Business Cycle Theory and Exogenous Shocks

Abstract

As was just pointed out, the shock-dependent business cycle models of Chapter 3 require some kind of exogenously initiated disturbance of the system’s dynamics in order to generate permanent fluctuations in the face of otherwise damped oscillations. There are basically two ways of treating the occurrence of exogenous shocks: 1) Exogenous shocks are beyond the scope of abstractive economic reasoning and are thus considered as influences from a world outside of economics which cannot be analyzed by economists. While this attitude may be appropriate in many cases of economic theorizing, it is definitely unsatisfactory in business cycle theory because of the essential importance of exogenous influences. Nevertheless, it may be useful to investigate the dynamic behavior of shock-dependent business cycle models under certain assumptions about the occurrence (or anticipation) of exogenous shocks over time. Although the nowadays most popular Rational Expectations business cycle models do not differ from the multiplier-accelerator models in their dynamic structure, it is essentially the incorporation (or neglect) of these exogenous shocks in the individual expectation formation process, which constitutes a real innovation in business cycle theory. This special way of dealing with exogenous influences is the main reason why a single section (cf. Section 4.3.) is devoted to Rational Expectations business cycle models instead of describing those models in the appropriate Chapter 3. Exogenous influences, however, do not only have interesting consequences in the shock-dependent models. If the exogenous shocks do not occur in regular patterns, but can be interpreted as a series of random numbers, then it may be possible that the exogenous shocks themselves display cyclical behavior (cf. Section 4.2.1.) or that the anticipation of probability distributions may influence individual behavior which can lead to fluctuations (cf. Section 4.2.2.). As the stochastic aspect of the exogenous forces plays an essential role in these explanations of business cycles, it is appropriate to term these models “stochastic business cycle models”. 2) While the exogenous forces which drive the system are considered to be given and unexplained in the model at hand, it could be believed that economic theory may provide explanations of these forces using other approaches. This idea of partial theorizing, which is standard in economics, may also be applied to business cycle theory and can be justified in the face of the high complexity of an attempted general and comprehensive approach. For example, the so-called political business cycle models investigate the behavior of governments which try to exploit economically given constraints for re-election purposes. While these models basically provide autonomous explanations of the fluctuating of otherwise stationary economies, they may as well be interpreted as being explanations of exogenous forces in the shock-dependent models above, because the essential result of the political business cycle model is that governmental activities may not be counter-cyclical as proposed by Keynesian income theory. The presentation of these political business cycle models may also be useful because it forcefully demonstrates the difficulties in modeling comprehensive approaches which integrate economic, political, or social aspects of business cycles.