Overview: Business-Cycle Theories

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Macroeconomics emphasizes the interrelatedness of the various sectors of the economy. Hence, disturbances in one part of the economy can result in symptoms in other parts that seem far removed. Two central questions of macroeconomics are where do disturbance originate in the system, and where are there forces that prevent the system from quick and smooth readjustment when it is disturbed.

Many economists see the process of money creation and destruction as a source of past macroeconomic disturbances. This group of readings will add the short-run story that many economists who believed the quantity theory of money told (and tell). The readings also introduce another story that many economists tell, that economic disturbances can originate not in the supply and demand for money, but in goods markets.

The central idea of business-cycle literature, that the economy has regular and periodic waves—a cycle—lasting for several years, has few adherents today. Perhaps such cycles never existed, or perhaps they once did but no longer do because the government now plays a large and active role in the economy. However, the business-cycle approach remains useful because it is an easy way to introduce a number of macroeconomic topics, including the adjustment process that remains central in macroeconomics. It also provides a transition from our examination of monetary theories to an introduction to Keynesian economics, a very different way of viewing the macroeconomy.

After you complete this unit, you should be able to:

  • Explain the business-cycle framework.
  • Explain the accelerator principle.
  • Give an example of a feedback relationship.
  • Explain how investment and money stock could interact to create a business cycle in the 19th century banking system.
Copyright Robert Schenk