Fischer Black and the business cycle

 

"Fluctuations in the match between resources and wants across many sectors create major fluctuations in output and unemployment, because moving resources from one sector to another is costly. Fluctuations in the demand for the services of durable goods causes much larger fluctuations in the output of durables, and causes unemployment that takes the form of temporary layoffs."

-Fisher Black 

Fischer Black focused on a general equilibrium business cycle long before other economists. As an academic and business practitioner, it is relevant to think about his model of the business cycle today in the context of disequilibrium across sectors. There are three potential sources of slowdown in the current economy: 

1. The pandemic 

2. Inflation 

3. Interest rates 

Each of these factors are causing disruptions which will play-out through a dislocation in labor, production, and purchases. During the GFC, the sector disruptions between housing and banking were significant. The current disruptions are not as strong and not as focused. The reason for the delay in this adjustment process is the strong fiscal and monetary policy already applied during the pandemic which has cushioned the downward shock. 

The impact of the pandemic is being felt now in the technology sector. Over investment in technology associated with being shut-in is being reassessed and layoffs are occurring. The reason it has not shown in the data is that these companies are not very labor intensive. We are seeing adjustments in the delivery sector as less is being purchased on-line. Additionally, switches into green markets are creating churn with traditional sectors. 

Inflation is causing disequilibrium across sectors because of pricing distortions. Purchasing mistakes are being made. Real wealth is being adjusted which changes purchasing patterns and generates further economic churn.

The rise in interest rates is creating distortion across markets sectors. Clearly, the housing sector has been hit hard. The IPO market has also been hit given the cost of capital has increased. Higher rates are reducing the reach for yield. 

So why has there not been a recession? The disequilibrium adjustments are taking time, against a background of government fiscal and monetary support. 

The important takeaway from a Fischer Black view of the world is that the focus must be on distortion in the economy across sectors. The sum of distortions leads to an aggregate slowdown, but there is a lot of potential opportunities focusing on the disaggregated effect of the economy. Government policies can slow the impact from disequilibrium economics, but it cannot eliminate it. Watch for growing sector distortions as a driver for aggregate distortions.