Transcript gunnar Myrdal

• Business Cycle
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Business cycle
This article may lend undue weight to
certain ideas, incidents, controversies or
matters relative to the article subject as a
whole.
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Business cycle
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The term business cycle (or economic
cycle or boom-bust cycle) refers to
economy-wide fluctuations in
production, trade and economic
activity in general over several
months or years in an economy
organized on free-enterprise
principles.
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Business cycle
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The business cycle is the upward and
downward movements of levels of
GDP (gross domestic product) and
refers to the period of expansions and
contractions in the level of economic
activities (business fluctuations)
around its long-term growth trend.
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Business cycle
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These fluctuations occur around a longterm growth trend, and typically involve
shifts over time between periods of
relatively rapid economic growth (an
expansion or boom), and periods of
relative stagnation or decline (a
contraction or recession).
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Business cycle
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Business cycles are usually measured
by considering the growth rate of real
gross domestic product. Despite being
termed cycles, these fluctuations in
economic activity can prove
unpredictable.
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Business cycle - Theory
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Prior to that point classical economics had
either denied the existence of business
cycles, blamed them on external factors,
notably war, or only studied the long term
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Business cycle - Theory
Sismondi and his contemporary Robert
Owen, who expressed similar but less
systematic thoughts in 1817 Report to the
Committee of the Association for the Relief
of the Manufacturing Poor, both identified
the cause of economic cycles as
overproduction and underconsumption,
caused in particular by wealth inequality
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Business cycle - Theory
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Sismondi's theory of periodic crises was
developed into a theory of alternating
cycles by Charles Dunoyer, and similar
theories, showing signs of influence by
Sismondi, were developed by Johann Karl
Rodbertus
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Business cycle - Classification by periods
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In 1860 French economist Clement Juglar
first claimed the existence of economic
cycles 7-11 years long, although he was
cautious not to claim any rigid regularity
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Business cycle - Classification by periods
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In the mid-20th century, Schumpeter and
others proposed a typology of business
cycles according to their periodicity, so
that a number of particular cycles were
named after their discoverers or
proposers:
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Business cycle - Classification by periods
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the Juglar fixed investment cycle of 7–11 years
(often identified as 'the' business cycle);
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Business cycle - Classification by periods
the Kuznets infrastructural investment
cycle of 15–25 years (after Simon Kuznets
also called building cycle]);
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Business cycle - Classification by periods
Interest in these different typologies of
cycles has waned since the development
of modern macroeconomics, which gives
little support to the idea of regular periodic
cycles.
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Business cycle - Occurrence
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There were frequent crises in Europe
and America in the 19th and first half of
the 20th century, specifically the period
1815–1939
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Business cycle - Occurrence
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Economic stabilization policy using fiscal
policy and monetary policy appeared to
have dampened the worst excesses of
business cycles, and automatic
stabilization due to the aspects of the
government's budget also helped mitigate
the cycle even without conscious action by
policy-makers.
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Business cycle - Occurrence
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In this period, the economic cycle – at least the
problem of depressions – was twice declared dead
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Business cycle - Occurrence
Various regions have experienced
prolonged depressions, most
dramatically the economic crisis in
former Eastern Bloc countries following
the end of the Soviet Union in 1991. For
several of these countries the period
1989–2010 has been an ongoing
depression, with real income still lower
than in 1989. This has been attributed not
to a cyclical pattern, but to a
mismanaged transition from command
economies to market economies.
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Business cycle - Identifying
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In 1946, economists Arthur F. Burns
and Wesley C. Mitchell provided the
now standard definition of business
cycles in their book Measuring
Business Cycles:
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Business cycle - Identifying
Business cycles are a type of fluctuation
found in the aggregate economic activity of
nations that organize their work mainly in
business enterprises: a cycle consists of
expansions occurring at about the same time
in many economic activities, followed by
similarly general recessions, contractions,
and revivals which merge into the expansion
phase of the next cycle; in duration, business
cycles vary from more than one year to ten or
twelve years; they are not divisible into
shorter cycles of similar characteristics with
amplitudes approximating their own.
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Business cycle - Identifying
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The problem of how business cycles come
about is therefore inseparable from the
problem of how a capitalist economy
functions.
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Business cycle - Identifying
In the United States, it is generally
accepted that the National Bureau of
Economic Research (NBER) is the final
arbiter of the dates of the peaks and
troughs of the business cycle
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Business cycle - Upper turning points of business cycle, commodity prices and
freight rates
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There is often a close timing relationship
between the upper turning points of the
business cycle, commodity prices and
freight rates, which is shown to be
particularly tight in the grand peak years of
1873, 1889, 1900 and 1912.
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Business cycle - Spectral analysis of business cycles
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Recent research employing spectral analysis
has confirmed the presence of Kondratiev
waves in the world GDP dynamics at an
acceptable level of statistical
significance.[non-primary source needed]
Korotayev & Tsirel also detected shorter
business cycles, dating the Kuznets to about
17 years and calling it the third sub-harmonic
of the Kondratiev, meaning that there are
three Kuznets cycles per Kondratiev.[nonprimary source needed]
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Business cycle - Cycles or fluctuations?
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In recent years economic theory has moved
towards the study of economic fluctuation
rather than a 'business cycle' – though some
economists use the phrase 'business cycle'
as a convenient shorthand. For Milton
Friedman calling the business cycle a "cycle"
is a misnomer, because of its non-cyclical
nature. Friedman believed that for the most
part, excluding very large supply shocks,
business declines are more of a monetary
phenomenon.
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Business cycle - Explanations
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If the economy is operating with less
than full employment, i.e., with high
unemployment, Keynesian theory
states that monetary policy and fiscal
policy can have a positive role to play
in smoothing the fluctuations of the
business cycle.
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Business cycle - Explanations
There are a number of alternative
heterodox economic theories of business
cycles, largely associated with particular
schools or theorists. There are also some
divisions and alternative theories within
mainstream economics, notably real
business cycle theory and credit-based
explanations such as debt deflation and
the financial instability hypothesis.
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Business cycle - Exogenous vs. endogenous
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Within mainstream economics, the
debate over external (exogenous)
versus internal (endogenous) being
the causes of the economic cycles,
with the classical school (now neoclassical) arguing for exogenous
causes and the underconsumptionist
(now Keynesian) school arguing for
endogenous causes
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Business cycle - Exogenous vs. endogenous
This debate has important policy
consequences: proponents of exogenous
causes of crises such as neoclassicals
largely argue for minimal government policy
or regulation (laissez faire), as absent these
external shocks, the market functions, while
proponents of endogenous causes of crises
such as Keynesians largely argue for larger
government policy and regulation, as absent
regulation, the market will move from crisis to
crisis
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Business cycle - Exogenous vs. endogenous
The view of the economic cycle as
caused exogenously dates to Say's law,
and much debate on endogeneity or
exogeneity of causes of the economic
cycle is framed in terms of refuting or
supporting Say's law; this is also
referred to as the "general glut"
debate.
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Business cycle - Exogenous vs. endogenous
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There has been some resurgence of
neoclassical approaches in the form of
real business cycle (RBC) theory
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Business cycle - Exogenous vs. endogenous
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Mainstream economists working in
the neoclassical tradition, as opposed
to the Keynesian tradition, have
usually viewed the departures of the
harmonic working of the market
economy as due to exogenous
influences, such as the State or its
regulations, labor unions, business
monopolies, or shocks due to
technology or natural causes.
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Business cycle - Exogenous vs. endogenous
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Contrarily, in the heterodox tradition
of Jean Charles Léonard de Sismondi,
Clement Juglar, and Marx the
recurrent upturns and downturns of
the market system are an endogenous
characteristic of it.
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Business cycle - Exogenous vs. endogenous
The 19th century school of
Underconsumptionism also posited
endogenous causes for the business
cycle, notably the paradox of thrift,
and today this previously heterodox
school has entered the mainstream in
the form of Keynesian economics via
the Keynesian revolution.
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Business cycle - Keynesian
Paul Samuelson's "oscillator model" is
supposed to account for business cycles
thanks to the multiplier and the accelerator
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Business cycle - Keynesian
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In the Keynesian tradition, Richard
Goodwin accounts for cycles in output
by the distribution of income between
business profits and workers wages
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Business cycle - Credit/debt cycle
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One alternative theory is that the primary
cause of economic cycles is due to the
credit cycle: the net expansion of credit
(increase in private credit, equivalently
debt, as a percentage of GDP) yields
economic expansions, while the net
contraction causes recessions, and if it
persists, depressions. In particular, the
bursting of speculative bubbles is seen as
the proximate cause of depressions, and
this theory places finance and banks at
the center of the business cycle.
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Business cycle - Credit/debt cycle
A primary theory in this vein is the
debt deflation theory of Irving Fisher,
which he proposed to explain the
Great Depression. A more recent
complementary theory is the
Financial Instability Hypothesis of
Hyman Minsky, and the credit theory
of economic cycles is often associated
with Post-Keynesian economics such
as Steve Keen.
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Business cycle - Credit/debt cycle
Post-Keynesian economist Hyman
Minsky has proposed an explanation
of cycles founded on fluctuations in
credit, interest rates and financial
frailty, called the Financial Instability
Hypothesis
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Business cycle - Credit/debt cycle
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While credit causes have not been a
primary theory of the economic cycle
within the mainstream, they have
gained occasional mention, such as
(Eckstein & Sinai 1986), cited
approvingly by (Summers 1986).
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Business cycle - Real business cycle theory
Within mainstream economics, Keynesian
views have been challenged by real business
cycle models in which fluctuations are due to
technology shocks. This theory is most
associated with Finn E. Kydland and Edward
C. Prescott, and more generally the Chicago
school of economics (freshwater economics).
They consider that economic crisis and
fluctuations cannot stem from a monetary
shock, only from an external shock, such as
an innovation.
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Business cycle - Real business cycle theory
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There were great increases in productivity,
industrial production and real per capita
product throughout period from 1870 to 1890
that included the Long Depression and two
other recessions. See:Long depression#Myth
of the Long Depression There were also
significant increases in productivity in the
years leading up to the Great Depression.
Both the Long and Great Depressions were
characterized by overcapacity and market
saturation.
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Business cycle - Real business cycle theory
Over the period since the Industrial
Revolution, technological progress has
had a much larger effect on the economy
than any fluctuations in credit or debt, the
primary exception being the Great
Depression, which caused a multi-year
steep economic decline
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Business cycle - Real business cycle theory
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Carlota Perez blames "financial capital" for
excess speculation, which she claims is
likely to occur in the "frenzy" stage of a
new technology, such as the 1998–2000
computer, internet, dot.com mania and
bust. Perez also says excess speculation
is likely to occur in the mature phase of a
technological age.
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Business cycle - Real business cycle theory
RBC theory has been categorically
rejected by a number of mainstream
economists in the Keynesian tradition,
such as (Summers 1986) and Paul
Krugman.
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Business cycle - Politically based business cycle
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The partisan business cycle suggests
that cycles result from the successive
elections of administrations with
different policy regimes
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Business cycle - Politically based business cycle
The political business cycle is an
alternative theory stating that when an
administration of any hue is elected, it
initially adopts a contractionary policy
to reduce inflation and gain a
reputation for economic competence. It
then adopts an expansionary policy in
the lead up to the next election, hoping
to achieve simultaneously low inflation
and unemployment on election day.
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Business cycle - Politically based business cycle
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(He did not see this theory as applying
under fascism, which would use direct
force to destroy labor's power.) In
recent years, proponents of the
"electoral business cycle" theory
have argued that incumbent
politicians encourage prosperity
before elections in order to ensure reelection – and make the citizens pay
for it with recessions afterwards.
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Business cycle - Marxian economics
For Marx the economy based on
production of commodities to be sold
in the market is intrinsically prone to
crisis
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Business cycle - Marxian economics
Some Marxist authors such as Rosa
Luxemburg viewed the lack of purchasing
power of workers as a cause of a
tendency of supply to be larger than
demand, creating crisis, in a model that
has similarities with the Keynesian one
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Business cycle - Marxian economics
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Goodwin formalised a Marxist model of
business cycles, known as the
Goodwin Model in which recession was
caused by increased bargaining power
of workers (a result of high
employment in boom periods) pushing
up the wage share of national income,
suppressing profits and leading to a
breakdown in capital accumulation
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Business cycle - Austrian School
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Austrian business
cycle theory
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Business cycle - Austrian School
Economists of the heterodox Austrian
School argue that business cycles are
primarily caused by excessive creation of
bank credit – or fiduciary media – which is
encouraged by central banks when they
set interest rates too low, especially when
combined with the practice of fractional
reserve banking
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Business cycle - Austrian School
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Adherents, such as the historian Thomas
Woods argue that these earlier financial
crises were prompted by government and
bankers' efforts to expand credit despite
restraints imposed by the prevailing gold
standard, and are thus consistent with
Austrian Business Cycle Theory.
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Business cycle - Georgism
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Henry George identifies land price
fluctuations as the primary cause of
most business cycles. The theory is
generally ignored in most of today's
discussions of the subject despite the
fact that the two great economic
contractions of the last 100 years
(1929–1933 and 2008–2009) both
involved speculative real estate
bubbles.
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Business cycle - Georgism
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Because housing and commercial real
estate provide collateral for a large
portion of lending, there is a tendency
for real estate prices to rise faster than
the rate of inflation in business cycle
upswings.
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Business cycle - Georgism
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Speculation in land concentrates profits in
landholders and diverts economic
resources to speculation in land,
squeezing profits away from production
that has to occur on this land.
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Business cycle - Georgism
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This shock to the economy occurs as long
as there is land speculation, creating an
underlying tendency toward inflation and
recession late in the growth phase of the
business cycle
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Business cycle - Georgism
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Land speculation slows the economy in
two ways. It increases production costs
by making land in general more
expensive (shifting the Aggregate
supply (AS) curve upward) as well as
decreasing productivity by denying
access to the best locations, shifting
the AS curve to the left and lowering
"potential output".
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Business cycle - Georgism
The Wisconsin Business School
publishes an on line database with
building cost and land values for 46
U.S. metro areas.
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Business cycle - Mitigating an economic downturn
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Since the 1940s, following the Keynesian
revolution, most governments of
developed nations have seen the
mitigation of the business cycle as part of
the responsibility of government, under the
rubric of stabilization policy.
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Business cycle - Mitigating an economic downturn
Since in the Keynesian view,
recessions are caused by inadequate
aggregate demand, when a recession
occurs the government should increase
the amount of aggregate demand and
bring the economy back into
equilibrium. This the government can
do in two ways, firstly by increasing the
money supply (expansionary monetary
policy) and secondly by increasing
government spending or cutting taxes
(expansionary fiscal policy).
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Business cycle - Mitigating an economic downturn
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By contrast, some economists, notably
New classical economist Robert Lucas,
argue that the welfare cost of business
cycles are very small to negligible, and
that governments should focus on longterm growth instead of stabilization.
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Business cycle - Mitigating an economic downturn
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Karl Marx claimed that recurrent
business cycle crises were an
inevitable result of the operations of
the capitalistic system
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Business cycle - Mitigating an economic downturn
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Additionally, since the 1960s neoclassical
economists have played down the ability
of Keynesian policies to manage an
economy
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Business cycle - Notes
1
Jump up ^ A. F. Burns and W. C. Mitchell,
Measuring business cycles, New York,
National Bureau of Economic Research,
1946.
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Business cycle - Notes
Jump up ^ Madhani, P. M.
(2010).Rebalancing Fixed and Variable
Pay in a Sales Organization: A
Business Cycle Perspective.
Compensation & Benefits Review
42(3), pp. 179–189
1
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Business cycle - Notes
Jump up ^ Over Production and Under
Consumption, ScarLett, History Of Economic
Theory and Thought
1
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Business cycle - Notes
1
Jump up ^ Batra, R. (2002). "Economics in
Crisis: Severe and Logical Contradictions
of Classical, Keynesian, and Popular
Trade Models".
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Business cycle - Notes
Jump up ^
http://www.thefreemanonline.org/featured/classicaleconomists-good-or-bad/
1
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Business cycle - Notes
Jump up ^ Charles Dunoyer and the
Emergence of the Idea of an Economic
Cycle, Rabah Benkemoune, History of
Political Economy 2009 41(2):271–295;
doi:10.1215/00182702-2009-003
1
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Business cycle - Notes
1
Jump up ^ M. W. Lee, Economic fluctuations.
Homewood, IL, Richard D. Irwin, 1955
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Business cycle - Notes
Jump up ^ Schumpeter, J. A. (1954). History of
Economic Analysis. London: George Allen & Unwin.
1
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Business cycle - Notes
1
Jump up ^ Kitchin, Joseph (1923). "Cycles
and Trends in Economic Factors". Review
of Economics and Statistics (The MIT
Press) 5 (1): 10–16. doi:10.2307/1927031.
JSTOR 1927031.
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Business cycle - Notes
1
Jump up ^ Kondratieff, N. D.; Stolper,
W. F. (1935). "The Long Waves in
Economic Life". Review of Economics
and Statistics (The MIT Press) 17 (6):
105–115. doi:10.2307/1928486. JSTOR
1928486.
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Business cycle - Notes
Jump up ^
http://www.albany.edu/~bd445/Eco_301/Slides/Busi
ness_Cycle_Notes_(Print).pdf
1
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Business cycle - Notes
1
Jump up ^ http://www.ici.org/pdf/per02-02.pdf
Stock Market Cycles 1942 - 1995
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Business cycle - Notes
1
Jump up ^ Fighting Off Depression, New
York Times,
http://www.nytimes.com/2009/01/05/opinio
n/05krugman.html
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Business cycle - Notes
1
Jump up ^ A. F. Burns, Introduction.
In: Wesley C. Mitchell, What happens
during business cycles: A progress
report. New York, National Bureau of
Economic Research, 1951
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Business cycle - Notes
1
Jump up ^ "US Business Cycle Expansions and
Contractions". NBER. Retrieved 2009-02-20.
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Business cycle - Notes
Jump up ^ Jan Tore Klovland
http://econpapers.repec.org/article/eeeexe
his/v_3a46_3ay_3a2009_3ai_3a2_3ap_3a
266-284.htm
1
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Business cycle - Notes
1
Jump up ^ See, e.g. Korotayev, Andrey V.,
& Tsirel, Sergey V. A Spectral Analysis of
World GDP Dynamics: [[Kondratieff
Waves, Kuznets Swings, Juglar and
Kitchin Cycles in Global Economic
Development, and the 2008–2009
Economic Crisis]. Structure and Dynamics.
2010. Vol.4. #1. pp. 3–57.
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Business cycle - Notes
1
Jump up ^ Mankiw, Gregory (1989).
"Real Business Cycles: A New
Keynesian Perspective". The Journal
of Economic Perspectives (JSTOR) 3
(3): 79–90. doi:10.1257/jep.3.3.79. ISSN
0895-3309. JSTOR 1942761.
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Business cycle - Notes
1
Jump up ^ Mary S. Morgan, The History of
Econometric Ideas, Cambridge University
Press, 1991.
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Business cycle - Notes
1
Jump up ^ Samuelson, P. A., 1939,
Interactions between the multiplier
analysis and the principle of
acceleration, Review of Economic
Statistics 21, 75–78
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Business cycle - Notes
Jump up ^ R. M. Goodwin (1967) "A
Growth Cycle", in C.H. Feinstein, editor,
Socialism, Capitalism and Economic
Growth. Cambridge: Cambridge University
Press
1
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Business cycle - Notes
1
Jump up ^ Wells, David A. (1890). Recent
Economic Changes and Their Effect on
Production and Distribution of Wealth and
Well-Being of Society. New York: D.
Appleton and Co. ISBN 0-543-72474-3.
https://store.theartofservice.com/the-business-cycle-toolkit.html
Business cycle - Notes
1
Jump up ^ Rothbard, Murray (2002).
History of Money and Banking in the
United States. Ludwig Von Mises Inst.
ISBN 0-945466-33-1.
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Business cycle - Notes
1
Jump up ^ Beaudreau, Bernard C.
(1996). Mass Production, the Stock
Market Crash and the Great
Depression. New York, Lincoln,
Shanghi: Authors Choice Press.
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Business cycle - Notes
1
Jump up ^ Lebergott, Stanley (1993).
Pursuing Happiness: American
Consumers in the Twentieth Century.
Princeton, NJ: Princeton University
Press. pp. a:Adapted from Fig. 9.1.
ISBN 0-691-04322-1.
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Business cycle - Notes
1
Jump up ^ [Carlota] (2002). Technological
Revolutions and Financial Capital: The
Dynamics of Bubbles and Golden Ages.
UK: Edward Elgar Publishing Limited.
ISBN 1-84376-331-1.
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Business cycle - Notes
1
Jump up ^ • Allan Drazen, 2008. "political
business cycles," The New Palgrave
Dictionary of Economics, 2nd Edition.
Abstract.
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Business cycle - Notes
1
• William D. Nordhaus, 1975. "The
Political Business Cycle," Review of
Economic Studies, 42(2), pp. 169–190.
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Business cycle - Notes
• _____, 1989:2. "Alternative
Approaches to the Political Business
Cycle," Brookings Papers on Economic
Activity, p p. 1–68.
1
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Business cycle - Notes
1
Jump up ^ Kalecki, Michal. "Political Aspects of Full
Employment". Retrieved 2 May 2012.
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Business cycle - Notes
Jump up ^ Henryk Grossmann Das
Akkumulations – und
Zusammenbruchsgesetz des
kapitalistischen Systems (Zugleich eine
Krisentheorie), Hirschfeld, Leipzig, 1929
1
https://store.theartofservice.com/the-business-cycle-toolkit.html
Business cycle - Notes
Jump up ^ Grossman, Henryk The Law of
Accumulation and Breakdown of the Capitalist
System. Pluto
1
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Business cycle - Notes
1
Jump up ^ Paul Mattick, Marx and Keynes: The
Limits of Mixed Economy, Boston, Porter
Sargent, 1969
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Business cycle - Notes
1
Jump up ^ Nelson H
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Business cycle - Notes
Jump up ^ George, Henry. (1881).
Progress and Poverty: An Inquiry into the
Cause of Industrial Depressions and of
Increase of Want with Increase of Wealth;
The Remedy. Kegan Paul (reissued by
Cambridge University Press, 2009; ISBN
978-1-108-00361-2)
1
https://store.theartofservice.com/the-business-cycle-toolkit.html
Business cycle - Notes
1
Jump up ^ Hansen, Alvin H. Business
Cycles and National Income. New
York: W. W. Norton & Company, 1964, p.
39
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Business cycle - Notes
Jump up ^ Quote from
Henry George on real
causes of business cycles
1
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Business cycle - Notes
1
Jump up ^ Wisconsin School of Business
& The Lincoln Institute of Land Policy
(Updated Quarterly). "Land Prices for 46
Metro Areas"
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Business cycle - Notes
1
Jump up ^ Ruhm C. 2000. Are Recessions
Good for Your Health? Quarterly Journal of
Economics Vol 115, No. 2, pp. 617–650.
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Economic growth - Economic growth versus the business cycle
1
Economists distinguish between short-run
economic changes in production
(economics)|production and long-run
economic growth. Short-run variation in
economic growth is termed the business
cycle. The business cycle is made up of
booms and drops in production that occur
over a period of months or years.
Generally, economists attribute the ups
and downs in the business cycle to
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Economic growth - Economic growth versus the business cycle
In contrast, the topic of 'economic
growth' is concerned with the long-run
trend in production due to structural
causes such as technological growth
and factor accumulation. The business
cycle moves up and down, creating
fluctuations around the long-run trend
in economic growth.
1
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Stabilization policy - Business cycle stabilization
1
Stabilization can refer to correcting
the normal behavior of the business
cycle. In this case the term generally
refers to demand management by
monetary policy|monetary and fiscal
policy to reduce normal fluctuations
and output, sometimes referred to as
keeping the economy on an even keel.
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Stabilization policy - Business cycle stabilization
The policy changes in these
circumstances are usually
countercyclical, compensating for the
predicted changes in employment and
output, to increase short-run and
medium run welfare.
1
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Real Business Cycle theory
1
Unlike other leading theories of the
business cycle, RBC theory sees
recessions and periods of economic
growth as the economic
efficiency|efficient response to
exogenous changes in the real
economic environment
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Real Business Cycle theory
According to RBC theory, business
cycles are therefore Real versus nominal
value (economics)|real in that they do
not represent a failure of Market
clearing|markets to clear but rather
reflect the most efficient possible
operation of the economy, given the
structure of the economy. RBC theory
differs in this way from other theories of
the business cycle such as Keynesian
economics and Monetarism that see
recessions as the failure of some market
1
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Real Business Cycle theory - Business cycles
1
If we were to take snapshots of an
economy at different points in time,
no two photos would look alike. This
occurs for two reasons:
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Real Business Cycle theory - Business cycles
1
#Many advanced economies exhibit
sustained growth over time. That is,
snapshots taken many years apart will
most likely depict higher levels of
economic activity in the later period.
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Real Business Cycle theory - Business cycles
#There exist seemingly random
fluctuations around this growth trend.
Thus given two snapshots in time,
predicting the latter with the earlier is
nearly impossible.
1
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Real Business Cycle theory - Business cycles
1
A common way to observe such behavior
is by looking at a time series of an
economy’s output, more specifically gross
national product (GNP). This is just the
value of the goods and services produced
by a country’s businesses and workers.
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Real Business Cycle theory - Business cycles
1
Figure 1 shows the time series of real GNP for the
United States from 1954-2005
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Real Business Cycle theory - Business cycles
1
Economists refer to these cyclical movements about
the trend as 'business cycles'
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Real Business Cycle theory - Business cycles
1
We call large positive deviations (those
above the 0 axis) peaks. We call
relatively large negative deviations
(those below the 0 axis) troughs. A
series of positive deviations leading to
peaks are booms and a series of
negative deviations leading to troughs
are recessions.
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Real Business Cycle theory - Business cycles
1
At a glance, the deviations just look
like a string of waves bunched
together—nothing about it appears
consistent
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Real Business Cycle theory - Business cycles
We might predict that
other similar data may
exhibit similar qualities
1
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Real Business Cycle theory - Stylized facts
1
By eyeballing the data, we can infer several
regularities, sometimes called stylized facts
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Real Business Cycle theory - Stylized facts
1
Another regularity is cyclical variability.
Column A of Table 1 lists a measure of
this with standard deviations. The
magnitude of fluctuations in output and
hours worked are nearly equal.
Consumption and productivity are
similarly much smoother than output
while investment fluctuates much more
than output. Capital stock is the least
volatile of the indicators.
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Real Business Cycle theory - Stylized facts
1
Acyclical, correlations close to zero, implies no
systematic relationship to the business cycle
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Real Business Cycle theory - Stylized facts
Observing these similarities yet
seemingly non-deterministic
fluctuations about trend, we come to
the burning question of why any of this
occurs. It’s common sense that people
prefer economic booms over
recessions. It follows that if all people
in the economy make optimal
decisions, these fluctuations are
caused by something outside the
1
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Real Business Cycle theory - Stylized facts
1
The one which currently dominates the
academic literature on real business
cycle theory was introduced by Finn E
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Real Business Cycle theory - Stylized facts
1
But exactly how do these productivity
shocks cause ups and downs in
economic activity? Let’s consider a
positive but temporary shock to
productivity. This momentarily
increases the effectiveness of workers
and capital, allowing a given level of
capital and labor to produce more
output.
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Real Business Cycle theory - Stylized facts
1
Individuals face two types of
tradeoffs
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Real Business Cycle theory - Stylized facts
1
The other decision is
the labor-leisure
tradeoff
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Real Business Cycle theory - Stylized facts
1
Overall, the basic RBC model predicts
that given a temporary shock, output,
consumption, investment and labor
all rise above their long-term trends
and hence formulate into a positive
deviation
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Real Business Cycle theory - Stylized facts
It is easy to see that a string of such
productivity shocks will likely result in a
boom. Similarly, recessions follow a string
of bad shocks to the economy. If there
were no shocks, the economy would just
continue following the growth trend with no
business cycles.
1
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Real Business Cycle theory - Stylized facts
The reason why this theory is so
celebrated today is that using this
methodology, the model closely mimics
many business cycle properties
1
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Real Business Cycle theory - Stylized facts
It follows that business cycles
exhibited in an economy are chosen in
preference to no business cycles at all
1
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Real Business Cycle theory - Stylized facts
A pre-cursor to RBC theory was
developed by monetary economists
Milton Friedman and Robert Lucas in the
early 1970s. They envisioned the factor
that influenced people’s decisions to be
misperception of wages—that
booms/recessions occurred when
workers perceived wages higher/lower
than they really were. This meant they
worked and consumed more/less than
otherwise. In a world of perfect
information, there would be no booms or
1
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Real Business Cycle theory - Calibration
1
Unlike estimation, which is usually used
for the construction of economic models,
calibration only returns to the drawing
board to change the model in the face of
overwhelming evidence against the model
being correct; this inverts the burden of
proof away from the builder of the model
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Real Business Cycle theory - Structural variables
Crucial to RBC models, plausible
values for structural variables such as
the discount rate, and the rate of
capital depreciation are used in the
creation of simulated variable paths
1
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Real Business Cycle theory - Criticisms
1
Real business cycle theory is a major point
of contention within macroeconomics :
RBC theory categorically rejects
Keynesian economics and the real
effectiveness of monetarism, which are the
pillars of mainstream
economics|mainstream macroeconomic
policy, while such noted mainstream
economists as Larry Summers and Paul
Krugman categorically reject RBC theory
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Real Business Cycle theory - Criticisms
1
:(My view is that) real business cycle
models of the type urged on us by [Ed]
Prescott have nothing to do with the
business cycle phenomena observed in
the United States or other capitalist
economies. –
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Real Business Cycle theory - Criticisms
However, technology-based theories of
real business cycles also imply that
consumers will change their intertemporal
consumption and savings decisions based
on the real interest rate available to them,
which is a shift in demand
1
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Real Business Cycle theory - Criticisms
1
By way of specific criticism of RBC theory as
advanced by Prescott, lists four:
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Real Business Cycle theory - Criticisms
1
* Prescott uses incorrect parameters
(one third of household time devoted
to market activity rather than one
sixth; historical real interest rates of
4% rather than 1%);
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Real Business Cycle theory - Criticisms
1
* absence of independent evidence for the
technology shocks that supposedly cause
the business cycle, and notably being
unable to point to technological causes of
observed recessions;
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Real Business Cycle theory - Criticisms
1
* Prescott ignores exchange failures (e.g.,
failures of factories to trade their goods for
workers' labor), which are central to
Keynesian accounts of the causes of the
Great Depression, among other crises.
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Inventory investment - Inventory investment over the business cycle
1
Starting from some point in the business
cycle, some group (consumers,
government, purchasers of exports, etc.)
decides for some reason to have a
sustained increase in their spending
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Inventory investment - Inventory investment over the business cycle
1
At some point, there is a sustained decline in
some type of spending for some reason
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Inventory investment - Inventory investment over the business cycle
1
At some point, there is a sustained increase in
some type of spending for some reason
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Joseph Schumpeter - Business cycles
1
The theory of economic development : an
inquiry into profits, capital, credit, interest,
and the business cycle translated from the
German by Redvers Opie (1961) New
York: OUP with a treatise of circular flow
which, excluding any innovations and
innovative activities, leads to a stationary
state
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Joseph Schumpeter - Business cycles
The entrepreneur disturbs this
equilibrium and is the prime cause of
economic development, which
proceeds in cyclic fashion along
several time scales. In fashioning this
theory connecting innovations, cycles,
and development, Schumpeter kept
alive the Russian Nikolai Kondratiev's
ideas on 50-year cycles, Kondratiev
waves.
1
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Joseph Schumpeter - Business cycles
1
See business cycle
for further
information
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Economic policy - Business cycles
The business cycle became a
predominant issue in the 19th century, as
it became clear that industrial output,
employment, and profit behaved in a
economic cycle|cyclical manner. One of
the first proposed policy solutions to the
problem came with the work of Keynes,
who proposed that fiscal policy could be
used actively to ward off depressions,
recessions and slumps. The Austrian
school argues that central banks create
the business cycle.
1
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Friedrich Hayek - The business cycle
1
In his Prices and Production (1931),
Hayek argued that the business cycle
resulted from the central bank's
inflationary Credit cycle|credit
expansion and its transmission over
time, leading to a capital
misallocation caused by the
artificially low interest rates
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Friedrich Hayek - The business cycle
Hayek's analysis was based on Eugen
Böhm von Bawerk|Böhm-Bawerk's
concept of the average period of
productionSee the chapter
[http://books.google.com/books?id=fkVHIn
8y8qkCpg=PA7 The collaboration with
Keynes and the controversy with Hayek,],
Heinz D
1
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Friedrich Hayek - The business cycle
According to Nicholas Kaldor, Hayek's
theory of the time-structure of capital and
of the business cycle initially fascinated
the academic world and appeared to offer
a less facile and superficial understanding
of macroeconomics than the Cambridge
school's.
1
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Friedrich Hayek - The business cycle
1
Also in 1931, Hayek critiqued Keynes's A
Treatise on Money|Treatise on Money
(1930) in his Reflections on the pure
theory of Mr
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Friedrich Hayek - Business cycle critiques
1
Others who responded negatively to
Hayek's work on the business cycle
included John Hicks, Frank Knight,
and Gunnar Myrdal.Bruce Caldwell,
Hayek's Challenge: An Intellectual
Biography of F
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Friedrich Hayek - Business cycle critiques
Lionel Robbins himself, who had
embraced the Austrian theory of the
business cycle in The Great
Depression (1934), later regretted
having written that book and accepted
many of the Keynesian counterarguments.Roger Garrison|R
1
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Friedrich Hayek - Business cycle critiques
Hayek never produced the booklength treatment of the dynamics of
capital that he had promised in the
Pure Theory of Capital
1
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Austrian School - Business cycles
The Austrian theory of the business
cycles|business cycle (ABCT) focuses
on banks' issuance of credit as the
cause of economic fluctuations.
Although later elaborated by Hayek and
others, the theory was first set forth by
von Mises, who believed that banks
extend credit at artificially low interest
rates, causing businesses to invest in
relatively Roundaboutness|roundabout
1
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Austrian School - Business cycles
According to the theory, malinvestment is
induced by banks' excessive and
unsustainable expansion of credit to
businesses.[http://www.econlib.org/library/Mis
es/msT.html Theory of Money and Credit],
Ludwig von Mises, Part III, Part IV
Businesses borrow at unsustainably low
interest rates and overinvest in capitalintensive production processes, which in turn
leads to a diversion of investment from
consumer goods industries to capital goods
industries
1
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Austrian School - Business cycles
According to the Austrian view, the
proportion of income allocated to
Consumption
(economics)|consumption rather than
saving is determined by the interest
rate and people's time preference,
which is the degree to which they
prefer present to future satisfactions
1
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Austrian School - Business cycles
Newly extended credit thus
malinvested will circulate from the
business borrowers to the factors of
production: landowners, capital goods
producers, and capital goods workers
1
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Austrian School - Business cycle theory
According to John Quiggin, most
economists believe that the Austrian
business cycle theory is incorrect
because of its incompleteness and
other problems. Economists such as
Gottfried von Haberler, Milton
Friedman, Gordon Tullock, Bryan
Caplan, and Paul Krugman have argued
that the theory is incorrect.
1
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Welfare cost of business cycles
1
In macroeconomics, the 'welfare cost of
business cycles' refers to the decrease
in social welfare, if any, caused by
business cycle fluctuations.
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Welfare cost of business cycles
Nobel Prize in Economics|Nobel
economist Robert Lucas, Jr.|Robert
Lucas proposed measuring the cost of
business cycles as the percentage
increase in Consumption
(economics)|consumption that would be
necessary to make a representative
agent|representative consumer
Preference#Preference in
economics|indifferent between a
smooth, non-fluctuating, consumption
trend and one that is subject to business
1
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Welfare cost of business cycles
1
Under the assumptions that business
cycles represent random shocks
around a trend growth path, Robert
Lucas, Jr.|Robert Lucas argued that
the cost of business cycles is
extremely small, and as a result the
focus of both academic economists
and policy makers on economic
stabilization policy rather than on
long term economic growth|growth
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Welfare cost of business cycles
1
Under this viewpoint, the welfare cost of
business cycles is larger, because an
economy with cycles not only suffers more
variable consumption, but also lower
consumption on average.
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Welfare cost of business cycles - Basic intuition
1
If we consider two consumption paths,
each with the same Trend
estimation|trend and the same initial
level of consumption – and as a result
same level of consumption per period
'Mean|on average' – but with different
levels of variance|volatility, then,
according to economic theory, the less
volatile consumption path will be
preferred to the more volatile one
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Welfare cost of business cycles - Lucas' formula
1
Robert Lucas' baseline formula for the
welfare cost of business cycles is given
by (see mathematical derivation below):
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Welfare cost of business cycles - Lucas' formula
where \lambda is the cost of
fluctuations (the % of average annual
consumption that a person would be
willing to pay to eliminate all
fluctuations in her consumption),
\sigma is the standard deviation of the
natural log of consumption and \theta
measures the degree of risk aversion.
1
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Welfare cost of business cycles - Lucas' formula
1
It is straight forward to measure \sigma from
available data. Using United States|US data
from between 1947 and 2001 Lucas obtained
\sigma=.032. It is a little harder to obtain an
empirical estimate of \theta; although it
should be theoretically possible, a lot of
controversies in economics revolve around
the precise and appropriate measurement of
this parameter. However it is doubtful that
\theta is particularly high (most estimates are
no higher than 4).
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Welfare cost of business cycles - Lucas' formula
1
As an illustrative example consider the
case of log utility (see below) in which
case \theta=1. In this case the welfare
cost of fluctuations is
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Welfare cost of business cycles - Lucas' formula
In other words eliminating 'all' the
fluctuations from a person's consumption
path (i.e. eliminating the business cycle
entirely) is worth only 1/20 of 1 percent of
average annual consumption. For
example, an individual who consumes
$50,000 worth of goods a year on average
would be willing to pay only $25 to
eliminate consumption fluctuations.
1
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Welfare cost of business cycles - Lucas' formula
The implication is that, if the
calculation is correct and appropriate,
the ups and downs of the business
cycles, the recessions and the booms,
hardly matter for individual and
possibly social welfare. It is the long
run trend of economic growth that is
crucial.
1
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Welfare cost of business cycles - Lucas' formula
1
If \theta is at the upper range of estimates found
in literature, around 4, then
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Welfare cost of business cycles - Lucas' formula
or 1/5 of 1 percent. An individual with
average consumption of $50,000 would be
willing to pay $100 to eliminate
fluctuations. This is still a very small
amount compared to the implications of
long run growth on income.
1
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Welfare cost of business cycles - Lucas' formula
One way to get an upper bound on the
degree of risk aversion is to use the
Ramsey model of intertemporal savings
and consumption. In that case, equilibrium
real interest rate is given by
1
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Welfare cost of business cycles - Lucas' formula
1
where r is the real (after tax) rate of
return on capital (the real interest
rate), \rho is the subjective rate of
time preference (which measures
impatience) and g is the annual
growth rate of consumption
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Welfare cost of business cycles - Lucas' formula
1
which in turn, combined with estimates given
above yields a cost of fluctuations as
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Welfare cost of business cycles - Mathematical representation and formula
Lucas sets up an infinitely lived
representative agent model where total
lifetime utility(U is given by the present
discounted value (with \beta
representing the Discount
factor#Discount factor|discount factor)
of per period utilities (u(.)) which in turn
depend on consumption in each period
(c_t)
1
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Welfare cost of business cycles - Mathematical representation and formula
1
In the case of the a certain consumption path,
consumption in each period is given by
https://store.theartofservice.com/the-business-cycle-toolkit.html
Welfare cost of business cycles - Mathematical representation and formula
1
where A is initial consumption and g is the
growth rate of consumption (as it turns out
neither of these parameters turns out to
matter for costs of fluctuations in the
baseline model so they can be normalized
to 1 and 0 respectively).
https://store.theartofservice.com/the-business-cycle-toolkit.html
Welfare cost of business cycles - Mathematical representation and formula
1
In the case of a volatile, uncertain consumption
path, consumption in each period is given by
https://store.theartofservice.com/the-business-cycle-toolkit.html
Welfare cost of business cycles - Mathematical representation and formula
1
where \sigma is the standard deviation
of the natural log of consumption and
\epsilon is a random shock which is
assumed to be Log-normal
distribution|log-normally distributed so
that the mean of ln (\epsilon_t) is zero,
which in turn implies that the expected
value of e^ \epsilon_t is 1 (i.e
https://store.theartofservice.com/the-business-cycle-toolkit.html
Welfare cost of business cycles - Mathematical representation and formula
1
We find this cost of
fluctuations by
setting
https://store.theartofservice.com/the-business-cycle-toolkit.html
Welfare cost of business cycles - Mathematical representation and formula
1
For the case of isoelastic utility,
given by
https://store.theartofservice.com/the-business-cycle-toolkit.html
Welfare cost of business cycles - Mathematical representation and formula
we can obtain an
(Approximation|approximate) closed
form solution which has already been
given above
1
https://store.theartofservice.com/the-business-cycle-toolkit.html
Welfare cost of business cycles - Mathematical representation and formula
A special case of the above formula
occurs if utility is logarithmic, u(c_t)=ln(c_t)
which corresponds to the case of \theta=1,
which means that the above simplifies to
\lambda=.5 \sigma^2. In other words, with
log utility the cost of fluctuations is equal to
one half the variance of the natural
logarithm of consumption.
1
https://store.theartofservice.com/the-business-cycle-toolkit.html
Welfare cost of business cycles - Mathematical representation and formula
1
An alternative, more accurate solution gives
losses that are somewhat larger, especially
when volatility is large.Latty (2011) A note on
the relationship between the Atkinson index
and the Generalised entropy class of
decomposable inequality indexes under the
assumption of log-normality of income
distribution or volatility,
https://www.academia.edu/1816869/A_note_on
_the_relationship_between_the_Atkinson_inde
x_and_the_generalised_entropy_class_of_dec
omposable_inequality_indexes_under_the_ass
umption_of_loghttps://store.theartofservice.com/the-business-cycle-toolkit.html
normality_of_income_distribution_or_volatility
Welfare cost of business cycles - Risk aversion and the equity premium puzzle
1
However, a major problem related to the
above way of estimating \theta (hence
\lambda and in fact, possibly to Lucas'
entire approach is the so-called equity
premium puzzle, first observed by Rajnish
Mehra|Mehra and Edward
Prescott|Prescott in 1985
https://store.theartofservice.com/the-business-cycle-toolkit.html
Welfare cost of business cycles - Risk aversion and the equity premium puzzle
1
In a survey of the implications of the equity
premium, Simon Grant and John Quiggin
note that 'A high cost of risk means that
https://store.theartofservice.com/the-business-cycle-toolkit.html
Welfare cost of business cycles - Risk aversion and the equity premium puzzle
1
recessions are extremely
destructive'.
https://store.theartofservice.com/the-business-cycle-toolkit.html
Austrian Business Cycle Theory
The Austrian business cycle theory
originated in the work of Austrian School
economists Ludwig von Mises and
Friedrich Hayek
1
https://store.theartofservice.com/the-business-cycle-toolkit.html
Austrian Business Cycle Theory
1
According to the theory, the business cycle
unfolds in the following way: Low interest
rates tend to stimulate borrowing from the
banking system
https://store.theartofservice.com/the-business-cycle-toolkit.html
Austrian Business Cycle Theory
1
Austrian business cycle theory states that
distortions in the availability of credit are
the cause of business cycles. A modern
presentation of this theory can be found in
the book Time and Money by Roger
Garrison, which presents a graphical
framework for capital-based
macroeconomics and offers a critique of
Keynesian graphical analysis.
https://store.theartofservice.com/the-business-cycle-toolkit.html
Austrian Business Cycle Theory
1
The Austrian explanation of the business
cycle differs significantly from the
mainstream economics|mainstream
understanding of business cycles and is
generally rejected by mainstream
economists.
https://store.theartofservice.com/the-business-cycle-toolkit.html
Austrian Business Cycle Theory - Malinvestment - boom
According to ABCT, a period of
malinvestment is induced when there
is a period of excessive business
lending by banks, and this credit
expansion is later followed by a period
of liquidation, (i.e
1
https://store.theartofservice.com/the-business-cycle-toolkit.html
Austrian Business Cycle Theory - Malinvestment - boom
1
Austrians argue that a boom taking place
under these circumstances is actually a
period of wasteful malinvestment. Real
savings would have required higher
interest rates to encourage depositors to
save their money in term deposits to
invest in longer term projects under a
stable money supply. According to
Mises's work, the artificial stimulus
caused by bank lending causes a
generalized speculative investment
bubble which is not justified by the longterm factors of the market.
https://store.theartofservice.com/the-business-cycle-toolkit.html
Austrian Business Cycle Theory - - bust
Mises wrote that a financial
crisis|crisis (or credit crunch) arrives
when the consumers come to
reestablish their desired allocation of
saving and consumption at prevailing
interest
rates.[http://mises.org/story/2810
Manipulating the Interest Rate: a
Recipe for Disaster], Thorsten Polleit,
13 December 2007 Mises conjectured
1
https://store.theartofservice.com/the-business-cycle-toolkit.html
Austrian Business Cycle Theory - - bust
1
Austrians argue that continually expanding
bank credit can keep the borrowers one
step ahead of consumer retribution (with
the help of successively lower interest
rates from the central bank). In the theory,
this postpones the day of reckoning and
defers the collapse of unsustainably
inflated asset
prices.[http://www.goldensextant.com/Savi
ngtheSystem.html Saving the System],
https://store.theartofservice.com/the-business-cycle-toolkit.html
Austrian Business Cycle Theory - - bust
Austrians argue that the monetary boom
ends when bank credit expansion finally
stops – when no further investments can be
found which provide adequate returns for
speculative borrowers at prevailing interest
rates. They further argue that the longer the
false monetary boom goes on, the bigger and
more speculative the borrowing, the more
wasteful the errors committed and the longer
and more severe will be the necessary
bankruptcies, foreclosures, and depression
readjustment.
1
https://store.theartofservice.com/the-business-cycle-toolkit.html
Austrian Business Cycle Theory - Government policy error
1
Austrian business cycle theory does not
argue that fiscal restraint or austerity will
necessarily affect economic
growth.America's Great Depression,
Murray Rothbard Rather, they argue that
all attempts by central governments to
prop up asset prices, bail out insolvent
banks, or stimulate the economy with
deficit spending will only make the
misallocations and malinvestments worse,
https://store.theartofservice.com/the-business-cycle-toolkit.html
Austrian Business Cycle Theory - Government policy error
According to Ludwig von
Mises:[http://mises.org/document/3250
Human Action], Ludwig von Mises,
Chapter XX, section 8
1
https://store.theartofservice.com/the-business-cycle-toolkit.html
Austrian Business Cycle Theory - Government policy error
There is no means of avoiding the final
collapse of a boom brought about by credit
expansion. The alternative is only whether
the crisis should come sooner as a result
of the voluntary abandonment of further
credit expansion, or later as a final and
total catastrophe of the currency system
involved.
1
https://store.theartofservice.com/the-business-cycle-toolkit.html
Austrian Business Cycle Theory - The role of central banks
Austrians generally argue that inherently
damaging and ineffective central bank policies,
including unsustainable expansion of bank credit
through fractional reserve banking, are the
predominant cause of most business cycles, as
they tend to set artificial interest rates too low for
too long, resulting in excessive credit creation,
speculative economic bubble|bubbles, and
artificially low savings.Thorsten Polleit,
[http://mises.org/story/2810 Manipulating the
Interest Rate: a Recipe for Disaster], 13 December
2007 Under fiat money|fiat monetary systems, a
central bank creates new money when it lends to
member banks, and this money is multiplied many
times over through the money creation process of
the private
banks
https://store.theartofservice.com/the-business-cycle-toolkit.html
1
Austrian Business Cycle Theory - History
1
This early development of Austrian
business cycle theory was a direct
manifestation of Mises's rejection of
the concept of neutral money and
emerged as an almost incidental byproduct of his exploration of the
theory of banking
https://store.theartofservice.com/the-business-cycle-toolkit.html
Austrian Business Cycle Theory - History
1
Others who responded critically to
Hayek's work on the business cycle
included John Hicks, Frank Knight,
and Gunnar Myrdal.Bruce Caldwell
(historian of economic
thought)|Bruce Caldwell, Hayek's
Challenge: An Intellectual Biography
of F
https://store.theartofservice.com/the-business-cycle-toolkit.html
Austrian Business Cycle Theory - History
Austrian economist
Roger Garrison
explains the origins of
the theory:
1
https://store.theartofservice.com/the-business-cycle-toolkit.html
Austrian Business Cycle Theory - History
1
In Business Cycles and
Depressions
https://store.theartofservice.com/the-business-cycle-toolkit.html
Austrian Business Cycle Theory - History
Ludwig von Mises and Friedrich
Hayek were two of the few economists
who gave warning of a major
economic crisis before Wall Street
Crash of 1929|the great crash of 1929.
In February 1929, Hayek warned that a
coming financial crisis was an
unavoidable consequence of reckless
monetary expansion.
1
https://store.theartofservice.com/the-business-cycle-toolkit.html
Austrian Business Cycle Theory - History
1
Austrian School economist Peter J
https://store.theartofservice.com/the-business-cycle-toolkit.html
Austrian Business Cycle Theory - History
1
Hanke identifies the Late-2000s financial
crisis|2007–2010 Global Financial Crises
as the direct outcome of the Federal
Reserve Bank's interest rate policies as is
predicted by the Austrian business cycle
theory
https://store.theartofservice.com/the-business-cycle-toolkit.html
Austrian Business Cycle Theory - Empirical research
Keeler argued that the theory is
consistent with empirical evidence In a
1998 interview, Friedman summarized
his view of the Austrian Business Cycle
Theory:
1
https://store.theartofservice.com/the-business-cycle-toolkit.html
Austrian Business Cycle Theory - Empirical research
1
:I think the Austrian business-cycle theory has done
the world a great deal of harm
https://store.theartofservice.com/the-business-cycle-toolkit.html
Austrian Business Cycle Theory - Empirical research
According to most economic historians,
economies have experienced less severe
boom-bust cycles after World War II, because
governments have addressed the problem of
economic recessions. Many argued, prior to
the events of 2008, that this has especially
been true since the 1980s because central
banks were granted more independence and
started using monetary policy to stabilize the
business cycle, an event known as The Great
Moderation.
1
https://store.theartofservice.com/the-business-cycle-toolkit.html
Austrian Business Cycle Theory - Reactions of economists and policymakers
According to Nicholas Kaldor, Hayek's
work on the Austrian business cycle theory
had at first fascinated the academic world
of economists, but attempts to fill in the
gaps in theory led to the gaps appearing
larger, instead of smaller, until ultimately
one was driven to the conclusion that the
basic hypothesis of the theory, that
scarcity of capital causes crises, must be
wrong.
1
https://store.theartofservice.com/the-business-cycle-toolkit.html
Austrian Business Cycle Theory - Reactions of economists and policymakers
Lionel Robbins, who had embraced the
Austrian theory of the business cycle in
The Great Depression (1934), later
regretted having written that book and
accepted many of the Keynesian
counterarguments.R. W. Garrison,
[http://www.auburn.edu/~garriro/amagi.htm
F. A. Hayek as 'Mr. Fluctooations:' In
Defense of Hayek's 'Technical
Economics'], Hayek Society Journal
1
https://store.theartofservice.com/the-business-cycle-toolkit.html
Austrian Business Cycle Theory - Reactions of economists and policymakers
The Nobel Prize Winner Maurice Allais
was a proponent of Austrian business
cycle theory and their perspective on the
Great Depression and often quoted
Ludwig Von Mises and Murray N.
Rothbard.See pp. 728–731, Jesus Huerta
de Soto(1998)
1
https://store.theartofservice.com/the-business-cycle-toolkit.html
Austrian Business Cycle Theory - Reactions of economists and policymakers
When, in 1937, the League of Nations
examined the causes of and solutions to
business cycles, the Austrian business
cycle theory alongside the Keynesian and
Marxian theory were the three main
theories examined.Prosperity and
Depression (1937)
1
https://store.theartofservice.com/the-business-cycle-toolkit.html
Austrian Business Cycle Theory - Similar theories
1
The Austrian theory is considered one
of the precursors to the modern credit
cycle theory, which is emphasized by
Post-Keynesian economics|PostKeynesian economists, economists at
the Bank for International Settlements
https://store.theartofservice.com/the-business-cycle-toolkit.html
Austrian Business Cycle Theory - Similar theories
1
In 2003 Barry Eichengreen laid out a
credit boom theory as a cycle in which
loans increase as the economy
expands, particularly where
regulation is weak, and through these
loans money supply increases
https://store.theartofservice.com/the-business-cycle-toolkit.html
Austrian Business Cycle Theory - Similar theories
In addition, White believes that the
Austrian explanation of the business cycle
might be relevant once again in an
environment of excessively low interest
rates
1
https://store.theartofservice.com/the-business-cycle-toolkit.html
Austrian Business Cycle Theory - Related policy proposals
Cochran
http://financialservices.house.gov/uploade
dfiles/hhrg-112-ba19-wstate-jcochran20120628.pdf have testified before
Congressional Committee about the
beneficial results of moving to either a free
banking system or a free Full-reserve
banking system based on commodity
money based on insights from Austrian
business cycle theory.
1
https://store.theartofservice.com/the-business-cycle-toolkit.html
Austrian Business Cycle Theory - Theoretical objections
Austrian economist Sean Rosenthal
(economist)|Sean Rosenthal argues
that widespread knowledge of the
Austrian business cycle theory
increases the amount of malinvestment
during periods of artificially low
interest rates.
1
https://store.theartofservice.com/the-business-cycle-toolkit.html
Austrian Business Cycle Theory - Theoretical objections
1
Austrian business cycle theory postulates
that business cycles are caused by the
misallocation of resources from
consumption to investment during booms,
and out of investment during busts
https://store.theartofservice.com/the-business-cycle-toolkit.html
Austrian Business Cycle Theory - Theoretical objections
1
Economist Jeffery Hummel is critical of
Hayek's explanation of labor asymmetry
in booms and busts. He argues that Hayek
makes peculiar assumptions about
demand curves for labor in his
explanation of how a decrease in
investment spending creates
unemployment. He also argues that the
labor asymmetry can be explained in
terms of a change in real wages, but this
explanation fails to explain the business
cycle in terms of resource allocation.
https://store.theartofservice.com/the-business-cycle-toolkit.html
Austrian Business Cycle Theory - Empirical objections
1
He argues that this casts doubt on the
notion that recessions are caused by a
reallocation of resources from
industrial production to consumption,
since he argues that the Austrian
business cycle theory implies that net
investment should be below zero
during recessions
https://store.theartofservice.com/the-business-cycle-toolkit.html
Austrian Business Cycle Theory - Empirical objections
1
In 1969, economist Milton Friedman,
after examining the history of
business cycles in the U.S., concluded
that The Hayek–Mises explanation of
the business cycle is contradicted by
the evidence. It is, I believe, false. He
analyzed the issue using newer data in
1993, and again reached the same
conclusion.
https://store.theartofservice.com/the-business-cycle-toolkit.html
Austrian Business Cycle Theory - Empirical objections
1
Economist Jesus Huerta de Soto claims that
Friedman has not proven his conclusion
because he focuses on the contraction of
GDP being as high as the previous
contraction, but that the theory establishes a
correlation between credit expansion,
microeconomic malinvestment and recession,
not between economic expansion and
recession, both of which are measured by an
aggregate (GDP) and that the empirical
record shows strong correlation.p. 495 (de
Soto 1998)
https://store.theartofservice.com/the-business-cycle-toolkit.html
Austrian Business Cycle Theory - Empirical objections
1
Referring to Friedman's discussion of the
business cycle, Austrian economist Roger
Garrison stated, Friedman's empirical
findings are broadly consistent with both
Monetarist and Austrian views, and goes
on to argue that although Friedman's
model describes the economy's
performance at the highest level of
aggregation; Austrian theory offers an
insightful account of the market process
that might underlie those
aggregates.Milton Friedman, The
'Plucking Model' of Business Fluctuations
Revisited Economic Inquiry April, 1993
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Economic cycle - Spectral analysis of business cycles
Korotayev Tsirel also detected shorter
business cycles, dating the Kuznets to
about 17 years and calling it the third subharmonic of the Kondratiev, meaning that
there are three Kuznets cycles per
Kondratiev.
1
https://store.theartofservice.com/the-business-cycle-toolkit.html
Economic cycle - Real business cycle theory
There were great increases in
Productivity improving technologies
(historical)|productivity, industrial
production and real per capita product
throughout period from 1870 to 1890
that included the Long Depression and
two other recessions
1
https://store.theartofservice.com/the-business-cycle-toolkit.html
Economic cycle - Real business cycle theory
Over the period since the Industrial
Revolution, technological progress has
had a much larger effect on the economy
than any fluctuations in credit or debt, the
primary exception being the Great
Depression, which caused a multi-year
steep economic decline
1
https://store.theartofservice.com/the-business-cycle-toolkit.html
Economic cycle - Real business cycle theory
1
Carlota Perez blames financial capital for
excess speculation, which she claims is
likely to occur in the frenzy stage of a new
technology, such as the 1998–2000
computer, internet, dot.com mania and
bust. Perez also says excess speculation
is likely to occur in the mature phase of a
technological age.
https://store.theartofservice.com/the-business-cycle-toolkit.html
Economic cycle - Politically based business cycle
1
Alternative Approaches to the Political
Business Cycle, Brookings Papers on
Economic Activity, p
[http://www.jstor.org/pss/2534461 p
https://store.theartofservice.com/the-business-cycle-toolkit.html
Economic cycle - Politically based business cycle
1
(He did not see this theory as applying
under fascism, which would use direct
force to destroy labor's power.) In
recent years, proponents of the
electoral business cycle theory have
argued that incumbent politicians
encourage prosperity before elections
in order to ensure re-election – and
make the citizens pay for it with
recessions afterwards.
https://store.theartofservice.com/the-business-cycle-toolkit.html
America's Great Depression - Part I: Business Cycle Theory
3. Some Alternative
Explanations of
Depression: A Critique
1
https://store.theartofservice.com/the-business-cycle-toolkit.html
History of macroeconomic thought - Business cycle theory
1
Beginning with William Stanley Jevons
and Clément Juglar in the 1860s,
economists attempted to explain the
cycles of frequent, violent shifts in
economic activity
https://store.theartofservice.com/the-business-cycle-toolkit.html
History of macroeconomic thought - Business cycle theory
1
Their partial equilibrium theories could not
capture general equilibrium, where
markets interact with each other; in
particular, early business cycle theories
treated goods markets and financial
markets separately
https://store.theartofservice.com/the-business-cycle-toolkit.html
History of macroeconomic thought - Real business cycle theory
1
Instead, Kydland and Prescott built
parsimonious models that explained
business cycles with changes in
technology and productivity
https://store.theartofservice.com/the-business-cycle-toolkit.html
History of macroeconomic thought - Real business cycle theory
1
Real business cycle modelers sought
to build macroeconomic models based
on microfoundations of Arrow–Debreu
model|Arrow–Debreu general
equilibrium. RBC models were one of
the inspirations for dynamic stochastic
general equilibrium (DSGE) models.
DSGE models have become a common
methodological tool for
macroeconomists—even those who
disagree with new classical theory.
https://store.theartofservice.com/the-business-cycle-toolkit.html
Economic theory - Business cycle
1
The economics of a depression were the
spur for the creation of macroeconomics
as a separate discipline field of study.
During the Great Depression of the 1930s,
John Maynard Keynes authored a book
entitled The General Theory of
Employment, Interest and Money outlining
the key theories of Keynesian economics.
Keynes contended that aggregate demand
for goods might be insufficient during
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Economic theory - Business cycle
He therefore advocated active policy
responses by the public sector, including
monetary policy actions by the central
bank and fiscal policy actions by the
government to stabilize output over the
business cycle.
1
https://store.theartofservice.com/the-business-cycle-toolkit.html
Economic theory - Business cycle
Thus, a central conclusion of
Keynesian economics is that, in some
situations, no strong automatic
mechanism moves output and
employment towards full employment
levels. John Hicks' IS/LM model has
been the most influential interpretation
of The General Theory.
1
https://store.theartofservice.com/the-business-cycle-toolkit.html
Economic theory - Business cycle
1
Over the years, understanding of the
business cycle has branched into
various research programs, mostly
related to or distinct from
Keynesianism
https://store.theartofservice.com/the-business-cycle-toolkit.html
Economic theory - Business cycle
1
lead by Robert Lucas, Jr.|Robert Lucas,
and real business cycle theory.Stanley
Fischer|Fischer, Stanley (2008)
https://store.theartofservice.com/the-business-cycle-toolkit.html
Economic theory - Business cycle
In contrast, the New Keynesian
economics|new Keynesian approach
retains the rational expectations
assumption, however it assumes a variety
of market failures
1
https://store.theartofservice.com/the-business-cycle-toolkit.html
Economic theory - Business cycle
Thus, the new classicals assume that
prices and wages adjust automatically to
attain full employment, whereas the new
Keynesians see full employment as being
automatically achieved only in the long
run, and hence government and centralbank policies are needed because the
long run may be very long.
1
https://store.theartofservice.com/the-business-cycle-toolkit.html
Inverted yield curve - Relationship to the business cycle
1
The slope of the yield curve is one of
the most powerful predictors of future
economic growth, inflation, and
recessions.Arturo Estrella Frederic S
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Inverted yield curve - Relationship to the business cycle
1
An inverted yield curve is
often a harbinger of
recession
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Inverted yield curve - Relationship to the business cycle
1
All of the recessions in the US since
1970 (up through 2011) have been
preceded by an inverted yield curve
(10-year vs 3-month). Over the same
time frame, every occurrence of an
inverted yield curve has been
followed by recession as declared by
the National Bureau of Economic
Research|NBER business cycle
dating committee.
https://store.theartofservice.com/the-business-cycle-toolkit.html
Inverted yield curve - Relationship to the business cycle
Estrella has postulated that the yield
curve affects the business cycle via the
balance sheet of banks.Arturo Estrella,
[http://papers.ssrn.com/sol3/papers.cf
m?abstract_id=1532309 FRB of New
York Staff Report No
1
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Freidrich Hayek - The business cycle
1
According to Nicholas Kaldor, Hayek's
theory of the time-structure of capital
and of the business cycle initially
fascinated the academic world and
appeared to offer a less facile and
superficial understanding of
macroeconomics than the Cambridge
school's.
https://store.theartofservice.com/the-business-cycle-toolkit.html
Freidrich Hayek - The business cycle
Also in 1931, Hayek critiqued
Keynes's A Treatise on
Money|Treatise on Money (1930) in
his Reflections on the pure theory of
Mr
1
https://store.theartofservice.com/the-business-cycle-toolkit.html
Freidrich Hayek - Business cycle critiques
1
Others who responded negatively to
Hayek's work on the business cycle
included John Hicks, Frank Knight,
and Gunnar Myrdal.Bruce Caldwell,
Hayek's Challenge: An Intellectual
Biography of F
https://store.theartofservice.com/the-business-cycle-toolkit.html
Conjuncture - Spectral analysis of business cycles
Korotayev Tsirel also detected shorter
business cycles, dating the Kuznets to
about 17 years and calling it the third subharmonic of the Kondratiev, meaning that
there are three Kuznets cycles per
Kondratiev.
1
https://store.theartofservice.com/the-business-cycle-toolkit.html
Conjuncture - Real business cycle theory
1
There were great increases in Productivity
improving technologies
(historical)|productivity, industrial
production and real per capita product
throughout period from 1870 to 1890 that
included the Long Depression and two
other recessions
https://store.theartofservice.com/the-business-cycle-toolkit.html
Jesús Huerta de Soto - Austrian business cycle and full reserve banking
Huerta de Soto advocates full-reserve
banking, a system in which 100% reserve
requirements for banks would prevent any
expansion of credit.
1
https://store.theartofservice.com/the-business-cycle-toolkit.html
Jesús Huerta de Soto - Austrian business cycle and full reserve banking
Sechrest rejected Huerta de Soto's
description of fractional-reserve
depositaries as “legal aberrations” and his
characterization of fractional reserve
banking as “sin” which must lead to
monetary inflation, excessive credit
creation, malinvestment, and business
cycles
1
https://store.theartofservice.com/the-business-cycle-toolkit.html
Yield curve - Relationship to the business cycle
1
All the recessions in the US since 1970
(up through 2013) have been preceded
by an inverted yield curve (10-year vs
3-month). Over the same time frame,
every occurrence of an inverted yield
curve has been followed by recession
as declared by the National Bureau of
Economic Research|NBER business
cycle dating committee.
https://store.theartofservice.com/the-business-cycle-toolkit.html
List of cycles - Economic and business cycles
Business cycle - Inflation / Recession Monetary policy - Virtuous circle and
vicious circle - Kitchin cycle - Juglar cycle Kuznets swing
1
https://store.theartofservice.com/the-business-cycle-toolkit.html
Business cycles
1
The term 'business cycle' (or 'economic
cycle' or 'boom–bust cycle') refers to
fluctuations in aggregate production, trade
and activity over several months or years
in a market economy.A. F. Burns and W.
C. Mitchell, Measuring business cycles,
New York, National Bureau of Economic
Research, 1946.
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Business cycles
The business cycle is the upward and
downward movements of levels of gross
domestic product (GDP) and refers to the
period of expansions and contractions in
the level of economic activities (business
fluctuations) around its long-term growth
trend.Madhani, P. M. (2010). Rebalancing
Fixed and Variable Pay in a Sales
Organization: A Business Cycle
Perspective. Compensation Benefits
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Business cycles
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Business cycles are usually measured
by considering the growth rate of real
versus nominal value (economics)|real
gross domestic product. Despite being
termed wikt:cycle|cycles, these
fluctuations in economic activity can
prove unpredictable.
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Business cycles - Theory
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[http://www.economictheories.org/2008/11/ov
er-production-and-under-consumption.html
Over Production and Under Consumption],
ScarLett, History Of Economic Theory and
Thought Prior to that point classical
economics had either denied the existence of
business cycles, blamed them on external
factors, notably
war,http://www.thefreemanonline.org/featured
/classical-economists-good-or-bad/ or only
studied the long term
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Business cycles - Theory
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Sismondi's theory of periodic crises
was developed into a theory of
alternating cycles by Charles
Dunoyer,[http://hope.dukejournals.or
g/cgi/content/abstract/41/2/271
Charles Dunoyer and the Emergence
of the Idea of an Economic Cycle],
Rabah Benkemoune, History of
Political Economy 2009 41(2):271–295;
and similar theories, showing signs of
influence by Sismondi, were
developed by Johann Karl Rodbertus
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Business cycles - Classification by periods
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In 1860 French economist Clement Juglar
first identified economic cycles 7 to 11
years long, although he cautiously did not
claim any rigid regularity.
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Business cycles - Classification by periods
M. W. Lee, Economic fluctuations.
Homewood, IL, Richard D. Irwin, 1955
Later, economist Joseph Schumpeter
(1883–1950) argued that a Juglar Cycle
has four stages:
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Business cycles - Classification by periods
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# expansion (increase in
production and prices,
low interest-rates)
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Business cycles - Classification by periods
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# crisis (stock exchanges crash
and multiple bankruptcies of
firms occur)
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Business cycles - Classification by periods
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# recession (drops in
prices and in output,
high interest-rates)
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Business cycles - Classification by periods
# recovery (stocks recover
because of the fall in prices and
incomes)
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Business cycles - Classification by periods
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Schumpeter's Juglar model associates
recovery and prosperity with
increases in productivity, consumer
confidence, aggregate demand, and
prices.
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Business cycles - Classification by periods
* the Clement Juglar|Juglar fixed
investment|fixed-investment cycle of 7
to 11 years (often identified as the
business cycle)
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Business cycles - Classification by periods
* the Kuznets swing|Kuznets
infrastructural investment cycle of 15 to
25 years (after Simon Kuznets – also
called building cycle)
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Business cycles - Classification by periods
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Interest in the different typologies of
cycles has waned since the
development of modern
macroeconomics, which gives little
support to the idea of regular periodic
cycles.
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Business cycles - Occurrence
This was particularly true during the
Golden Age of Capitalism (1945/50–
1970s), and the period 1945–2008 did not
experience a global downturn until the
Late-2000s
recession.http://www.ici.org/pdf/per0202.pdf Stock Market Cycles 1942–1995
Economic stabilization policy using fiscal
policy and monetary policy appeared to
have dampened the worst excesses of
business cycles, and automatic
stabilization due to the aspects of the
government's budget also helped mitigate
the cycle even without conscious action
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Business cycles - Occurrence
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In this period, the economic cycle – at least the
problem of depressions – was twice declared
dead
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Business cycles - Occurrence
Various regions have experienced
prolonged depression
(economics)|depressions, most
dramatically the economic crisis in
former Eastern Bloc countries following
the end of the Soviet Union in 1991. For
several of these countries the period
1989–2010 has been an ongoing
depression, with real income still lower
than in 1989. This has been attributed
not to a cyclical pattern, but to a
mismanaged transition from command
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Business cycles - Identifying
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In 1946, economists Arthur F. Burns
and Wesley Clair Mitchell|Wesley C.
Mitchell provided the now standard
definition of business cycles in their
book Measuring Business Cycles:A. F.
Burns and W. C. Mitchell, Measuring
business cycles, New York, National
Bureau of Economic Research, 1946.
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Business cycles - Identifying
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According to A. F. Burns:A. F. Burns,
Introduction. In: Wesley C. Mitchell,
What happens during business cycles:
A progress report. New York, National
Bureau of Economic Research, 1951
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Business cycles - Explanations
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If the economy is operating with less than
full employment, i.e., with high
unemployment, Keynesian theory states
that monetary policy and fiscal policy can
have a positive role to play in smoothing
the fluctuations of the business cycle.
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Business cycles - Explanations
There are a number of alternative
heterodox economic theories of
business cycles, largely associated
with particular schools of economic
thought|schools or theorists. There are
also some divisions and alternative
theories within mainstream economics,
notably real business cycle theory and
credit-based explanations such as debt
deflation and the financial instability
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Business cycles - Exogenous vs. endogenous
Mainstream economists working in the
neoclassical economics|neoclassical
tradition, as opposed to the Keynesian
tradition, have usually viewed the
departures of the harmonic working of the
market economy as due to exogenous
influences, such as the State or its
regulations, labor unions, business
monopolies, or shocks due to technology
or natural causes.
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Business cycles - Exogenous vs. endogenous
Contrarily, in the heterodox tradition of
Jean Charles Léonard de Sismondi,
Clement Juglar, and Crisis theory|Marx the
recurrent upturns and downturns of the
market system are an endogenous
characteristic of it.Mary S. Morgan, The
History of Econometric Ideas, Cambridge
University Press, 1991.
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Business cycles - Keynesian
In the Keynesian
tradition, Richard M
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Business cycles - Credit/debt cycle
Post-Keynesian economics|PostKeynesian economist Hyman Minsky has
proposed an explanation of cycles
founded on fluctuations in credit, interest
rates and financial frailty, called the
Financial Instability Hypothesis
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Business cycles - Marxian economics
For Marx the economy based on
production of commodities to be sold
in the market is intrinsically prone to
Crisis (Marxian)|crisis
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Business cycles - Marxian economics
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Some Marxist authors such as Rosa
Luxemburg viewed the lack of
purchasing power of workers as a
cause of a tendency of supply to be
larger than demand, creating crisis,
in a model that has similarities with
the Keynesian one
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Business cycles - Marxian economics
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Goodwin formalised a Marxist model of
business cycles, known as the Goodwin
Model in which recession was caused by
increased bargaining power of workers (a
result of high employment in boom
periods) pushing up the wage share of
national income, suppressing profits and
leading to a breakdown in capital
accumulation
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Business cycles - Austrian School
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Economists of the Austrian School argue
that business cycles are caused by
excessive issuance of credit by banks in
fractional reserve banking systems
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Business cycles - Austrian School
Adherents of the Austrian School,
such as the historian Thomas Woods,
argue that these earlier financial
crises were prompted by government
and bankers' efforts to expand credit
despite restraints imposed by the
prevailing gold standard, and are thus
consistent with Austrian Business
Cycle Theory.
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Business cycles - Yield curve
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Estrella has postulated that the yield
curve affects the business cycle via
the balance sheet of banks.Arturo
Estrella,
[http://papers.ssrn.com/sol3/papers.
cfm?abstract_id=1532309 FRB of New
York Staff Report No
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Business cycles - Georgism
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Business Cycles and
National Income
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Business cycles - Georgism
Because housing and commercial real
estate provide collateral for a large portion
of lending, there is a tendency for real
estate prices to rise faster than the rate of
inflation in business cycle upswings.
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Business cycles - Mitigating an economic downturn
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Since the 1940s, following the Keynesian
revolution, most governments of
developed nations have seen the
mitigation of the business cycle as part of
the responsibility of government, under the
rubric of stabilization policy.
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Business cycles - Mitigating an economic downturn
By contrast, some economists, notably
New classical economics|New classical
economist Robert Lucas, Jr.|Robert Lucas,
argue that the welfare cost of business
cycles are very small to negligible, and
that governments should focus on longterm growth instead of stabilization.
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Business cycles - Mitigating an economic downturn
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Karl Marx claimed that recurrent Crises
(economic)|business cycle crises were an
inevitable result of the operations of the
capitalism|capitalistic system
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Business cycles - Mitigating an economic downturn
Additionally, since the 1960s
Neoclassical economics|neoclassical
economists have played down the
ability of Keynesian policies to
manage an economy
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