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I SSUE 5SEPTEMBER/OCTOBER 1997 thwe u s o tt ss

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bank of dallas ROLLING RsECESSIONS EGIONAL ECONOMIES ARE growing across the nation, lead- ing some to observe that this shared national expansion differs considerably from the traditional seesaw of regional downturns and upswings. However, this perception about the past is based on the relatively recent experience of the R 1980s and early 1990s, in which some regions contracted while others expanded. Before then, regional economies tended to move together. What contributed to this out-of-sync behavior? Does the situation differ today? A continuation of this pattern of regional disparities could have significant implications for the national . Just as the nation is composed of regions, the national business cycle can be thought of as the sum of regional business cycles. If parts of the nation expand while others contract, the nation as a whole may have INSIDE less severe and less volatile business cycles. The current U.S. expansion, along with the expansion of the 1980s, has been ex- Is the Fed Slave to a ceptionally long, far exceeding the four-year average for post–World Defunct Economist? War II expansions. One contributor to this phenomenon may be diverging regional business cycles. Corporate Financing Many factors can cause regional business cycles to differ. For ex- And Governance: ample, national shocks may affect regions differently, due to differ- An International Perspective ing tax and regulatory environments or combinations of labor and capital. Regional cycles are also influ- Chart 1 economic activity as gross domestic enced by shocks specific to the region, Cyclical Components of Real product or the unemployment rate. At such as droughts or regional regulatory Personal Income of 12 Federal the state or Federal Reserve district changes. Reserve Districts, 1953–91 level, a narrower range of indicators is One particular explanation for di- Percent available, such as personal income and verging regional cycles gained promi- 10 employment. nence in the 1980s—“rolling recessions.” 8 The cyclical components of personal

Analysts coined this term to describe a 6 income in the 12 Federal Reserve dis- phenomenon in which some industries 4 tricts are shown in Chart 1. The picture experienced downturns in reaction to 2 reveals that the cyclical components of shocks, or changes in the national econ- personal income tend to move together, 0 omy, while others continued to do well. increasing and decreasing at about the –2 These rolling recessions may have led same time, although not perfectly and –4 to divergent regional cycles as regions not at all times. To the extent the cycles –6 with varying output mixes reacted dif- ’53 ’57 ’61 ’65 ’69 ’73 ’77 ’81 ’85 ’89 are similar, this suggests that regional ferently to each industry downturn. San Francisco St. Louis Cleveland cycles are responses to changes in the While industry downturns may have Dallas Chicago Philadelphia national economy, rather than region- Kansas City Atlanta New York influenced the regional economic differ- Minneapolis Richmond Boston specific changes. As can be seen in ences of the 1980s and early 1990s, Chart 1, the degree of correlation of other factors were also at work, such as economic activity among the 12 Federal differences in taxes, local construction Reserve districts was strongest for the cycles and labor costs. These factors a decade or more. For example, over a cycle associated with the run-up to the may become relatively more important long period, employment numbers will oil price of 1974. in future regional differences, as in- trend upward with a growing popula- During the 1980s, however, there creasingly similar regional output mixes tion. Elimination of both the short-term were signs that the districts’ cycles were should lead to more similar responses ups and downs and the long-term becoming less synchronized, to a de- to industry shocks. trends leaves the cyclical components, gree not seen in earlier postwar which show where the economy is decades. While there were a few years relative to where it would be if it grew before the 1980s in which some regions Business Cycles at a nice, steady pace over the years. diverged, the disparities were not as There are a number of ways to pronounced or as frequent. Chart 2 There are two basic ways of looking divide the nation for the purpose of shows the same pattern for employ- at the business cycle. The one underly- studying regional cycles, such as at the ment. It is difficult to say how close the ing most media discussion focuses on state or census-region level. One inter- regional cycles are today. While regions absolute increases and decreases in eco- esting approach is to look at regions across the country are growing in terms nomic activity. For example, an increase that form or encompass clusters of eco- in many indicators, such as employment nomic activity, which was the basis for and gross domestic product, over many how the country was divided when the months is considered an expansion. Federal Reserve districts were deline- Chart 2 Cyclical Components of Conversely, a decline in these indicators ated in 1913. One might expect to find, Nonfarm Employment over many months is regarded as a con- within each area of concentrated eco- Of 12 Federal Reserve traction. nomic activity, a common business Districts, 1953–93

An alternative definition of the busi- cycle that could differ from that of Percent ness cycle, which this article uses, is another location. Although the econ- 4 grounded not in terms of absolute omy has evolved since 1913, this divi- 3 increases and decreases in economic sion seems reasonable for an analysis of 2 activity but in terms of fluctuations regional business cycles. around a trend. When economists look 1 at economic indicators, they first ex- 0 clude the seasonal patterns, such as the Do Regional Cycles Just Reflect –1 increase in holiday retail sales, to get a –2 more accurate picture of how the econ- National Industry Cycles? –3 omy is doing relative to other times of –4 ’53 ’57 ’61 ’65 ’69 ’73 ’77 ’81 ’85 ’89 ’93 the year. When looking at business As already noted, one can think of San Francisco St. Louis Cleveland cycles, economists go a step further, the business cycle in terms of fluctua- Dallas Chicago Philadelphia eliminating not only these short-term tions in economic activity around the Kansas City Atlanta New York Minneapolis Richmond Boston changes but also the trends—changes trend. At the national level, economists that occur over a long horizon, such as typically focus on such indicators of

Page 2 Southwest Economy September/October 1997 of absolute measures, they may still dif- Chart 3 before the 1980s, such as the oil price fer in terms of movement around their Cyclical Components of changes and defense cuts of the 1970s, trends. Unfortunately, the econometric Real Personal Income were not accompanied by widely vary- techniques used to obtain cyclical com- Of the Dallas and Boston ing regional responses, in spite of a ponents do not allow reliable estimates Districts, 1980–91 greater degree of regional industry con- for more recent years. Percent centration. The cause of this increased The divergence in regional cycles in 3 responsiveness to industry shocks in the 4 the 1980s may have been caused by a 2 Boston 1980s is still unknown. series of changes in the national econ- 1 omy that had varying effects on regions 0 due to their differing regional output –1 Other Regional Influences Dallas mixes. This is consistent with the notion –2 of rolling recessions—different indus- –3 The series of national shocks to tries experiencing downturns at differ- –4 the manufacturing, energy and defense ent times—that permeated U.S. policy industries is clearly reflected in move- –5 discussions in the 1980s. For example, a ’80 ’81 ’82 ’83 ’84 ’85 ’86 ’87 ’88 ’89 ’90 ’91 ments in Federal Reserve districts’ per- manufacturing downturn hit the Mid- sonal income and employment. Regions west in the early 1980s. Then the oil responded differently to these shocks price drop of 1986 hurt the oil patch, because they had differing degrees of and defense cuts stung California and defense spending caused the defense dependence on these industries. How- New England in the early 1990s. In industry to decline. This national shock ever, other region-specific factors also addition, these downturns caused some was clearly a source of weakness for influence regional cycles. migration of workers, which in turn New England and some other areas of For example, a change in federal tax helped fuel other regions’ expansions, the country, such as California. Dallas laws affects states differently, depending such as those of Texas and California in Fed economist Lori Taylor studied em- on state tax structure. States may choose the early 1980s. ployment sensitivity to defense spend- from a variety of levies to raise revenue, Studies of rolling recessions’ effect ing by state, based on each state’s such as sales, income, property and busi- on regional economies in the 1980s industrial mix and each industry’s sensi- ness taxes. Since some of these taxes centered on absolute increases or de- tivity to defense spending.1 She found are not deductible against federal in- creases in regional indicators such as that Connecticut was the most defense- come taxes, sensitivity to changes in employment, gross state product or sensitive state because of its high con- federal income taxes will depend on personal income. However, looking at centration of transportation equipment the state tax structure. In addition, these fluctuations around the trend, the same manufacturing, particularly shipbuilding. differences in taxes, or in government patterns appear. In 1985, personal in- For example, as Chart 4 shows, trans- services and quality of life, can lead come in the Midwestern districts de- portation equipment manufacturing fell to various combinations of labor and creased toward their trends with the much further than the national average capital across regions. Differing capital– decline of the manufacturing sector, in states with a high concentration of labor mixes in turn contribute to vary- while personal income in the Dallas defense-related transportation manufac- ing regional responses to national and Kansas City districts continued to turing, such as Connecticut and Cali- shocks, such as changes in minimum increase. This decline in certain national fornia. In addition to Connecticut, other wage laws or capital gains taxation.5 manufacturing industries affected the New England states had above-average Midwest to a greater extent because sensitivities, due in part to high concen- of the region’s larger concentration of trations of electronics manufacturing. Chart 4 these industries. If these rolling recessions were to Change in Transportation The following year, the oil industry recur, the regional responses might be Equipment Manufacturing plummeted with the oil price shock less disparate since there is evidence Employment, 1988–93 of 1986. Oil price changes, although that over the decades regions have be- Percent national shocks, affect the cycles of come more similar in terms of industry 0 2 energy-producing and energy-consuming mix. For example, Dallas Fed econ- –5 regions differently. In 1986, when oil omists Steve Brown and Mine Yücel –10 prices dropped by half, Texas’ personal found that because state economies are –15 income plunged below trend. But while becoming more similar in their compo- the oil price drop had a large negative sition, the variation across states in the –20 impact on the Texas economy, it response to changing oil prices is nar- –25 3 spurred growth in other parts of the rowing. However, industry mix does –30 country, such as New England, as en- not seem to be the only determinant of –35 ergy costs fell (Chart 3 ). regional response to an industry down- California Connecticut A few years later, cuts in national turn. The industry shocks that occurred

Federal Reserve Bank of Dallas Page 3 Implications for the Economic and Monetary Union Conclusion Business cycles at the Federal Reserve district level may shed light on what Europeans The concept of the rolling can expect under the Economic and Monetary Union (EMU), scheduled to go into effect January 1, 1999.1 In discussions of EMU’s likely implications for Europe, the United States emerged in the 1980s in response to is often cited as an example of an enduring monetary union, while the U.S. central bank, shocks in the economy that affected the Federal Reserve, is cited as a model of how a central bank would function in a mone- some industries more than others. By tary union. Thus, at least in principle, the business-cycle experience of the U.S. regions extension, the downturns in these in- holds useful lessons for what Europe can expect under EMU. Dallas Fed economists Mark Wynne and Jahyeong Koo found a greater similarity among dustries, in combination with other eco- Federal Reserve district business cycles than among those of prospective EMU members. nomic influences, affected some regions Insofar as the United States can be a model of what might occur in Europe with a credible more than others, causing some areas monetary union, these patterns suggest the possibility of greater synchronization of busi- of the country to experience slowing of ness cycles across EMU countries than has been the case in the past. However, important differences remain between the Federal Reserve System and EMU, such as the degree to their economies while others saw their which each region or EMU country can influence economic policy. Policy differences, such economies expand. Whether the diver- as those that affect the cost of doing business, influence economic activity within the United gence of the 1980s represents just a States. The policy differences between the EMU countries are likely to be even more temporary phenomenon unlikely to be important than those of regions with much less autonomy. repeated or a fundamental change in the 1 Mark A. Wynne and Jahyeong Koo, “Business Cycles Under Monetary Union: EU and U.S. Business characteristics of the national economy Cycles Compared,” Federal Reserve Bank of Dallas Working Paper no. 7, 1997. cannot be determined without further study and a longer period of observa- tion. Therefore, it is too soon to tell if the The construction sector, although in- while the U.S. economy and oil prices regional business cycles are currently in fluenced by national factors such as had the largest effect, the construction sync or not. and tax law changes, also sector also had a significant impact. — Sheila Dolmas responds to local characteristics. For Another example of region-specific Mark A. Wynne instance, changes in a region’s industry influences can be found in New Eng- Jahyeong Koo mix or demographic characteristics may land’s late-1980s downturn. Although trigger a change in construction activity. defense cuts and nationally declining This response to local characteristics manufacturing industries certainly con- may lead construction activity to diverge tributed to the downturn, a loss of s from economic activity that is more de- market share to competitors in other Notes pendent on national demand. For ex- regions was also to blame. Edward ample, in the 1980s, both New England Moskovitch, in a Boston Fed article, re- 1 Lori Taylor in Defense Spending & , James A. and Texas experienced construction ported that a wide range of durable Payne and Anandi P. Sahu, editors (Oxford: Westview Press, 1993), pp. 203 – 20. booms as other parts of their economies goods industries lost market share in 2 Sukkoo Kim, “Expansion of Markets and the Geographic Distribution 8 slowed. Although oil prices fell in 1982 the mid-1980s. Moskovitch cited the of Economic Activities: The Trends in U.S. Regional Manufacturing and the Texas economy slowed, Texas high cost of doing business in the re- Structure, 1860–1987,” Quarterly Journal of Economics 110 construction activity surged throughout gion, compared with other regions, as (November 1995): pp. 881– 908. 3 the mid-1980s. This boom was due in the reason for the decline across so Stephen P. A. Brown and Mine K. Yücel, “Energy Prices and State Economic Performance,” Federal Reserve Bank of Dallas Economic part to Texas banking institutions’ in- many New England industries. Thus, Review, Second Quarter, 1995, pp. 13–23. creased interest in real estate invest- New England’s downturn was fed by 4 There are many opinions about why the 1980s were different. Some ments following losses in energy-related local characteristics as well as national speculate that the Federal Reserve adopted a more forward-looking, lending and Texas thrifts’ ability to fund influences. low policy in the early 1980s. See Ken Emery and Nathan commercial construction projects fol- However, regional factors that greatly Balke, “Inflation and Monetary Restraint: Too Little, Too Late? ” Fed- eral Reserve Bank of Dallas Southwest Economy, Issue 1, 1995, lowing deregulation. Similarly, in the influenced regional economies in the pp. 3–5, for a description of how monetary policy may have changed mid-1980s, New England construction past may not be as important in the course. Such a policy change could potentially influence regional thrived, largely because of strong de- future. Some of these regional charac- business cycles as well. mand from locally oriented industries, teristics may be changing, possibly be- 5 See Lori Taylor and Mine Yücel, “The Policy Sensitivity of Industries masking employment declines in the coming more alike across regions, as and Regions,” Federal Reserve Bank of Dallas Working Paper no. 12, 1996. region’s export-related manufacturing lower transportation costs, better com- 6 For more detail, see Lynne E. Browne, “Why New England Went 6 sector. munications options, and access to the Way of Texas Rather than California,” New England Economic This out-of-sync behavior within the national and international capital mar- Review, January/February 1992, pp. 23 – 41. Texas and New England economies led kets allow firms to locate in places not 7 D’Ann Petersen, Keith Phillips and Mine Yücel, “The Texas Con- Dallas Fed economists to study the in- previously considered. On the other struction Sector: The Tail that Wagged the Dog,” Federal Reserve Bank of Dallas Economic Review, Second Quarter, 1994, pp. 23–33. fluences of the construction sector, oil hand, this may just mean that other 8 Edward Moskovitch, “The Downturn in the New England Economy: prices and the national business cycle characteristics, such as local taxes or What Lies Behind It?” New England Economic Review, July/August on the Texas business cycle of the late quality of life, will become more impor- 1990, pp. 53 – 65. 1970s and 1980s.7 They found that tant influences on business formation.

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