The Economics of Recessions and Depressions

Term 4 2006-2007



Professor Todd Knoop

Office:             201 College Hall

Telephone:      895-4208  (voice mail)





Class Times:  9:15-11:30       Monday-Friday

                        1:00-2:15         Monday and Wednesday


Office Hours:   11:30-12:00     Monday-Friday and by appointment



Required Texts:  Recessions and Depressions: Understanding Business Cycles, Todd A. Knoop, first edition, 2005






     Consistent with the popular conception of Economics as the “dismal science”, economists secretly long for economic crises.  Not in any real or concrete sense, for no economist that I know of enjoys seeing people suffer through the kinds of hardships suffered by the residents of nations that are going through an economic recession or depression.  As a general rule, economists are not sadists.  However, when it comes to the state of economic knowledge, nothing improves our understanding of how markets and macroeconomies work than an economic crisis.  The most obvious analogy is that of an auto mechanic who learns his craft best not by working on cars that are running well but by getting under the hood of autos that have broken down.  Much the same can be said of economists.  Recessions and depressions are essentially the only substitute that macroeconomists have for an experiment, when markets breakdown so completely that the underpinnings of what is actually driving the operations of fully functioning markets become more readily apparent.  It is an opportunity for economists to pop open the hood and take a look inside the engine of modern economies.

     Probably the greatest learning opportunity in the study of Economics during the 20th century was the Great Depression, an economic downturn of such a massive scale that the whole discipline of economics was eventually turned on its ear.  The Great Depression played a crucial role in the development of Macroeconomics as a field of study separate from that of Microeconomics and in the development of Keynesian Economics, the most fundamental change in the way that economists think about the world since 1776 when Adam Smith published The Wealth of Nations.  Keynesian Economics in turn spawned some of the most radical developments in public policy since the industrial revolution and provided the theoretical foundation for the modern welfare state.

     In this course, we will provide in-depth analysis of the following two questions:


(1)    Why are economies subject to periods of negative output growth (recessions)?

(2)    How do you explain severe economic contractions (depressions)?


     As mentioned above, many of the developments in macroeconomic theory, from Keynes on, have centered around these two questions.  The big problem, unfortunately, is that after more than 100 years of debate, there is still no agreement about what causes recessions and depressions.  There continues to be multiple competing models of business cycles used among economists.  In fact, there is a large disconnect between the models used by academic economists and those used by private sector economists. This debate over the over the proper explanation for business cycles continues to be a key question in the development of macroeconomic thought.  Our goal in this course is not necessarily to put an end to this debate by providing a definitive answer on why business cycles exist, because there is none, but rather to understand all of the competing theories and factors in the debate.

     For an example of how disagreements persist in Macroeconomics, consider the last recession in the U.S. during 1990-1991 (at the time of this writing it is not clear that there has technically been a recession during the 2001-2002 period).  Some economists have argued that it was caused by an aggregate demand downturn resulting from a reduction in consumer confidence during the Gulf War or by a decrease in the money supply by the Federal Reserve.  Others have argued that it was caused by a decrease in aggregate supply brought about by an increase in the price of oil during the war or the delayed effects of tax increases and government regulation adopted in the late 1980s.  To this day there is no single cause that is generally agreed upon among economists.  Another example of the discord among economists is evident in their handling of the East Asian crisis from 1997-1999, the most significant international economic crisis since the Great Depression.  Economists did not forecast the East Asian crisis.  There was (and still is) no agreement upon the policies that should have been followed to best deal with the crisis.  In addition, the crisis occurred in countries that were previously thought to be exemplar economies.  Clearly there is still much work to be done before economists can come to any sort of consensus as to the causes of recessions and depressions.

     Many people (including many economists) have asked, “Why study business cycles if, in the long run, they all average out?”  The obvious answer is that they are extremely costly to a society, not just in terms of lost income but in terms of disrupted lives- higher suicide and homicide rates, higher poverty, and higher divorce rates.  Keynes’ answer to this question is one of the classic responses in all of Economics:


“Now ‘in the long run’ this is probably true…But this long run is a misleading guide to current affairs.  In the long run we are all dead.  Economists set themselves too easy, too useless a task if in tempestuous seasons they can only tell us that when the storm is long past the ocean is flat again.”



Grading:  Course grades will be determined by four classes of assignments and will be based on 500 possible points.  I reserve the right to use my discretion at the margin and things such as class participation will be considered in borderline cases.


(1) Exams:  Three midterm exams will be given.  Each midterm will be worth 100 points.  If a make-up exam is needed, a time must be arranged in advance of the test date.


(2) Research Assignments: A series of 5 research assignments will be given throughout the block.  These assignments will review key concepts from our discussions of business cycles theory in class.  More importantly, these assignments will ask you to become familiar with accumulating and working with economic data related to macroeconomics and business cycles, as well as become familiar with basic econometric, modeling, and forecasting techniques.


 (3) Class Participation:  Class participation will count for 50 points toward the final grade and will be assigned on the basis of both quantity and quality of participation. Topics that are important enough to find their way onto exams will definitely be reviewed extensively in class.  If you miss a class it is your responsibility to find out what announcements and other materials or assignments were presented in class. 





Academic Honesty: Academic dishonesty will not be tolerated and will be dealt with in accordance with Cornell’s student regulations.



Learning Disabilities: Cornell College is committed to providing equal educational opportunities to all students.  If you have a documented learning disability and will need any accommodation in this course, you must request the accommodation(s) from [the instructor of the course] as early as possible and no later than the third day of the term.  Additional information about the policies and procedures for accommodation of learning disabilities is available on the Cornell web site at





Schedule of Topics and Primary Readings


(Note:  Readings in parenthesis will be make available in class)





Section 1:  The Facts of Business Cycles



Monday #1:      Introduction                                         Preface, Chapter 1



Tuesday #1:    Describing Business Cycles              Chapter 2




Section 2: The Macroeconomic Theory of Business Cycles and Forecasting



Wednesday #1:Early Theories/Classical Model         Chapter 3


Thursday #1:   Keynes’ and Keynesian Theory          Chapter 4

(Keynes (1932) Chap. 1-3)


Friday #1:        Keynes, cont.                                     



Monday #2:      The Monetarist Model                          Chapter 5

(Friedman (1968))


Tuesday #2:    Exam #1 In Class



Wednesday #2:Rational Expectations                       Chapter 6

                        The Real Business Cycle Model        Chapter 7



Thursday #2:   New Keynesian Models                      Chapter 8



Friday #2:  New Institutional Theories of Finance       (Handout)       

Monday #3:  Economic Forecasting                           Chapter 9




Section 3: Recessions and Depressions in U.S. and Internationally



Tuesday #3:    The Great Depression                        Chapter 10

Post-WWII Business Cycles              Chapter 11



Wednesday #3:Exam #2 In Class



Thursday #3:   Banking Crises and Asset Bubbles    (Handout)

                        Japan                                                  Chapter 15



Friday #3:        Intl’ Financial Crises                            Chapter 13

                        East Asian Crisis



Monday #4:      Intl’ Financial Crises and the IMF        Chapter 14




Tuesday #4:    A “New” Economy in the U.S.?           Chapter 12

                        Conclusions                                        Chapter 16



Wednesday #4:Final Exam In Class