Business Cycle Volatility and Economic Growth: The Historical Record, 1870–1986

Abstract

A rich theoretical and empirical tradition exists in the economics liter- ature that argues that business cycle volatility is strongly and positively correlated with real per-capita economic growth. Joseph Schumpeter (1961) argues that economic development critically depends on the introduction and adoption of new technology which occurs in waves, and is therefore a main cause of business cycle volatility. Simon Kuznets (1967), addressing both the empirical and theoretical literature of his time (including Schumpeter's), concludes that business cycle volatility and economic growth are both statistically and causally related, with those variables that cause increased cyclical volatility increasing the rate of economic growth. The Schumpeter-Kuznets tradition maintains that a fall in business cycle volatility should result in a fall in the rate of economic growth. And, given the rate of population growth, this would invariably reduce the rate of per-capita economic growth. An important component of real business cycle theory, which incor- porates some of the most recent literature on business cycles, follows the Schumpeter-Kuznets tradition in arguing that real shocks to the economy, largely embodied in technical change, play the detennining role both in affecting business cycle volatility and in determining the rate of economic growth. Technological shocks take the form of a random walk with drift, thereby affecting the pace of economic growth.