1.3. Types of economic cycles
Economic theory distinguishes several types of the business cycles that are called waves. These types are usually given the names of economic scholars who devoted their studies to this problem. One of the most famous cycles include: “long-term waves of Kondratyev (50-60 years), ” “medium-term waves of Kuznets (18—25 years)5”, “short-term waves of Jugular (10 years) ” and “short cycles of Kitchin (4 months to 2 years) ”.
Currently, most of the economists believe the ideas of the existence of short-term cycles, but consider them only as part of a cyclical system. The basis of this system is found in medium-term economic cycles of Jugular. Jugular believed that the duration of the medium-term cycle is 10 years and that the cause was in credit. Some economists find the main determinant of the short-term cycles in the physical deterioration of an active part of fixed assets.
The development of the theory of long waves began in 1847, when English scientist Clark, noted the 54-year gap between the crises of 1793 and 1847. Clark suggested that the gap was not accidental. Jevons was the first who applied statistics of fluctuations to the analysis of long-waves in order to explain the new phenomenon of the science. The original statistical analysis of technical progress as a determinant of cyclicality is found in the writings of Dutch scientists Gedern and Wolf.
Marx’s contribution to the theory of economic crises cannot be neglected. In general, Marx studied short-term cycles, which were called periodic cycles or overproduction crises.
A special place in the development of the cycles’ theory is given to the Russian scientist Kondratyev. His research focused on the development of England, France and the United States between 100-150 years, using the end of the XVIII century (1790) statistics on such indicators as the average level of trade, production and consumption of coal, iron and lead. In fact, Kondratyev fulfilled multivariate analysis of economic growth. The results of Kondratyev studies identified three major cycles: 1 cycle was represented by upward wave (from 1787 to 1814) and downward wave (from 1814 to 1951); 2 cycle was represented by downward wave (from 1844 to 1875) and upward wave (from 1870 to 1896); 3 cycle from 1896 to 1920 was represented by an upward wave6.
Fig. 1.3simplified kondratieff wave pattern svg version of file:kondratieff wave.gif
Kondratyev showed that one of the major characteristics prior to increasing phase was technological boom. The stage of economic recovery is associated with introduction to the economy of the "products" of the technological boom. Each country’s adjustment to the products of this technological boom during this long-term wave determined it dominance in the global arena.
Kondratyev explained the existence of large cycles by different periods of operation of various household goods, the production of which required different time periods. This was, especially important when capital accumulation is considered. Thus, large cycles arose during the periods of capital accumulation for new infrastructure. The essence of the fluctuations was that economic infrastructure had to be in the state of equilibrium (including all other parameters) specific at this development stage.
Disequilibrium implied the beginning of a new cycle. In accordance with Kondratyev’s statistical analysis the frequency rate of these repetitions is approximately 45 to 50 year. Later, independent study of French economist Simian supported this view. The theory of long-term or large cycles is of particular importance, as it allows forecasting market system development well in advance and, there hence; increase market economy’s adaptability to potential shocks.
Austrian economist Schumpeter associated long-term waves with technological progress constantly receiving new impulses through introduction of innovations.
Cyclical changes were also typical for unemployment, inflation, the interest rate and money supply. However, the main indicators of the business cycle phases were employment and unemployment rates along with output volume since the rates of inflation, interest and exchange can depend on factors that cause recession.
Currently, such famous scholars as Schumpeter, Kuznets, Clark, Mitchell, Bokkara, Gordon and others have extensively studied the long-term waves.
1.4. Non-cyclical fluctuations
The discussion above, however, does not indicate that all cycles of economic activity are explained by business cycles. Some cycles are intrinsically seasonal. For instance, consumer confidence “booms” during Christmas and Easter may lead to annual fluctuations in the rates of economic activity, especially in retail trade. Agricultural sector and automobile industry are also to some degree are subject to seasonal fluctuations.
Business activity depends also on long-term economic trends, that is, on rises or falls of economic activity during 25, 50 or 100 years. It is important to consider that the long-term trend of American economy is associated with substantial economic growth. Currently, fluctuations of business activity in the presence of long-term trends in economic growth are typical for the business cycles.
1.5. Causes of the business cycles: major theories
Each economic school of thought provides own and distinct explanation for the business cycles in the national economies. Studies of the causes of business cycles resulted in a number of theories being developed. As a result, different methods and approaches provide modern picture:
Monetary theories of business cycles assert that monetary changes are the main causes of the occurrence of the business cycles. These were initially recognized as superficial since the conclusions were based on the sphere of circulation.
Physiological theories associate business cycles with perceptional changes as periods of optimism and pessimism. This point of view is common to such economists as Vessel, Shpitgof, and Schumpeter. Pigu devoted large amount of research to study this point of view.
Political business cycle theories consider fiscal and monetary policies as the key causes of the business cycles. In accordance with this point of view, actions of policymakers are mostly directed to earn sympathies during election processes in order to be re-elected. At the same time, governments strive to follow strict monetary and fiscal policies after the election period. These actions, then, may lead to recession requiring “smooth” and popular macroeconomic policy (such increases in government spending or tax reduction) prior to the election. As a result, some adherents of these theories believe those periods of the business cycles coincide with the election periods (nearly 5 years).
In accordance with equilibrium business cycle theories, business cycles occur as a result of short-term and long-term changes in economic trends rather than changes around potential output. Real business cycle theory asserts that macroeconomic fluctuations arise as a result of productivity or technology shocks in some sectors of the economy.
Some theories see, that multiplier and accelerator effects lie at the heart of the business cycles; below some well-known business cycle theories are discussed.
1.5.1 Hansen’s neo-keynesian theory of the business cycles.
American economist Elvin Hansen (1887-1975) (along with Harrod, Samuelson and Hicks) in the book "Business Cycles and National Income” (1951), based on data from U.S. economic history presents the concept of multiple cycles, highlighting at least four models of cyclical fluctuations:
«Small cycles» with duration from 2 to 3 years. The major cause is uneven reproduction of capital stock ( as a result of fluctuations in capital accumulation);
“Large cycles” with the duration of 6-13 years. The major cause is uneven capital investment;
“Construction cycles” with the duration on average 17-18 years with fluctuation frequencies from 16 to 20 years (buildings’ construction);
“Secular cyclic waves” with the duration of 50 years and more. The major cause is fundamental changes in technology and large shifts in the production.
According to Hansen’s point of view7, the depth of recession is determined by a combination of waves from corresponding cycles. His work provides an explanation to the causes of global economic crisis. Thus, the Great Depression of 1929-30 is associated with a combination of decreasing waves with the phases of construction cycle.
By its nature, Hansen’s business cycles theory resembles investment theory, since cyclical fluctuations are the result of non-uniformity of inventory investment. Non-uniformity of investment is explained by “lag and lead8” approach that shows the substantial lagging response of factors to disequilibrium state of the other.
From Keynesian standpoint, Hansen’s investment fluctuations are explained by autonomous investment categories (independent of current economic conditions). Autonomous investment are found to be influenced by technological changes, demographical shifts that cause changes in labour demand and supply, the discovery of new natural resources, and involvement in the turnover of new business areas.
Autonomous investment triggers multiplier effect (ΔY/Δ i autonm.) with the last being determined by the marginal propensity to consume (MPC):
Multiplier effect is closely related with accelerator’s response. Keynesian theory is based on the presence of only autonomous investment. But autonomous investment also co-exists with derived or induced investments. The main difference between induced and autonomous investment lies on the functional dependence of the former on income. Therefore, if income and aggregate demand remain constant, then the level of induced investment will also stay constant. Consequently, induced investments change due to changes national income:
A = ΔIstim./ΔI.
On the basis of these effects Hansen explains the expansion phase: if technological progress in certain sector of the economy pushes the volume of autonomous investment then the initial increase in autonomous investment through multiplier and accelerator effects will lead to even higher increase in national income. Hence the multiplier effect triggers the accelerator and economic system shifts from static to dynamic state.
In contrast to neoclassicals, who regarded crises as a result of changes in exogenous factors solely, Hansen also insisted on the existence of “self-correcting endogenous cycle9”, that is, internal mechanism of cyclical fluctuations.
Since the business cycle is typical for developing capitalist economy, “the invisible hand10” was not enough for market clearance. Hence, there was a strong need in positive counter cyclical programs. Hansen’s counter cyclical measures are concerned with exchange and income allocation (without direct government intervention in property relations)
Built-in flexibility mechanisms (automatic stabilizers)
Automatically stabilizing countermeasures
Controllable compensation measures
Subsequently, these measures were complemented by a broad strategy of government spending and budget deficits to achieve full employment and potential output growth rate.
1.5.2 Supply shocks
In general, the production function of a particular economy does not stay constant over time. Changes in the production methods or, specifically, in the production function are associated with supply shocks (a.k.a. productivity shocks11). Positive or favorable supply shocks increase the amount of production that can be achieved for the given values of capital and labor. Negative or unfavorable, supply shocks reduce the amount of production that can be achieved for each specific combination of labor and capital. Favorable and unfavorable supply shocks in the real world can be caused by:
• Natural conditions - favorable and unfavorable changes in the weather;
• Technical conditions - innovations in technology that increase efficiency of inputs of production. For example, the use of personal computers or statistical analysis in quality control;
• The political events of the change of government regulation, which affect the use of technology and production methods.
Supply shock types 12also include changes in other factors of production than capital and labor. These shocks tend to increase the amount of output produced with given amounts of capital and labor.
Figure 1.5.1 shows the effect of negative supply shocks on the production function relating labor input and output. As can be seen, negative supply shock shifts the production function downwards reducing the amount of output being produced for any given levels of capital and labor. Moreover, negative supply shock reduces the slope of the production function implying that each additional worker brings less additional output in the economy.
And vice versa, positive supply shock allows producing more output with the same number of inputs of production. This is illustrated as an outward shift of the productions function
Strictly said, Figure 1.5.1 does not always imply reduction in the marginal products of labor and capital. Instead, the production function may experience a parallel onward shift. However, reduction in the marginal products as a result of negative supply shock is more common. The shift of the production as illustrated by Figure 1.5.1 happens due to changes in total factor productivity А.
Fig. 1.5.2 Negative supply shocks13
Negative supply shocks shifts the production function downwards. Hence, for each level of labor the amount of output being produced is lower than initially. Negative supply shock reduces the slope of the production function for the number of employed in the economy.