The Business Cycle: Theories and Evidence.

Wood, J. Stuart

One might churlishly observe the omission of the word "Some" preceding the word "Theories." This book consists of the texts of presentations (sometimes with substantial changes between presentation and publication) and commentaries made at the Sixteenth Annual Economic Policy Conference of the Federal Reserve Bank of St. Louis in October, 1991. The framework is that of Monetarist, Keynesian, "New-Keynesian," and "Real Business Cycle" theories, based on aggregate economic theories. All of the papers and comments based in the naive ignorance of Hayek's Scientism and the Study of Society, "The Pretense of Knowledge," and his works on business cycles. The Austrian framework, and other theories linking monetary expansion and malinvestment, are completely ignored.

The Bank's President Thomas C. Melzer set the tone of the conference: ignorance and controversy regarding the nature of business cycles and the forces that drive them cause policy actions taken by government to have unanticipated and undesired effects. An economist more "maverick" (in Mr. Melzer's word) or "crackpot" (in Kenneth Arrow's word) would note that Mises and Hayek, two writers on the business cycle whose contributions are completely ignored in this volume, would not be surprised at all by such contrary policy effects. All of our authors are amazed that empirical studies of the macro-economic variables which are modeled cast no light on the causes of business cycles. They are secure in their ignorance of what Mises, Hayek, and Buchanan have taught us about unintended consequences of government policy.

An uncredited Preface does a good job in a few pages of summarizing the main points of the various presentations.

The keynote chapter is "What is a Business Cycle?" by Victor Zarnowitz, who presents in a historical framework his thoughts about business cycles, and attempts to reach a single definition of the cycle by studying empirical data relating to cycles. Zarnowitz also compares international business cycles to American cycles, providing a very useful context. Because of its comprehensive consideration of the analysis of empirical data regarding business cycles, this is a very informative paper, providing a wealth of description of the symptoms of business cycles. Zarnowitz discusses cyclical variables, "exogenous" variables, some of the effects of money, shocks, leads and lags, and co-movements and amplitudes. But in a bibliography spanning six pages, he gives no mention to Mises, Hayek, Haberler, or Rothbard, or any other writers in that tradition. In my view, this is a devastating omission, for it denies access to what appears to some to be the most successful and comprehensive analysis of the business cycle.

James H. Stock comments on Zarnowitz's paper, mostly complaining about the NBER's dating chronology, which is based on different data series, a telling criticism. Stock also suggests more intensive and detailed study of individual cycles to ascertain changes in their mechanisms, a very intelligent suggestion.

The second paper is by David Laidler, "The Cycle Before New-Classical Economics." Laidler follows a historical path in this paper, beginning with the Multiplier-Accelerator Theory (I heard Sir John Hicks recant the accelerator model as an unfortunate mis-direction at a conference in the late 70s), continuing through a discussion of the Monetarist theory, to a discussion of the Phillips curve and "sticky" prices. Laidler's chapter concludes with a mathematical appendix providing the generic models of the multiplier-accelerator theory and the monetarist model. Laidler lays out the framework of what he calls "modern" business cycle theory as predominantly reflecting real shocks to the economy. He falls to follow up the most interesting observation of his paper, however, when he merely mentions that Martin Bailey's National Income and the Price Level included a chapter on "Expectations and Adjustment to Change."

Ben S. Beranke provides commentary on Laidler's paper from the standpoint of the contributions of monetarism to business cycle understanding, and then compares and contrasts the monetarist criticisms of the Keynesian view with those of the Real Business Cycle approach. One who believes that monetary factors do have a profound influence on the occurrence of business cycles will be gratified at this attention which monetary factors are getting, but somewhat frustrated that the detailed mechanism of the concatenation of individual decisions receives so little shrift due to the emphasis on Walrasian general equilibrium theorizing.

The third paper in the book is "For a Return to Pragmatism" by Olivier Jean Blanchard, a somewhat different paper from what he presented to the actual conference. Blanchard argues that what is needed is successful policies that bring about intended effects; in the absence of a correct theory of business cycles, of course, one cannot know in advance which policy is going to have the desired effect, and one takes a substantial chance of making things worse. Blanchard also takes a historical approach in describing the theoretical changes which have occurred in the "mainstream" approach to business cycle analysis within the standard macro-economic paradigm. Blanchard provides a pointed and vigorous criticism of the many useless directions of recent research, and suggests integrating views which he thinks would aid understanding the economic system. Since this paper was not presented at the conference, there is no comment.

Ray C. Fair presents "The Cowles Commission Approach, Real Business Cycle Theories, and New-Keynesian Economics." As do all the participants, he decries the lack of empirical testing of the modern alternative (real) models of cycles. After a description of the "Cowles Commission Approach", which consisted of the specification, estimation, and analysis and testing of structural econometric models, Fair describes the transformation of macroeconomic models from research tools to business forecasting tools, which in the view of Lucas, ruined models for the purpose of understanding and policy research. Fair then criticizes the Real Business Cycle theories which have resulted from Lucas's critique because they neglect the comprehensive understanding of the economy pursued by the Cowles Commission Approach. Fair also complains that the New-Keynesian approach has moved macroeconomics away from its proper econometric basis.

In his comments, Arnold Zellner argues that the models used in his analysis are superior to the Cowles-type approaches recommended by Fair.

Benjamin M. Friedman then asks, "How Does It Matter?" and supports an activist fiscal and monetary policy on the part of government, which he believes could have significant success in opposing the business cycle. Friedman wants to do good, and believes that desire to be sufficient to achieve success. Friedman

believes that "Price inflation . . . also can and does occur on a time scale different from that which defines most business cycle research" (a problem which causes a great deal of misunderstanding of the causes of cycles), and, "inflation can and does arise from causes not directly related to the business cycle." (But he does not support this assertion, which may be incorrect). Friedman traces the relationship between main stream business-cycle theory and economic history. Friedman argues that the apparent differences between policy prescriptions of supply-side versus demand-side theories really are chimerical, depending more upon the assumptions underlying the theories than upon differences in real effects. He thinks one stumbling block in the successful implementation of contra-cyclical policy is the mis-definition of "income," and he suggests that the heterogeneity of the individual economic roles complicates policy prescriptions. He concludes that "real business cycle" theories are not really as helpful as has been believed. Friedman discusses some very interesting questions from a different point of view. He notes the problems of defining the quantities which are parts of the theory, and notes that the difficulty in specification assures that monetary policy cannot be neutral, so we might as well pursue it actively. He invokes the mantra of "expectations" which he ascribes to Keynes's General Theory; but Friedman thinks of "expectations" as the unified single "expectation" of the hive-mind, not the heterogeneous uncoordinated expectations of Keynes's individual market participants. This precludes his carrying the concept very far.

Michael Darby provides the most strenuous opposition to Friedman's views in his comment, pointing out the utter failure of government policies intended to stabilize the economy and concluding that the disrepute in which counter-cyclical policy is presently held is appropriate and beneficial, because "economists . . . are no longer promising a cure that in actuality makes things worse."

In "Deja Vu All Over Again", Alan S. Blinder tries to summarize the conference and the underlying debates among all the factions in the context of his professional life. He provides a useful summary of positions and a neat chart which doctoral students will find invaluable.

Herschel I. Grossman comments about "Business Cycle Developments and the Agenda for Business Cycle Research." In a characteristically serious historical review of events and cycle research during his lifetime, Grossman suggests that a return to the old concept of Political Economy would prove fruitful in understanding why business cycles occur. It is very frustrating to observe the concept of continuing governmental expansion of the quantity of money seething unremarked under the placid surface of Grossman's analysis.

The last paper is yet another professional autobiography disguised as a summarizing commentary, by Michael Parkin, titled "Where Do We Stand?", which reviews the ever-changing pro- and anti-Keynesian debates. Parkin supports the real-business-cycle approach and believes it has been misunderstood and misrepresented. He suggests that it is not so important "which [policy] instrument [is assigned] to which target, with what intensities and timing" but rather, he thinks that what is important is the details "concerning the way in which policy makers react to the evolving economy and the ways in which alternative institutional arrangements . . . operate to stabilize the economy." People magazine could not have said it better.

J. Stuart Wood Loyola University, New Orleans