Investment Behavior and Business Cycles

Abstract

M OST economists agree that the primary source of cyclical instability is to be found in the determinants of investment behavior. Current cycle theory largely takes the following simple form. Today's value of output is equal to today's aggregate demand, which is the sum of consumption and investment (plus government expenditures). Consumption is assumed to be more or less inflexibly tied to current or past income. Hence the essence of the problem is to find the determinants of current investment. These determinants, so far as they are considered endogenous, are usually taken to be either the rate of change in total output (the acceleration principle) or the level of total output and the size of the total capital stock. The business-cycle models which result from this approach are open to a number of objections. They are unable to account for the important differences among past cycles; they abstract from most of the complexities of economic growth; they ignore some features of the cumulative process which observation suggests may be important in shaping the course of the cycle; and they yield explanations of investment behavior which, as often as not, do not seem to fit the facts. The purpose of the present paper is to suggest a different approach to the study of economic fluctuations one which links cyclical change more closely to the underlying forces making for growth and structural change than is usually the case today.2 First, we shall examine whether cyclical fluctuations are likely to take place in the absence of significant variations in (long-term) investment. Following this, we shall attempt to lay the groundwork for a theory of investment behavior in terms of the opening up of investment opportunities and the varying inducements to exploit these opportunities. The analytical framework resulting from these two sections is then used to elaborate and refine the usual distinction between major and minor cycles. In a concluding section, we shall try briefly to evaluate this way of looking at the causes of cyclical instability.