions in those two economies. And maybe we can talk more about that as we go along.

So really what you are doing in the book is each chapter is kind of starting off with an explanation for what causes recessions or the drivers, the reasons we experience recessions. And then you say, okay, well, let’s take a look at the data and see if that holds up.

And the first idea that you test is pretty straightforward. It’s really, does the duration of an economic expansion influence the chances of recession and its severity? And you say that you’re testing kind of a Dorian Gray explanation versus Peter Pan. So, I know those are pretty technical terms. Maybe you could just explain what you mean by them and then tell us what you found when you looked at that.

[00:08:26] Tyler

Yeah, so under the boom/bust view of economic fluctuations, we should expect to observe that as economic expansions age, the imbalances, the excesses, the misallocations, accumulate such that the probability that the expansion dies in recession increases the longer it’s been going on. And what I find, using the 132 recessions in my sample, both UK and US recessions, what I find is that actually economic expansions have never died of old age on either side of the Atlantic either before or after 1945. And the literary analogies I compare this to are Peter Pan. So, Peter Pan, as we know, he never grows old, but he can die. And if he loses a battle with Captain Hook, he will die.

In another view of economic fluctuations is what I describe as the picture of Dorian Gray, that while Dorian Gray the person seems to be eternally youthful, to all outward appearances everything is fine, hidden away in an attic. The picture of Dorian Gray bears all the blemishes and disfigurements of each hedonistic excess until the whole rotten item can only be restored to its youthful beauty by execution at the hands of a very instrument of one of those hedonistic excesses.

So, the picture of Dorian Gray view of economic fluctuations is very much in keeping with the boom/bust view, whereas the Peter Pan view of economic fluctuations is in keeping with, no, sometimes these expansions that never grow old, just history or misfortune happens upon them.

[00:10:30] Kevin

Tell us how you went about examining that and drawing the conclusions that in the end it’s really the Peter Pan view that’s more correct.

[00:10:44] Tyler

Yeah. So, there are statistical tools that you can use to estimate the probability of death as a function of the age of an economic expansion. And, statistically, I found that an economic expansion on either side of the Atlantic is no more likely to die in its 10th year as in its first or second year.

Now, some earlier researchers in the 1990s, Diebold and Rudebusch, did find that already and confirmed that already. But they seem to find that the same was not true of pre-1945 US expansions, that earlier expansions seemed to die of old age. But when I used the improved recession chronologies at Davis and Romer, I found that, in fact, US economic expansions have never died of old age. And, indeed, the same is true for the United Kingdom.

But what is interesting is that the same is not true of recessions. So, statistically, recessions do die of old age and always have. And in fact, the single strongest predictor of whether a recession is going to end in the next quarter or the next year is simply how old the recession is. And that is true both since 1945 and before 1945.

[00:12:03] Kevin

Yeah, that’s interesting. I mean, there’s pretty clear differences in terms of returns to say, equities and bonds and recessions and in expansions. And so, it struck me that we spent a lot of time kind of trying to predict whether you’re going to go from expansion to a recession, but maybe the juice is really, once you’re in recession, to build a model of when you’re going to get out of it. Although again, the number of data points there is pretty small, so it might not be that useful. (That’s not part of your book. That’s me just kind of thinking with my investor hat on.)

But let’s talk about… So, that’s one idea that you tested. And then there’s multiple other ones. Chapter three and chapter four were similar in that you’re kind of looking at, I guess what I would call, an over investment story. In the one case that you’re sort of looking, I think in particular, at infrastructure investment like railroads, and in another, you’re looking at building stock. And again, the idea is that you get, essentially, too much capital invested either in, like I said, in infrastructure or in buildings. And that leads, eventually, to a big correction. So, you get this kind of oscillation above and below trend. And tell us about why you wanted to test those ideas, why you thought they were important to test, and what you found.

[00:13:48] Tyler

One of the most common features of the boom/bust view of economic fluctuations is that there’s information in the height of an economic expansion that can tell you something about the probability and the depth of the subsequent recession. And so, height can be measured in different ways. One could be just a cumulative increase in, say, GDP, or consumption, or investment, or bank lending.

It can also be a physical measure. There are some who suggest that skyscraper records, new skyscraper height records tend to correlate with the onset of deep recessions. And so, I test, in these chapters, whether higher, faster, longer economic expansions precede deeper, faster, longer economic recessions. And the answer is no. There is simply nothing, no informational content in the height, speed or duration of an economic expansion that can tell you anything about the depth, speed, duration or even probability of the subsequent recession.

And that finding is consistent with an older model of economic fluctuations that contrasts to that oscillationist view you described, that economic fluctuations are not about an economy rising above trend or rising above potential, and then enduring the inevitable correction, the negative deviation that corrects for that. Rather, economic fluctuations are about an economy that’s growing pretty close to its potential, pretty close to its long run trend, and then it endures adverse shocks. It temporarily deviates from trend, negatively deviates from trend, and then recovers back to trend.

And so, while there’s nothing in the height, the speed or the duration of an economic expansion that can tell you anything about the depth, speed or duration of the subsequent recession, there is information in the depth and speed of a recession that can predict the height and speed of the subsequent recovery. So, as I put it, economic expansions adhere to Newton’s third law of motion, that to every action there’s an equal and opposite reaction, whereas economic recessions are perennial violators of Newton’s third law.

[00:16:10] Kevin

Yeah. And that seems to me, I mean, I think that, from my perspective, that was kind of one of the core takeaways from the book. I think you call it the pluck model versus the oscillation model. And essentially, if you’re trying to visualize it, you can imagine a long-term trend with occasional falls below and then catch up.

And it struck me that’s really, really important if that idea is true, because it suggests that the important things for government policy are, one, making sure that trend is as strong as it can be, number one, the long-term trend. Number two, don’t do anything to screw up the recovery back to the trend. Would you agree with that?

[00:17:04] Tyler

I would because at the end of the day, though it’s kind of odd for a book about recessions to conclude in this way. In the book, I conclude that at the end of the day, we probably ought to be at least as worried about economic expansions as we are about economic recessions. Because the majority of the years in which economies expand ultimately matters more for long run economic prosperity than the minority of years in which they contract. I mean, the UK has had many fewer recessions over the past 200 years in the United States, but the UK is also, and has long been, about 30% poorer.

And so, insofar as recessions are about adverse shocks that we could neither fully anticipate nor effectively hedge against, that probably ought to caution policymakers against presuming that they can medicate or otherwise sedate economic expansions that at the end of the day die healthy and innocent in the mistaken belief that doing so will prevent recession because recessions will continue to happen, because history will continue to happen.

[00:18:13] Kevin

Does that mean that you are not a believer in the Fed kind of adjusting interest rates and credit conditions based on its view of the economy that we should be, I don’t know, I mean, given what you’re saying, should monetary policy be almost programmatic or rule based in some way, not trying to adjust for a business cycle that you say really isn’t there?

[00:18:45] Tyler

I think there is a large literature that would support that conclusion. In terms of what I find in the book, I think it would suggest that maybe monetary policy doesn’t matter quite as much as we tend to think. Because if you think about all the institutional changes in monetary policy regimes over the past four centuries, what really is amazing is that, I find in the book, the depth and duration of recessions has been remarkably constant across time – remarkably constant across time going all the way back to 1700.

And while macroeconomic volatility within cycle, macroeconomic volatility for GDP, for consumption, for investment, for bank lending, has declined since 1945, it’s actually only declined to levels that prevailed before 1914. So, the real outlier was the incredibly Marshall period between 1914 and 1945.

[00:19:52] Kevin

That really surprised me that conclusion too, because I guess I had this notion that the economic cycle was quite volatile, especially when we didn’t have a central bank before 1913. I guess my read of economic history was that we had a lot more frequent recessions. But you’re saying that’s not the case, that economic volatility now is consistent with back then.

[00:20:20] Tyler

Well, great question. So, there are two things. One is, yes, the periods of positive growth were more volatile because you have a more agricultural economy and then a more manufacturing based economy. So, you have more volatility within the periods of positive growth. But within each succession of expansion and contraction, that volatility of negative and positive was statistically no greater before 1914 than post 1945.

In terms of recession frequency, yes, you are absolutely correct that recessions have become less frequent over time in both the United States and the United Kingdom. What’s interesting is that, statistically, there are no breakpoints at specific points in time, toward fewer recessions, toward longer-lived expansions. You can test for 1913 with the establishment of the Federal Reserve. You can test for 1946 with the establishment of the Beveridge reforms in the United Kingdom. And you cannot reject the null hypothesis of no trend break.

There’s possibly one exception, and that is 1785 in the United States, a break toward longer-lived US economic expansions. And you can think about some recent institutional changes that had happened just before 1785, as the United States left behind a lot of colonial era armed conflict.

[00:21:57] Kevin

Yeah, I want to come back to that point right there. I think essentially what you’re saying, if I’m right, is that there’s been a kind of a general long-term trend toward longer expansions and less volatility. And I want to come back to a potential explanation of that. But before that I did want to circle back to one other reason for oscillations, which you reject, but which I think is important enough that we should talk about.

So, you talk about infrastructure investment and building investment and there’s also just kind of credit growth. And there’s a famous book by Carmen Reinhart and Ken Rogoff, This Time Is Different, which you talk about in your book, where they say, hey, recoveries following financial crises are particularly slow. And I think the implication is that, hey, you have got to be careful to not allow the economy to get into a situation where you have a big financial crash.

And you kind of dispute that conclusion. You say there’s no real statistical evidence that that’s the case. And I note that Ken Rogoff also wrote you a nice note on your book jacket, so I assume he’s read that. But I’m curious, why are your results different? And tell us why they’re different and let’s start with that.

[00:23:36] Tyler

Yeah. So, first of all, when it comes to plucking, one of the variables I test is bank credit. And I find that the height and speed of the increase in bank credit and the volume of bank credit over the course of US and UK economic expansions does not explain variation in the depth or speed of the contraction in bank credit during the subsequent recession. Now that’s on average, I mean, statistical regression is about averages. So, there could be… there’s going to be a distribution there. So that’s one finding.

The other statistical test I conduct is to test whether the height or the speed of a recovery is slower from a recession if that recession was coincident with a financial crisis. And I measure financial crises in two ways. One, using just a binary indicator variable that was developed by my former Oxford colleague Stephen Broadberry and co-authors. So, they coded up all UK recessions as to whether they involved a financial crisis or not. And the other way I proxy for financial crisis is to just include the volume of the contraction in bank credit during that recession.

And in either case, I find that the speed of economic recoveries for the United Kingdom going all the way back to 1700 is no different if that recession involved a financial crisis or not. And then when it comes to the United States, it was actually research by a professor at Rutgers, Mike Bordo, who found, looking all the way back to the 1880s in the United States, that economic recoveries were no slower in the United States if a recession was coincident with a financial crisis.

So, how do I square that with the work of Reinhart and Rogoff for whom I have enormous respect? I think they’re looking at a broader set of countries. I’m looking at just the United States and the United Kingdom. And if one is looking at a broader set of countries, I think that there might be a lot of other correlates with why those countries were having economic recessions that were coincident with financial crises. And those other correlates could be correlated with the speed, the pace of the subsequent recoveries.

[00:26:12] Kevin

Have you talked to Ken Rogoff about your results versus his?

[00:26:17] Tyler

We have, yeah. And it’s still something we’re comparing notes on.

[00:26:29] Kevin

The other thing I think that people naturally would be interested in and you address is energy supply shocks. Energy, some people would argue is kind of like the fundamental currency of economics, right? We have to use energy to make stuff. And when there’s shocks to the availability and the price of that, it makes sense that would be a trigger of recessions. You looked at energy shocks going all the way back to when people were burning peat for home heating. You looked at coal, oil. What did you find in terms of the impact of energy supply shocks on recessions?

[00:27:11] Tyler

Great question. So, I should specify that the book and my remarks… the book was written entirely in my personal capacity. My remarks are entirely in my personal capacity. And actually, most of the research preceded me starting my current role. This result surprised me because I wasn’t familiar either with the frequency of energy supply shocks, particularly in the United States over the past century, in terms of oil. I mean, if you look back since 1945, oil shocks, they were major contributors to US recessions in 1948, ‘53, ‘57, ‘70, ‘73, ‘80, ‘81, ‘90, and underappreciated in 2001 and 2008.

But if you go back farther in time, then industrial action on both sides of the Atlantic in the essential coal industry was a perennial contributor to recessions. And then as you just noted, if you go even further back in time, adverse harvest shocks were effectively energy supply shocks because provender, animal feed, was the primary fuel for the primary source of ground transportation, namely animal draft power. And also, when you had adverse winter weather, in particular, in the United Kingdom, it would destroy the supply of peat. And peat was regularly combusted to provide not only residential heating, but also industrial power generation.

And I think this speaks to the fact that there are sort of two different types of shocks, of recessionary shocks. You can either have big macro shocks that affect all sectors of the economy roughly equally, roughly contemporaneously. So, for example, a pandemic. But at least as important, and actually I find in the book, even more important, are sector-specific shocks that maybe only directly impact one or two sectors, but those sectors have very high linkages to the rest of the economy. And over a near-term time horizon, so say 12 months, it’s just very difficult for households and businesses to find substitutes.

So that’s why energy has been a perennial contributor to recessions on both sides of the Atlantic. But if you go back farther in time, another example would be cotton harvest shocks.

[00:29:46] Kevin

And so, I mean, that also seemed to me to be a quite important conclusion to the book because you said right at the beginning that, hey, if you actually look at the correlation of recessions in the UK and the US, they’re not as correlated as one might expect, given that they’re two kind of open economies with very tight trade and financial linkages.

And it seemed to me that part of the reason was that the way… basically, if you think of economies as like portfolios that have different sector compositions, different stock compositions, basically shocks propagate their way through those economies in different ways. They’re insulated to different types of shocks. So that, I guess number one is that kind of correct?

Number two, does that make the job of, say, someone like you less about forecasting a recession and more about saying, hey, this is the kind of shock that we’re exposed to, as an economy, given its construction, and this is the kind of shock that we’re more insulated against?

[00:30:57] Tyler

Yeah. So, you touch upon two of the reasons why the United Kingdom was historically much less recession prone than the United States. Under the boom/bust view, one would think, well, maybe Brits are just less prone to mania and panic than are Americans. They’re more excitable counterparts here in the US. But really, the main reasons are really much more prosaic.

So, for one, since 1826, in the United Kingdom, you had a nationwide system of branch banking. And yes, if you think about a national economy, the economy of a big, widely diversified economy, akin to a large diversified portfolio, then weakness in one sector or one region can be offset by strength and resilience in other sectors and other regions.

In contrast, for most of US history, right up until the 1980s, not only could you not operate a bank across state lines, you couldn’t even operate more than one bank branch within a state. And what that meant was that we had tens of thousands of tiny, undercapitalized, under diversified financial institutions that would amplify and propagate adverse shocks when they would occur.

The second reason that the United Kingdom was historically less recession prone than the United States was that a lot of the post-World War II US recessions, as I noted earlier, were oil related. ‘48, ‘53, ‘57, ‘70. And during that time, up until the ‘73 recession, the UK economy was just much less impacted by oil shocks for the simple reason that they were still a very coal intensive economy. And for somewhat idiosyncratic historical reasons, they went from 1926 to 1972 without a single official coal strike. So, the United Kingdom emerged from a very severe post war recession in 1947. It wasn’t until 1973 that they had another recession.

[00:33:13] Kevin

Although that recession was extremely severe. Right? They had to go to the IMF for a bailout, if I remember correctly.

[00:33:24] Tyler

That was a nasty period. And I can’t remember the IMF bailout came during the recession or a little bit after, but certainly, yeah, very much related. And yes, they had to limit workdays. There was the Arab oil embargo and then there was a major coal strike. And the Prime Minister, Ted Heath, decided to call an election and the slogan of his campaign was Who Governs Britain? And the answer of the British electorate was not Ted Heath.

[00:34:00] Kevin

You got to be careful with those slogans.

Okay, so, I guess we mentioned this earlier that it does appear that the length between recessions maybe has gone up in the post-World War II era. But you say it’s really been more kind of a long-term trend across economies, a very long-term trend towards smoother economic growth.

And the natural thought that I had was, well, that’s because the government is much bigger and the government has the ability to spend when other sectors are saving. So, the classic kind of Keynesian offset. And so, it functions as a kind of, you call it a buffer. I like to think of it as like an insurance provider. And you kind of analyze that in a chapter that you call firefighters and arsonists.

And I think you were a little kind of skeptical of that view in the end that you didn’t really find that the government’s role was a big driver, and the reason that we’ve got these kinds of longer expansions, if I’m correct. If not, let me know, but tell me how you went and thought about that and tested those ideas.

[00:35:31] Tyler

Yeah, so, because that was one of my priors as well, that the intervention, the rise of a more interventionist countercyclical state, that we might expect to smooth fluctuations in economic activity over time. There are a number of testable hypotheses that this hypothesis would generate – that view would generate.

So, for one thing, we should expect trend breaks, at specific points in time, when there were discontinuous increases in the role of the state, the countercyclical role of the state. So, for example, during the 1930s, maybe during the 1960s with the Great Society, I noted in 1946 with the Beveridge reforms in the United Kingdom. But statistically there are no clear break points toward longer lived economic expansions on either side of the Atlantic.

And another thing that we would expect to observe would be that recession depth should have declined over time, and in particular over the past hundred years with the rise of a more interventionist state. But as I noted, recession depth has been remarkably constant over time. Statistically, it’s been no different since 1945 versus before. And if anything, UK recessions have actually been living longer since 1945 than before.

So, that’s the other one to test, not just depth but also the duration of recessions. So that, yeah, neither depth nor duration of recessions has been significantly different since 1945 versus before.

Now, I should note, is not an argument for inaction because, while it may be the case that economies, in the aggregate, recover from recessionary shocks, that doesn’t necessarily mean that every individual, every household does. And I make this point in the book. I think there’s a strong normative case to be made for the provision of relief where relief is needed. And, in my view, that’s where the income and employment loss is greatest.

And fortunately, we do now have infrastructure in place through unemployment insurance to target that relief where it is needed. And I think there’s a compelling case to be made for having higher replacement rates, for example, when in a high unemployment context. We saw that during the 2020 pandemic recession.

But yeah, though the rise of a more interventionist state does not appear to have affected the frequency of recessions nor their depth, nor their duration, that is not necessarily an argument for inaction.

[00:38:17] Kevin

Toward the end of the book you sort of go through an examination of, I guess, the notion that recessions are a cleansing of the rottenness of the system. Right? To go forward we need to get rid of the excesses of the past. Or if you’re going to be nerdier about it, do recessions serve a growth enhancing, reallocative purpose?

And I think a lot of people hold that view that there’s creative destruction, this notion that we kind of almost have to… we deserve a recession in some sense. And can you tell us about how you examined whether that was the case or not and why you concluded that wasn’t true?

[00:39:08] Tyler

Yeah. And so, I should begin by noting that I wanted it to be true.

[00:39:14] Kevin

Why did you want it to be true?

[00:39:16] Tyler

Because recessions are painful, they can be traumatic, they hurt a lot of people. So, one kind of wants to believe that at least it was for something. But what I find is that, while there is a large literature that demonstrates that so called creative destruction, I mean the movement of people and capital from less efficient to more efficient firms, often involving the failure of those less efficient enterprises, that view of creative destruction is important for long-term growth. However, I find that process is impaired rather than enhanced by recessions.

So, for example, I find that research and development is, I hate to use the word cyclical, but research and development is pro cyclical. So, it rises more during economic expansions, and then falls during economic recessions. Recessions are rampant age discriminators. They discriminate against younger workers. They discriminate against younger, often more dynamic firms.

Also, one thing I find in the book, and there’s a large literature supporting this, is that one of the key mechanisms by which people and capital resources move from less efficient enterprises to more efficient enterprises is by quitting one job and being hired by another job that’s a better match, that’s more productive. And that whole ladder, that whole productivity ladder just collapses during economic recessions. Because quitting plummets because no one dares to leave the job, and hiring plummets because firms don’t dare to take on new workers. And so, you usually have this period of poor quality employer/employee matches that follows during and immediate aftermath of a recession.

The other way I test this is to simply ask, well, okay, if there is reallocation that’s taking place, then we should expect to observe the allocation of people and output across sectors to look fundamentally different at the end of a recovery versus how it would have looked had the economy continued uninterrupted along long run trends. And what I find is that typically the economy, the allocation looks pretty darn similar to how it would have looked had it continued uninterrupted along trend.

[00:41:44] Kevin

Yeah, those were fascinating sections of the book. And the story about the inefficiency of the matching of jobs really resonated with me. I remember I was running my business back, right after the financial crisis, and we were looking to hire someone, and we thought it was a good job in kind of accounting, and we couldn’t get anyone. And a friend of mine who was a recruiter says, well, anyone who’s got a job right now is not leaving. So, the only people that you’re going to be able to interview are the people that you really wouldn’t want to hire. And then also your point that the firms that tend to go under in recessions are younger, arguably are the ones that have the potential to change that structure of the economy. Had they survived, maybe they would be able to take business away from an incumbent. So, it’s almost like the counter argument could be made that it leads to stagnation.

[00:42:44] Tyler

And also, often those younger firms, they don’t have physical capital that they can pledge as collateral. It’s hard for them to get a bank loan because they don’t have a long credit history. So, that’s why I say, yeah, recessions are often rampant age discriminators.

[00:43:03] Kevin

I want to… There are a couple semi-unrelated questions, but I thought we could talk about them as we kind of conclude here. But you’ve included the UK in your analysis. I know you’ve also studied there and worked there. And the pluck view of economic recessions, that you’re suggesting, fits the data. So, kind of a long-term trend, occasional recessions, deviate from the trend and then you go back to it. That has not really mapped onto what has happened in the UK post-2008.

There’s been a lot written about that. You can see graphs of the pre-2008 trend growth in the UK and we’ve never got back there. And so, my question is… Well, you actually offer quite an interesting explanation in the book, one that, honestly, I hadn’t heard before and I thought that made a lot of sense. But can you sort of talk about the UK’s experience and then maybe talk us through that explanation that you gave for why there hasn’t been that recovery?

[00:44:16] Tyler

Yeah, great, and great question. And it relates to what we were talking about earlier with respect to what are some of the implications for policymakers in terms of first doing no harm. So, you’re absolutely right that there was both a level effect for the UK economy during 2008, 2009 and a subsequent rate of change effect, that not only did the UK incur this drop in economic output, but then the subsequent rate of growth was slower than the pre-2008 trend. And this was one of the few exceptions to the overall pattern over the past three and a half centuries of plucking.

And the explanation I give in the book, and I’ve actually, outside the book, done some additional statistical econometric analysis of this, that after 2008, 2009, there was a policy regime change on both sides of the Atlantic in that we policymakers mandated that our economies produce with less of a critical input for which only over any economically meaningful time horizon is just very difficult for households and businesses to find substitutes, namely bank credit.

Now that had a much bigger impact, with liquidity coverage ratios, and supplemental leverage ratios, and additional tiered capital requirements, and stress testing, and all of these measures that effectively induced a substitution of lending to the public sector for lending to the private sector. Now this had a much bigger, more persistent impact in the United Kingdom than in the United States for two reasons. First, the United Kingdom was historically much more reliant on bank credit for external financing businesses, whereas in the United States we’ve always long had a robust ecosystem of venture capital, private equity, also, it’s still a legacy of those thousands of regional banks that engage in relationship lending.

But the second reason is the UK was always going to be more impacted by a persistent policy shock to banking. The second reason is that, for historical reasons, the United Kingdom has long had fewer banks that are on average bigger. And so, they were all more likely to be treated by the post-2009 policy regime. And so, I think it’s a reminder that no policy is without trade-offs.

[00:46:54] Kevin

Do you think that is… I mean, I can think of two explanations for that policy change. Number one, I think the obvious one is looking back and they’re like, well hey, the banks caused this. They were the over-leveraged, undercapitalized, under-regulated, etc. So, we’re going to tighten things up. That’s one.

The other one, maybe slightly more cynical, but I personally think longer-term is more important is governments are running huge deficits with no end in sight. And so, they need buyers of the debt. And so, it’s like, hey, let’s change the rules to basically, if not force banks to buy the debt, kind of force them by the back door. So, it’s almost a form of financial repression. Do you have a personal view on either of those explanations?

[00:47:51] Tyler

I think they’re both plausible. Whether it was deliberate or subconscious. I mean it did effectively resemble financial repression. I mean you’re forcing financial institutions to hold more of your sovereign debt. That looks an awful lot like how both the UK and the United States got out of high debt burdens after World War II.

But also, I think one thing that I find in the book is that these narratives, these very morally laden narratives about economic fluctuations set in quite early, whether it’s 1857, 1772, 1873, 1929 and 2008. The narrative, the parables of, there’s a villain, there are heroes. Ben Bernanke, Hank Paulson, Tim Geithner, describe themselves as firefighters. And then there’s resolution, because no economic recession has ever been infinitely lived, has never been immortal. So, they have all the essential ingredients of a parable.

But, as I also demonstrate in the book, typically the reality is more prosaic. So, the highest ever price of a barrel of oil or a gallon of gas was not during the Arab oil embargo of 1973, or the Iraqi invasion of Kuwait in 1990. It was in June 2008. In fact, the price of energy, overall, has never been higher in the United States since 1945 than it was in the summer of 2008 due to a number of coincident shocks to both energy supply and energy demand.

The result of which was that by summer of 2008, the average American household was having to spend $2,000 more per year on energy goods and services, and they’d been having to spend just a couple years prior. And when you think about it, typically about half of American households have no savings after tax. And these are not easy expenditures on which to economize.

You’re talking commuting to work, dropping your kids off at school, heating and cooling your home, putting food on the table, because food is a very energy-intensive commodity product. So, in that context, under those constraints, by summer 2008, about 5% of American homeowners were seriously delinquent on their mortgage. And the rest, as they say, is history.

[00:50:18] Kevin

Yeah, and that’s a narrative that is not quite forgotten, but close to being forgotten. And I remember that very well. There’s this notion of peak oil, that the world was running out and prices might get to $200 a barrel or even more.

In the end, I think you kind of say, well, we should probably imagine ourselves as enrolled in a kind of negative economic lottery, which, in other words, if you imagine rolling a series of dice and if enough of the dice come up, recession or shock (I suppose is a better way to put it), then you’re going to have recession. And you say that feels a bit disheartening because there’s no… it is a random process. But you say, on the other hand, we have to remember that a lot of those dice have to come up red for us really to hit recession. The economy is actually remarkably robust. It’s not just a shock. You need multiple shocks hitting at the same time and probably of a different nature.

[00:51:32] Tyler

Yeah, so, one of the starkest ironies that I encountered when researching the book was that while all these eminent Western European and American economists, in the 1920s and 1930s, were trying to develop theories of the endogenous or self-generating business cycle, it was actually a Soviet economist in Moscow, Eugen Slutsky, who took a bunch of old Imperial Russian lottery tickets and created a moving sum series of the numbers in the lottery tickets. And that series mapped almost perfectly onto an index of British business conditions over a near half century period.

And what that demonstrated was that the summation of chance or random causes can generate what looks like cyclical behavior, even though the underlying data generating process is in fact random. Now, that doesn’t mean that we should just throw our hands up in desperation or in frustration that recessions are unforecastable and unpredictable, which I demonstrate in the book, that recessions are unforecastable and unpredictable, but what we can do is look at, as you know, the kinds of shocks that historically contributed to recessions. And to think about, okay, well, conditional on what I’ve seen in recent months or recent quarters, would I raise or lower the unconditional probability?

So, in the past century there’s been about, in any given year there’s been about a 1 in 100 chance of pandemic related recession. In any given year, in the United States, there’s been about a 1 in 10 chance of an energy related recession, although that probability has been going down. And in any given year there’s been about a 1 in 50 chance of a credit controls related recession. And so, you can subjectively ask yourself, okay, conditional on what I’ve just observed, do I think the probability in the next year is going to be higher or lower than that unconditional probability?

And then in terms of your observation about being enrolled in this negative lottery, which can be kind of depressing, but I actually end on the optimistic finding that we talked about earlier, which is that we’ve been getting better as households, as businesses, as investors, we’ve been getting better at absorbing the kinds of shocks that historically tended to generate recessions. And I think a lot of that is diversification. So, our banking systems, generally, are more diversified than they were previously in earlier periods. And our energy systems are more diversified, both across fuels and within fuels. And this is a long process that, as I note, has been going on since 1700 and I’m sure before.

[00:54:39] Kevin

Yeah, I don’t know if you’re familiar with Nassim Taleb’s first book, which was called Fooled by Randomness, but your book reminded me a lot of that because his basic idea was, hey, we’re programmed to see patterns and sequences that are random. And it was very statistically focused. And yours is, it’s a different book but essentially the underlying theme is similar. Right?

There’s this randomness that we have this kind of need to assign a narrative to and we might be better off, or we would be better off just appreciating some of the key findings you talked about. Focus on long-term economic growth, focus on not screwing up the rebound and in making the economy as robust as it can to absorb as many shocks as it can.

I’m going to ask you a potentially unfair question to end it up. But since you mentioned that, maybe what economists should be focusing on now is kind of looking at what shocks have hit the economy and what that says for their ability to withstand future shocks. I mean, if we look at the US economy now, we have had some shocks in the last 18 months. We’ve had the imposition of tariffs, although that’s changed up and down. We’ve had the oil shock with the Iran war. What does that tell you about the types of shocks that might be particularly dangerous now given what we’ve just experienced in the last 18 months? Or do you find that those shocks, maybe, aren’t that meaningful? I mean, how are you thinking about it?

[00:56:20] Tyler

So, I was concerned at the start of the Iran conflict because it seemed, to me, reminiscent of the 1973 recession, during the Arab oil embargo, in the sense that there were physical barrels and physical cubic feet that were not flowing into global markets. And if the conflict were to have persisted at the intensity of say, March, April, it’s hard for me to see the global economy or the US economy not having incurred recession.

But I think, also, we learned over the past few months the differences between 2026 and 1973. So, a dollar of economic output is, today, much less energy-intensive generally, and oil-intensive specifically, than it was in 1973. Non-core OPEC supply is both greater as a share of the global market and also it’s more elastic, it’s more responsive. We also have a more diverse energy stack into 2026 than in 1973. And we also learned lessons from the 1970s.

And so, across most advanced economies, we maintain strategic petroleum reserves as sort of a hedge against these kinds of supply disruptions. So, there are similarities, but also some key differences, which is why I think we’ve seen a lot of resilience over the past few months. In terms of potential shocks that the book has led me to consider, that maybe others aren’t as concerned about, but probably should be, I found that a lot of recessions are related to sector-specific shocks, to specific sectors that are both highly linked to the rest of the economy and that the output of which is difficult for households and businesses to find substitutes.

So, right now we have on hold the threat of imposition of export restrictions on rare earth elements from the People’s Republic of China. I mean, that’s currently deferred until the autumn. But that’s the kind of shock that reminds me of some of the past energy supply shocks, or some steel shocks, or cotton, on these essential products, the supply disruption of which can really have spillover effects into other parts of the economy.

[00:59:03] Kevin

Great. Well, I appreciate the thoughts on the current situation and very much appreciate you writing the book and taking the time to come and talk to us about it on the show. So, Tyler, thanks so much for your time today and thanks for joining us.

[00:59:21] Tyler

Thanks for having me on, Kevin, great talking with you.

[00:59:24] Kevin

Okay. The book is called Recession: The Real Reasons Economies Shrink and What to Do About It. And it’s full of fascinating stories, great graphics, data. I guarantee we’ve only just scratched the surface, so please make sure you go out and get a copy and follow Tyler’s work because I think you can tell from today’s conversation many of these ideas are not being discussed on mainstream media. So, for all of us here at Top Traders Unplugged, thanks for listening and we’ll see you next time.

[00:59:55] Ending

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