3. Survey of Business Cycle Theories
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Transcript of 3. Survey of Business Cycle Theories
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3. Business Cycle Theories (Survey)
History: pre-Keynesian vs. modern theories
Principal: real vs. monetary theories
Stability: endogenous instability vs. exogenous shocks
(rocking chair)
Price flexibility: new Keynesian vs. new classicalMacroeconomics
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monetary real
endogenous Ralph Hawtrey
(1879-1975):
Instability of v
Knut Wicksell(1851-1926):
interest rate spread
F.A. von Hayek
(1899-1922):
excess investment
M. Woodford: dynamicstochastic general
equilibrium model
(DSGE)
E. Lederer, R. Malthus, K. Marx: underconsumption
Albert Aftalion (1874-1956), Artur Spiethoff (1873-
1957), Gustav Cassel (1866-1945):
Excess investment, accelerator
J.R. Hicks, P.A. Samuelson: multiplier/accelerator
Goodwin/Pohjola:
distribution battle, chaos theory
E. Prescott: New classical Macroeconomics
Technological shocks, real business cycle (RBC)
G.Akerlof, P. Romer: New KeynesianMacroeconomics
Sticky prices
exogenous Milton Friedman:
monetary policy
Robert Lucas, B.T.
McCallum (1980):
Price expectations
William St. Jevons (1835-1882):
sunspot-theory
W.D. Nordhaus (1975):
political cycles
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Interdependency of Macroeconomics
M
*V
:
P
=
=
Lnet
+
Gnet
+
T
= C + I + E + EX - IMC + S = Y
underconsumption
theoriesKeynesian theories
monetary/monetaristic theories
distribution theories
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Basic idea of monetary theories
HP = Mv = MB * m * v (quantity equation)
v dependent on i and dP/dt)/P => instability m dependent on behavior of banks and households => instability
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Central bank balance(simplified)
Assets Liabilities
credit claims
bonds foreign currency
other
currency in circulation
reserves
monetary base MB
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monetary base MB
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Velocity of circulation v in Euro-Zone (19802000)
source: ECB
ln [GDPnom/M3]
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Pure monetary theory by Ralph Hawtrey (1928) (I)
inventories are sensible to interest rate
Inventory bought at 1000.-
leveraged 900.-
equity: 100.-
inventory sold at 1100.-
=> Profit before interest 100.-
Rate of return ( i = 10%): 10%
Rate of return (i = 11%): 1%
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Pure monetary theory by Ralph Hawtrey (1928) (II)
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inventories are also sensible to inflation
Interest rates decline
inventory and commoditydemand increase
Inflation
rising velocity of
money circulation
(Hawtrey effect)
Inflation
Interest rates rise
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Criticism on Hawtrey`s theory
Inventory less important today
Explanation of cycle is one-sided
Stimulus of initial interest rate decline unclear
However: leverage effect was relevant in recent financialcrisis
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Monetary over-investment theory (Knut Wicksell 1922,
F.A. von Hayek 1934 )
upswing downswing
inat
imon
imon
S
I
S + d(M/P)
S + d(M/P)
S
I
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Interest rate spread causal for disparity between investment
and consumption goods
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Criticism on Wicksell`s theory
Stimulus of initial interest rate spread unclear
Neglect of real effects (e.g. accelerator)
However: interest rate spread was also relevant in recent
crisis
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Critisicm:
real wage increase by technical is progress neglected
turning points are not sufficiently explained one sided theory, no formal exposition
export demand neglected
Theories of under-consumption
(Lauderdale, Malthus, Lederer)
KuB 3.1 12KuB 4 12
technical progress and capital accumulation
pressure on wages and rising unemployment
sales crisis and depression
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Criticism:
cause of initial rise in aggregate demand?
no formal exposition
one sided
Accelerator effect:
K/GDP = 300/100
d = 10%
=> D = 30
suppose demand rises at 10% in t1
=> I1 = 60 + 100% I2 = 33 -45%
=> extreme instability
Non-monetary theory of excess investment (Aftalion u.a.)
Aggregate Demand
Investment
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Accelerator effect in East German Housing Market
Housing
stock
./.
outs
(99)
adds
(1)
Demand
(100)
Housing
stock
./.
outs
(99)
adds
(11)
Demand(110)
increase in aggregate demand by 10% => rise in investment by 1100% !
after completed construction of new houses drop in investment
Demand(110)
Housing
stock./.
outs
(108,9)
adds
(1,1)
previous
After unification today
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Auftragseingang / Werte / Bauhauptgewerbe Ost/ arbeitstglich bereinigt
0
50
100
150
200
250
Jan91
Jul9
1
Jan92
Jul9
2
Jan93
Jul9
3
Jan94
Jul9
4
Jan95
Jul9
5
Jan96
Jul9
6
Jan97
Jul9
7
Jan98
Jul9
8
Jan99
Jul9
9
Jan00
Jul0
0
Jan01
Jul0
1
Jan02
Jul0
2
Jan03
Jul0
3
Jan04
Monatswerte
12 Per. Gleitender Durchschnitt (Monatswerte)
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Orders in East-German Construction Industry
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Dynamics of the business cycle
GDP
Investment
GDP
Investment
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Demand Supply
)(11
1
)1(
1
t
N
N
N
NN
IIs
Is
Y
IsY
IYs
IcYY
1
t
A
A
AA
A
IxY
KxY
dK
dY
K
Yx
KxY
Is there an equilibrium of aggregate demand and investment?
(Harrod-Domar 1939):
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xswI
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Dynamics in Harrod/Domar-model:
t
SYln
lnI
lnY
DYln
Y* = 1/(1-c)Iaut
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a) equlibrium: gI = g* = 0,1
Numerical example I: s = 0,2 x = 0,5 => g* = 0,2 * 0,5 = 0,1
Period: 0 1 2
K 200 220 242
=> YS = xK 100 110 121
I = I t-1 (1 + gI) 20 22 24,2
=> YD = I/s 100 110 121
ALG = YD/YS 100% 100% 100%
Steady-state: all variables grow at the same rate
t
SDYY lnln
lnI
lnY
I = sY = 0,2*100 = 20
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c) disequilibrium: gI = 0,05 < g*
Numerical example III: s = 0,2 x = 0,5 => g* = 0,2 * 0,5 = 0,1
Period: 0 1 2
K 200 220 241
=> YS = xK 100 110 120,5
I = I t-1 (1 + gI) 20 21 22,05
=> YD = I/s 100 105 110,25
ALG = YD/YS 100% 95% 91%
Lack of investmentleads to excess capacity!
t
DYln
lnY
SYln
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Criticism of Harrod/Domar
model does not reflect reality
s, x bzw. v need not be constant
no cycles
model is far too simple (no consumption, no public sector, no
money, no labor market)
U van Suntum, Vorlesung KuB 22
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Learning goals/Questions
How do we classify business cycle theories?
Which pre-Keynesian theories do we know?
To what extent are they still relevant today?
Explain why we cannot forecast GDP for more than two yearsat best!
Explain the Harrod-Domar condition for a balanced growth!
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