Economic Fluctuations: A Framework for Analysis and Policy Design

Abstract

A general framework for assessing validity of alternative theories of business cycles and longer term economic cycles is described. The evaluative framework draws upon a generic model of the production sector of the economy. Evaluation of alternative theories of economic cycles is carried out by isolating the central causal elements of each theory and incorporating those elements into the basic production sector. Through computer simulation of the resulting model, relative importance of each hypothesized factor can be gauged. To illustrate the theory-testing process, the evaluative framework is applied to study the role of labor adjustments and fixed capital investment in generating economic cycles. The dominant business-cycle theories, including those of Hicks, Samuelson, and Duesenberry, center on the role of fixed capital investment in the short-term business However, analysis of the production-sector model shows that long delays inherent in planning, construction, and depreciation of capital equipment render it unlikely that investment in fixed capital is an intrinsic cause of short-term cycles. Instead, the analysis suggests that labor-acquisition and short-term production and inventory-management policies principally underlie business cycles. Moreover, capital-investment policies appear to cause a fifteen- to twenty-year cycle in potential output resembling the so-called Kuznets cycle. By isolating the major influences on different fluctuating modes in the economy, analysis of the production sector can deepen insight into underlying causes of economic cycles and thereby contribute to design of enhanced policies for economic stabilization.