Custom Search

“Observed cyclical fluctuations are consistent with the normal workings of an efficient economy.” Discuss. (1994, Q9)


1)      Intro

2)      What is observed?

a)      Growth rates of GDP, Investment, unemployment etc. move together

b)      Stylised facts – invetment more volatile and leading etc.

c)      After a period of growth (3-7 years normally) there is a short period of decline

d)      After the boom economists can normally identify the shock(s) that caused the recession

e)      Interesting bits:

f)        No-one has really been able to predict the cycle. By now the US economy should be falling already. This is probably due to good interest rate management. - Lucas critique – once they identified the cycle they corrected it.

g)      The cycle length is very variable (now more than 10 years in USA, about 1.5 years in Estonia) and changing. However, developing countries seem to have shorter cycles.

3)      What is consistent?

a)      Different theories of business cycles. Most prominent monetary business cycles. Also government disturbing the economy etc. These all imply that cycles are inefficient and often caused by irrational behaviour.

b)      RBC theories – imply that cycles are rational response to shocks. As shocks cannot be elliminated the response is efficient.

4)      What is normal workings?

a)      Maximising the utility of the subjects.

b)      Low inflation and unemployment. Stable (low volatility) consumption.

5)      Are the business cycles consistent?

a)      Peter Temin – most cycles by real factors support RBC and consistent

b)      Once the cycle was discovered in 1990-s there has not been any in USA.

c)      But, LDC-s have cycles (as do Estonia J ) that are easily identified (still) from USA data. Agents will learn eventually how to use derivatives and insurance to eliminate the propagation mechanisms in a cycle. Until then the cycles in LDC-s are probably inefficient.

6)      Extentions:

a)      Inefficiency in capital markets – loss of liquidity and increase in volatility

b)      Without the cycle there would be less volatility (shocks affect only one period mean, from a basic st. dev formula the st. dev is smaller). Should we look at third moments of consumption etc to figure out utility?

c)      Liquidity – big issue. Credit crunches often occur after a boom. However, it was not evident in Brasil, implying that people might learn.

7)      Conclusion:

a)      Lots of interesting research done

b)      This all helps people to learn about the cycles and also how to eliminate bad effects

c)      Cycles are inefficient if people haven’t yet learned. Some definitely haven’t however, on aggregate they might have in USA already.

d)      People who learn could benefit instead of people who do not (the clever ones just buy more derivatives). Thus on aggregate inequality can occur, but not loss of efficiency, even if some people never learn.

e)      The research into the amount that people have learned should be delegated to sociologists and the way they could learn should be delegated to psychologists. The more economists find evidence of BC-s the better people can hedge against them and the less effect they have. Thus the least important the monetary irrational explanations become and the more important the RBC efficient behaviour becomes.


“Asset Prices, Consumption, and the Business Cycle.” John Y. Campbell. NBER Working Paper No. W6485. Issued in March 1998

“The Causes of American Business Cycles: An Essay in Economic Historiography” Peter Temin NBER Working Paper No. W6692 Issued in August 1998

“Has the Business Cycle Been Abolished?” Victor Zarnowitz NBER Working Paper No. W6367 Issued in January 1998

Click here to see more economics,politics and school papers from me