Goldman Finds Most Modern Recessions Were Caused By The Fed

One week ago, Deutsche Bank issued a loud warning that as a result of the aging of the current economic expansion, now the third longest in history at 32 quarters, if with the lowest average growth rate of just 2%...

.... coupled with the collapse in the yield curve...

... and the risk that the Fed could fall behind the inflationary curve as a result of near record low unemployment (assuming the Phillips urve still works which it doesn't)...

... the risk is growing that the Fed could hike rates right into a recession that it itself causes:

... which makes sense: recall BofA's chart from earlier this year which showed that every tightening episode usually ends with a financial "event."


Overnight, it was Goldman' turn to scare its clients with an extended analysis of when and under what conditions the next recession could strike, and as Hatzius and co write in "s economic team write in The Next Recession: Lessons from History, "with the current expansion already the third longest in US history, investors have begun to look ahead to the next recession. We ask how likely the next recession is to come soon and where it is likely to come from....

While some frequent contributors to postwar recessions such as oil shocks look less threatening today, others such as declines in financial asset prices, sentiment-driven investment swings, and too-rapid tightening of monetary policy retain their relevance as recession risks. Combining lessons from this historical investigation, our cross-country recession model, and both our own research and academic research on US-specific leading indicators, we then develop a recession risk dashboard. The dashboard reinforces our view that recession risk remains only moderate.

While the answer to the first part remains elusive, and to Goldman it is still relatively low, the answer for the second part is clear: in the post WW2, virtually every recession (and depression) was caused by the Fed.

Goldman starts with a historical overview of the causes of recessions. Looking at 33 US recessions since the 1850s, it finds that while many pre-WW2 recessions originated in the financial sector, most post-WW2 recessions were caused by monetary policy tightening and oil shocks and, and sentiment-driven swings in borrowing and investment led to recessions in both eras. A similar IMF study of the key contributors to 122 advanced economy recessions shows that even before 2008, financial crises were a fairly common source of modern recessions too.

Here is what Goldman found:

A Historical Look at the Causes of Recessions


A starting point in understanding past recessions is to simply look at the contributions of the various components of GDP during prior downturns. Exhibit 1 shows the cumulative growth contributions over all quarters included in the NBER-defined recessions since the introduction of the national accounts. The main lesson is a familiar one: while consumption has declined more often than not in recessions, investment spending—including inventories, business fixed investment, and housing—has accounted for the largest contributions to declines in output. This same stylized fact holds for a broad international sample of advanced economy recession.


Exhibit 1: Investment Usually Dominates Output Declines During Recessions


We turn next to classifying the most important causes of prior downturns to create a taxonomy of recessions. To expand our sample, we study all prior US recessions as defined by an NBER database that includes 33 business cycles back to 1854, shown in Exhibit 2. Of the 33, 21 occurred before World War 2, when the US economy was much more frequently in recession, and 12 have occurred since.


Exhibit 2: The US Economy Has Spent Much Less Time in Recession Since WW2


Relying on several historical sources, we identify the key contributors to each recession. Exhibit 3 summarizes our findings. We draw four lessons.


  1. First, the most frequent contributors to modern recessions have been monetary policy tightening and oil price shocks, with the former in response to inflation that often gained momentum from the latter.
  2. Second, sentiment-driven swings between over-borrowing and heavy investment followed by deleveraging and investment cutbacks contributed to the two most recent recessions and also played a role in early recessions, especially during boom-and-bust cycles of railroad investment.
  3. Third, while the financial sector has not been the origin of as many modern US recessions, it was a very frequent source of early US recessions.
  4. Fourth, fiscal policy shocks have sparked US recessions, but only in the context of demobilizations from major wars.

Exhibit 3: Major Contributors to Early and Modern US Recessions

With all that in mind, what does Goldman's model say about probability of recession today? According to the bank's preferred tool for answering this question, its cross-country recession model shown in Exhibit 7, while recession risk has risen, primarily due to the decline in spare capacity in the US economy. recession risk remains only moderate at about 13% on a 1-year horizon (compared to an unconditional probability of 23% since 1980) and 24% on a 2-year horizon (compared to an unconditional probability of 34%). 

Exhibit 7: US Recession Risk Has Risen, but Remains Only Moderate

Of course, if Goldman is right, the current expansion, already the third longest, will surpass the 1961-1969 expansion as the second longest in history, and take aim at the 1991-2001, the last real economic cycle the US had before the Fed started inflating bubbles to "deal" with the consequences of previous burst bubbles.

Goldman's conclusion:

Both our cross-country recession model and our US recession risk dashboard suggest that near-term recession risk remains only moderate. But when the next recession does come, where will it come from? Our historical analysis offers three main lessons.  

  • First, the dominant cause of postwar US recessions—monetary policy tightening in response to high inflation often boosted by oil shocks—looks much less threatening in a world with well-anchored inflation expectations and shale-imposed limits on oil prices.
  • Second, this does not mean that over-tightening is not a risk; tightening cycles in the late 1950s were quite tame, but nonetheless ended in recession.
  • Third, the more timeless drivers of the business cycle—the sentiment-driven swings in both financial asset prices and borrowing and investment that are often attributed to “animal spirits”—retain their relevance as recession risks.

So while the Fed clearly has been the driver behind most modern recessions, the irony will be if the US economy is already contracting - as commercial loan data suggest - just as the Fed not only tightens but begins to shrink its balance sheet, a combination that would resut in such a massive expansion in the Fed's reserves (as QE4, 5 and so on are unleashed) some time in 2018, it will make everyone's head spin.


Lonesome Crow Doom and Dust Sat, 06/24/2017 - 10:35 Permalink

The overwhelming context here is that the Fed causes problems only by raising rates. The insinuation is that the "inflationary curve" is somehow a natural element foreign and mysterious to the Fed which it must constantly battle. This is absurd, as if the giant squid must wrestle its own tentacles.

Only buried near the bottom, as is typical of cheerleading pieces instead of frontloading the key principle and relentlessly turning on it, is an intimation that the Fed causes expansions. These "expansions," if problematic, are then affectionately referred to as bubbles; something cute, soft, bouncy, playful, and innocuous. Really? And in someway the principle has suddenly become more pronounced when the Fed has become so problematic that it is wrestling against itself too much? Has the Fed only just become a monster lately because it is calling to arms new weapons or has it always been a monster and just acting according to its own nature?

One would expect this art of attacking the symptoms while condoning the cause of a Goldman, but of ZH? Come on, ZH! Don't go the way of the MSM. Stay true to your manifesto and maybe the mainstream will come to you. If not, it is no small thing to say at least you were true to your principles; especially since your stated principles are true:

"our mission:
— to widen the scope of financial, economic and political information available to the professional investing public.
— to skeptically examine and, where necessary, attack the flaccid institution that financial journalism has become.
— to liberate oppressed knowledge.
— to provide analysis uninhibited by political constraint.
— to facilitate information's unending quest for freedom."

In reply to by Doom and Dust

Manthong Truther Sat, 06/24/2017 - 09:30 Permalink

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Hilarious… I was about to post this: No Shit, GS Sherlock.

In reply to by Truther

DangerClams rejected Sat, 06/24/2017 - 09:09 Permalink

Well, that's nice and easy to assume, but flat-out wrong.  The United States is first in the world in charitable donations, and gives more in charitable donations annually than #2-#4 combined.Secondly, the fact that people will pay much more money for things that are easily substituted, like say, coffee, pops your wee hate balloon rather spectacularly.But feel free to make wrong assumptions while you go about your day buying the most expensive things even though you could get by with something less, which makes you the smarter animal.

In reply to by rejected

brushhog Sat, 06/24/2017 - 08:57 Permalink

It always made sense to me that prices should be a result of supply and demand. Interest rates are the price of money over time. If you tinker with the price of money, you are tinkering with the price of all goods and services across the entire economy.

Sudden Debt Sat, 06/24/2017 - 08:58 Permalink

The fact that Goldman sits on the board of the FED makes all this stuff worthless.All it says is : don't worry, we're a long way off of a recession.

D3vildog Sat, 06/24/2017 - 09:00 Permalink

This was predicted from the start:

Congressman Lindbergh: Articles of Impeachment Against Federal Reserve

Lindbergh: Articles of Impeachment Against Federal Reserve

This Act establishes the most gigantic trust on earth. When the President signs this Act the invisible government by the Money Power, proven to exist by the Money Trust Investigation, will be legalized. The new law will create inflation whenever the trusts want inflation. From now on depressions will be scientifically created.” – Congressman Charles A. Lindbergh, Sr., 1913, on the Federal Reserve Act Charles Lindbergh Sr. – Congressional record – Feb 12, 1917

Greed is King Sat, 06/24/2017 - 09:12 Permalink

We`re already in a recession, but it`s not being admitted, and it`s why the Fed, the B.O.E and E.C.B are desperately printing money and manipulationg the markets trying to prop up the crumbling financial edifice, and it`s also why the American Establishment are desperately trying to start WW3 to divert attention from it and hopefully if they`re successful bring about a financial reset, I.E the money you owe to the enemy is wrote off, and sovereign debt is cancelled due to martial law. So far Putin has managed to dodge the blows, despite all the prodding and poking he has not reacted in anger, long may he continue, at least until the financial collapse.The great depression of the 1930`s will be nothing compared to the depression that will engulf the global economy soon, but every cloud has a silver lining; in the 1930`s the crash was caused by the bankers, and what did the bankers then do to the millions of people who through no fault of their own found themselves penniless and unable to pay the mortgage ?, the banks foreclosed on them and made them homeless !. Why did the people put up with this treatment ?, who knows, probably because they did`nt know where the cause of the crash lay, but, and here`s the silver lining of this particular storm cloud, we do this time though, don`t we.

Doom and Dust Sat, 06/24/2017 - 09:13 Permalink

Their first trick was Christianity - it destroyed the Western Roman Empire.Their second trick was Islam - it destroyed the Eastern Roman Empire, the Persian Sassanid empire and the Hindu Civilization.Their third trick was Communism - it destroyed the Russian Empire.Their fourth trick was Central Banking - it destroyed the British-American empire."We have ALWAYS been at war with Indo-Europeans"

GRDguy Doom and Dust Sat, 06/24/2017 - 10:13 Permalink

Abraham was the first documented financial sociopath.The Abrahamic religions are the excuse for a few sheep to control many sheep.That's why Elie Wiesel wrote "The Trial of God" and found god guilty.He couldn't deal with the real fact that Abraham was guilty.Abraham lied and was guilty, not god.There was no covenant. Don't hate, just move on and don't do business with anyonewho lies, steals, or murders.

In reply to by Doom and Dust

Doom and Dust GRDguy Sat, 06/24/2017 - 10:23 Permalink

Well he wasn't documented - myhts, legends and fairytales don't count as such.But we, and I mean the Western Civilization, have got to come to terms with the war I'm talking about, waged against us for literally thousands of years.Our culture, our heritage, our power and our influence are compromised by Christianity (Nietzsche was onto this), Communism (let's say many were onto this), Central Banking and Islam (only the dim-right is onto this)We are literally talking about a Two Thousand Year's War.

In reply to by GRDguy

sirsmokum (not verified) Sat, 06/24/2017 - 09:14 Permalink

Do your part. End the fed and criminal banks. Be your own bank. There is only one. Bitcoin.

Gohigher Sat, 06/24/2017 - 09:16 Permalink

I inherited this mess from Obama. I inherited this mess from sonny Bush. I inherited this mess from Clinton. I inherited this mess from daddy Bush.GODFED: "Oh my minions who have served me so well ... I am the creator of all this mess". Jimmy Carter: Ya'll never even gave me a chance!JFK: I called you shit for brains, you blew mine out!Nixon: Gold Bugs! Crawling all over me! Arrgh! Make it stop! Make it stop ! Pitchforks. Same as it ever was and will be......

me123me Sat, 06/24/2017 - 09:21 Permalink

The problem is not that they raise them but they lower them too much and then have to dig out of the hole they created.  They should not be meddling with the interest rates so much. They should leave them at a relatively constant rate.