business cycles and financial crises

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A W Mullineux

Business Cycles and Financial Crises

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A W Mullineux

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Business Cycles and Financial Crises

ISBN 978-87-7681-885-2

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Contents

Contents

1 he Nature of the Business Cycle 7

1.2 he Monte Carlo Hypothesis 11

1.3 Are Business Cycles Symmetric? 18

1.4 he Frisch-Slutsky Hypothesis 23

1.5 Has the Business Cycle Changed Since 1945? 33

2 Business Cycle heory 41

2.2 Equilibrium Business Cycle (EBC) Modelling 48

2.3 Nonlinear Cycle heory 56

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Contents

3 he Financial Instability Hypothesis 63

3.2 he Role of Money and Credit in Pre-Keynesian Business Cycle Literature 64

3.3 he Financial Instability Hypothesis (FIH) 71

3.4 Rational Speculative Bubbles 88

4 Towards a heory of Dynamic Economic Development 101

4.1 A Brief Overview of Cycle Modelling 101

4.2 Schumpeter on Economic Evolution 104

4.3 he Long Swing Hypothesis and the Growth Trend 108

4.4 Shackle on the Business Cycle 116

4.5 Goodwin’s Macrodynamics 120

4.6 Concluding Remarks 124

5 he Uninished Research Agenda 128

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Preface

Preface

My interest in business cycles was rekindled by Professor Jim Ford, my mentor during the irst part of my career at the University of Birmingham Since completing my PhD on business cycles in 1983, my lecturing and research had focussed

on money, banking and inance Jim introduced me to Shackle’s much neglected work on business cycles, which is discussed

in Chapter 4 and emphasises the key role bank lending decisions play in the propogation of business cycles

he 2007-9 Global Financial Crisis (GFC) was a clear demonstration of the role of bank lending in the propogation of inancial crises and business cycles and a reminder that Minsky’s inancial stability hypothesis, discussed in Chapter 3, had also been reglected, but remained highly relevant to modern banking systems Indeed the onset of the GFC has been described as a ‘Minsky moment’ when the euphoria of the credit and house price bubbles in the US and elsewhere, turned

to ‘revulsion’ and panic, resulting in a major recession

his second edition revisits the topic of the role of the banking system in generating inancial crises and business cycles

in the light of the biggest inancial crisis since the 1930s

Andy Mullineux Professor of Global Finance Birmingham Business School University of Birmingham, UK

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The Nature of the Business Cycle

1 The Nature of the Business Cycle

1.1 Deinitions

Perhaps the most widely quoted and inluential deinition is that of Burns and Mitchell (1946, p.l)1 who state that:

Business cycles are a type of luctuation found in the aggregate economic activity of nations that organise their work mainly in business enterprises: a cycle consists of expansions occurring at about the same time in many economic activities, followed by similarly general recessions, contractions, and revivals which merge into the expansion phase of the next cycle; the sequence of changes is recurrent but not periodic; in duration cycles vary from more than one year to ten or twelve years; they are not divisible into shorter cycles of similar character with amplitudes approximating their own

A number of features of this deinition should be highlighted Firstly, it stresses only two phases of the cycle, the expansionary and contractionary phases It will be seen in section 1.2 that the peak or upper turning point and the trough or lower turning point are not analysed as distinct phases but are merely used to identify business cycles in aggregate economic time series Many economists, however, regard the turning points as particular phases requiring separate explanation his is especially evident in the discussion of the inancial instability hypothesis, which stresses the role of inancial crises

in terminating the boom phase, in Chapter 3

he second main feature is the emphasis on the recurrent nature of the business cycle, rather than strict periodicity Combined with the wide range of acceptable durations, encompassing both major and minor cycles (Hansen 1951), this means that cycles vary considerably in both duration and amplitude and that the phases are also likely to vary in length and intensity Minor cycles are oten assumed to be the result of inventory cycles (Metzler 1941), but Burns and Mitchell reject these as separable events as postulated by Schumpeter (1939), among others.2 Finally, and perhaps most importantly, they emphasise comovements as evidenced by the clustering of peaks and troughs in many economic series his is a feature stressed in numerous subsequent business cycle deinitions, a sample of which are discussed below

he original National Bureau of Economic Research (NBER) work of Burns and Mitchell concentrated on the analysis of non-detrended data In the post-war period such analysis has continued but the NBER has also analysed detrended data

in order to identify growth cycles,3 which tend to be more symmetric than the cycles identiied in non-detrended data

he issue of asymmetry is an important one because it has implications for business cycle modelling procedures; it will

be discussed further in section 1.3

Concerning the existence of the business cycle, there remain bodies of atheists and agnostics Fisher (1925, p 191) is oten quoted by doubters and disbelievers He states:

I see no reason to believe in the Business Cycle It is simply a luctuation about its own mean And yet the cycle idea is supposed to have more content than mere variability It implies a regular succession of similar luctuations constituting some sort of recurrence, so that, as in the case of the phases of the moon, the tides of the sea, wave motion or pendulum swing we can forecast the future on the basis of a pattern worked out from past experience, and which we have reason

to believe will be copied in the future

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The Nature of the Business Cycle

he work done at the NBER has subsequently attempted to show that there is indeed more to the business cycle than mere variability Doubters remain, however, and tests of Fisher’s so-called Monte Carlo hypothesis will be discussed in section 1.2

he NBER view that there is suicient regularity, particularly in comovements, to make the business cycle concept useful

is shared by two of the most distinguished students of cycle theory literature, Haberler (1958, pp 454-9) and Hansen Hansen (1951) notes that some would prefer to substitute ‘luctuations’ for cycles but concludes that the usage of the term cycles in other sciences does not imply strict regularity his point is also made by Zarnowitz and Moore (1986) in

a recent review of the NBER methodology

Lucas (1975) helped to rekindle interest in business cycle theory4 by reviving the idea of an equilibrium business cycle he cycle had tended to be regarded as a disequilibrium phenomenon in the predominantly Keynesian contributions to the post-war cycle literature Lucas (1977) discussed the cycle in more general terms and stressed the international generality

of the business cycle phenomenon in decentralised market economies He concluded (p 10) that:

with respect to the qualitative behaviour of comovements among series, business cycles are all alike

And that this:

suggests the possibility of a uniied explanation of business cycles, grounded in the general laws governing market economies, rather than in political or institutional characteristics speciic to particular countries or periods

he intention here is not to deny that political or institutional characteristics can inluence actual cycle realisations and help account for their variation between countries and periods It is rather to stress the existence of general laws that ensure that a market economy subjected to shocks will evolve cyclically Research that aims to gauge the extent to which the US business cycle has changed since the Second World War is reviewed in section 1.5

Sargent (1979, p 254) attempts to formalise a deinition of the business cycle using time series analysis He irst analyses individual aggregate economic time series and arrives at two deinitions Firstly:

A variable possesses a cycle of a given frequency if its covariogram displays damped oscillations of that frequency, which

is equivalent with the condition that the non-stochastic part of the diference equation has a pair of complex roots with argument… equal to the frequency in question A single series is said to contain a business cycle if the cycle in question has periodicity of from about two to four years (NBER minor cycles) or about eight years (NBER major cycles)

Secondly, Sargent argues that a cycle in a single series is marked by the occurrence of a peak in the spectral density of that series Although not equivalent to the irst deinition, Sargent (1979, Ch XI) shows that it usually leads to a deinition of the cycle close to the irst one

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