Is it a power law distribution? The case of economic contractions
One of the first steps to understand and forecast economic downturns is identifying their frequency distribution, but it remains uncertain. This problem is common in phenomena displaying power-law-like distributions. Power laws play a central role in complex systems theory; therefore, the current limitations in the identification of this distribution in empirical data are a major obstacle to pursue the insights that the complexity approach offers in many fields. This paper addresses this issue by introducing a reliable methodology with a solid theoretical foundation, the Taylor Series-Based Power Law Range Identification Method. When applied to time series from 39 countries, this method reveals a well-defined power law in the relative per capita GDP contractions that span from 5.53% to 50%, comprising 263 events. However, this observation does not suffice to attribute recessions to some specific mechanism, such as self-organized criticality. The paper highlights a set of points requiring more study so as to discriminate among models compatible with the power law, as needed to develop sound tools for the management of recessions.
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