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'Is the Business Cycle obsolete

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Introduction

'Is the Business Cycle obsolete?' Discuss. The business cycle refers to the ups and downs seen somewhat simultaneously in most parts of an economy. The cycle involves shifts over time between periods of relatively rapid growth of output, alternating with periods of relative stagnation or decline. These fluctuations are often measured using the real gross domestic product. As Burns identifies, in duration, business cycles vary from more than one to ten or twelve years, they are not divisible into shorter cycles of analogous character with amplitudes approximating their own. This essay shall mainly focus on the United States Business cycle, to deduce whether the business cycle has become obsolete. Over the past century economists have been carrying out studies to deduce whether the business cycle is obsolete, or, has merely become less volatile. Lengthy expansion in the 1960s spurred debates about economic stabilisation, speculations about the end of business cycles, as well as a search for possible causes of the controlled business cycles. The majority of studies have been carried out in the United States (U.S.) by economists such as Romer and Burns, although many have been carried out since. Burns mainly targets two areas of research. Firstly, the decrease in volatility of the business cycle, and secondly, changes in the duration of phases in the business cycle. In a progress report written by Burns, he highlights the fact that the phenomenon of the business cycle has been substantially reduced over the past century. 'The characteristic of the business cycle itself appears to have changed, apart from the intensity of its over-all movement'.1 The key components of the business cycle identified by Burns are production, employment, incomes, consumption and prices. ...read more.

Middle

Most financial bodies and governments around the world have 'replaced uncontrolled random shocks from a wide variety of sources with controlled policy shocks that explain the changes we do and do not see over time'.8 Moreover, changes in monetary policy after a peak in the business cycle have helped to increase the stability of the business cycle. A key finding was that monetary policy has played a key role in the post war period in stabilising the business cycle. The main result that Romer deduces is the fact that 'both monetary and automatic fiscal policy have served to moderate postwar recessions'.9 The phenomenon of a 'new economy' has been a major result from Romer's findings. Romer suggests that the potential for the business cycle to become non-existent is there, although this will take a number of years. Overall, the application of monetary policy to control inflation with the aggregate demand policy of using automatic stabilizers have been the main source of greater stability of the business cycle. In addition, empirical evidence on international stabilisation has shown increasing economic stability over time, and confirms that the modern decrease in U.S. GDP volatility is part of a broader long-term development shared by all the industrialised countries, mainly the G7. First, the amplitude of output volatility cycles has been decreasing over time. Secondly, the long run trend in output volatility is negative for all countries considered. Finally, the empirical results present evidence that there have been numerous structural breaks in the countries studied, leading to larger stability over time. Moreover, the amplitude of the cycles has been decreasing over time, both during expansions and recessions. ...read more.

Conclusion

Indeed, empirical evidence is strongly on the side of the New Keynesian view that cycles are often the result of changes in economic policy. Monetary policy, in particular, appears to have played a crucial role in causing business cycles in the United States since World War II. The severe recessions of both the early 1970's and the early 1980's, for example, were directly attributable to the Federal Reserve's decisions to increase interest rates. On the positive side, the booms of the 1960's and the 1980's were both at least partly due to monetary ease and falling interest rates. The role of money in causing business cycles is even stronger if one considers the era before World War II. Many of the worst prewar depressions, including the recessions of 1908, 1921, and the Great Depression, were to a large extent the result of declines in the money supply and the related high real interest rates. In this earlier era, however, most monetary swings were engendered not by conscious monetary policy, but by financial panics and international monetary developments. But appearances are deceiving. The kind of statistics that economists use to measure the severity of business cycles, such as data on the unemployment rate, real gross national product, and industrial production, have been kept carefully and consistently only since World War II. Therefore, the conclusion that government policy has smoothed business cycles is based on a relationship of fragmentary prewar evidence among sophisticated postwar statistics. For economists to say the business cycle is obsolete is merely ambiguous as there has been no empirical evidence to date to prove this phenomenon. ...read more.

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