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Economic crises of various kinds (financial and commercial failures, crop failures or overabundance, etc.) have afflicted agricultural and industrial societies for centuries. Toward the mid-nineteenth century, however, it was becoming apparent that crises linked to industrial production were recurring with some regularity, with common features, and with approximate periodicity. While previous debates on such crises focused on the partiality or generality of “gluts,” the emphasis slowly started shifting from the explanation of individual crises (whose cause could be attributed to one or another historical accident) to the determinants of the general pattern. The theory (or theories) of crises gradually gave place to theories of the recurrence of crises, and eventually to theories of cycles.
The first stages in the transition were the recognition that crises tended to come in “waves” (Tooke 1823, vol. 1, p. 6), mainly described in terms of prices rising and abruptly falling instead of gently gravitating toward their natural level. The distinction of a number of phases regularly succeeding each other followed: Lord Overstone (1837) and S. Mountiford Longfield (1840), for instance, listed ten, but quickly the list boiled down to three to five. Then, estimates of the average period were formulated. An anonymous American reported in 1829 that “an opinion is entertained by many” that the average period of these “fluctuations” that “do take place, and … always will take place in countries, where paper money has been extensively introduced” is about fourteen years (pp. 303–304). In 1833 John Wade estimated it at about seven years, while a few decades later most writers agreed on a period of about seven to eleven years (see Jevons  1884, pp. 222–224; Miller 1927, pp. 192–193). The seminal intuition that the explanation of the whole sequence requires phases to be linked to each other seems to be due to Clément Juglar (1862). This now paved the way for theorists to look for a cause, set of causes, or at least some premises common to all crises.
During the latter part of the nineteenth century, however, the emphasis remained on crises. Whether conceived as anomalies and interruptions in the normally smooth working of the system, or as the result of intrinsic malfunctioning of industrial economies, crises—with the havoc they brought—remained the focus of theorists’ and practical people’s concerns. This is reflected in the asymmetry of the explanations, often focusing on the interruption of the phase of advance, in the asymmetry of the division in phases, and in the asymmetry of the cycle itself, as almost all authors stressed the abrupt and destructive character of the crisis as opposed to the gentleness of the recovery. This is also witnessed by the terminology of the time; in most languages, the subject was named “theory of crises.”
In truth, the terminology (especially in German, Italian, and French) was slow to adapt to the theoretical change that rapidly intervened at the turn of the century and was completed in the interwar years. In the hands of authors such as Mikhail Tugan-Baranovsky (1865–1919), Dennis Holme Robertson (1890–1963), Arthur Spiethoff (1873–1957), Albert Aftalion (1874–1956), and others, the explanation of the sequence of events became more and more detailed; the other phases were described not only as a launching pad for, or consequences of, crises, but as phenomena of interest on their own ground; and the focus gradually shifted from the crisis to the overall movement. Crises at first became the name of the upper turning point (Lescure , quickly followed by Aftalion  and Mitchell ), and eventually disappeared altogether. Finally, in the hands of the “econometricians” who formulated the first mathematical theories of the cycle in the early 1930s, the cycle became symmetrical, with an even number of phases, all of which were equally important in the overall sine-curve representation of the cycle. Gradual and smooth transitions from one phase to the next substituted for the violence and suddenness of the crises. The prevalent metaphor also changed: while in the prewar literature crises were frequently depicted as a disease of the system (the normal, healthy state of which corresponded to the prosperous phase), the analogy introduced by mathematical economists was that of the pendulum (or rocking horse).
The cycle was thus becoming a new phenomenon: no longer a sequence of crises, but an entity of its own. It became identified by related fluctuations (not necessarily synchronous nor simultaneous, lags were actually called to play a relevant role) in a number of variables, among which prices gradually lost importance (only to regain the center of the stage with the real and equilibrium business cycles theories). Accordingly, the cycle deserved a proper name of its own: the term cycle evokes the returning of the system to a same round of states. The attribute “business” seems to be due to Wesley Clair Mitchell (1874–1948), and reflects his institutionalist creed that the cycle is a phenomenon rooted in the nature of capitalist economies and his emphasis on processes rather than equilibrium. The expression was first used in a number of articles that appeared between 1909 and 1913 and was quickly established in the American literature after the publication of Mitchell’s Business Cycles (1913). The expression trade cycle was already in use in 1879 (Arthur Ellis); it appeared in an article title in 1902 (George Charles Selden), but became established in British usage after the publication of Frederick Lavington’s book with the same title in 1922. The term takes up the emphasis on “commercial crises,” widely spread in Britain, Germany (Handelskrisen) and France (crises commerciales).
Cycles and Equilibrium
Almost anyone who counted anything in economics in the first three decades of the twentieth century contributed to the debate on the causes of the business cycle. Not surprisingly, there are as many theories as there are economists, each emphasizing different mechanisms capable of explaining how the system could go out of gear. New doctrines were formulated, but some of those propounded in the nineteenth century were further elaborated. Among these doctrines are to be cited those relying on the mechanisms of credit and banking, which often blamed overspeculation, and especially the tradition focusing on the lack of demand with respect to supply, whether in the form of underconsumption or of overproduction. The denomination of these and other causes, with its stress on excesses or shortages, reveals the general attitude of arguing in terms of a comparison to some norm, not always explicitly identified but providing nonetheless a reference point.
Other authors focused on the development of vertical or horizontal imbalances, overinvestment, overindebtedness, or psychological mechanisms. The result is a plethora of causal explanations of variegated (and sometimes irreconcilable) character giving rise to currents of thought based on different views as to the working of the economic system, in particular between those who blamed the supply side of the economy and those who lamented the lack of sufficient demand. (For a still-classical classification of theories based on the alleged causes of cycles see Gottfried Haberler , who also attempted to synthesize what is good in these explanations.)
Parallel to the proliferation of cycle theories and models, the interwar years were also marked by reflections on the ultimate nature of crises and cycles and the possibility of theorizing the phenomenon. The divide between two mutually exclusive groups became apparent. On one side, the “orthodox” approach conceived of equilibrium as a state toward which the system ultimately tends. In this view, fluctuations can only be explained as the result of some external force temporarily maintaining the system in disequilibrium. Accordingly, the system’s rhythmic movement results from the variable’s tendency to return toward its “natural” state (or to move toward a new position, to become the “natural” one), perhaps with some kind of impediment (such as Aftalion’s construction lag) in response to an exogenous disturbance to equilibrium. The latter is the cause of the crisis, while the system’s structure determines the mode in which movement takes place. The “heretics,” on the contrary, believed that the economic system does not have an intrinsic tendency to move toward a position of rest (or a path of balanced growth), but tends instead to further depart from it. In this view, movement is the “natural” state of the system, and the problem is that of explaining how movement is constrained and why the system does not explode or collapse. The cycle results from endogenous forces, although exogenous events can be called to explain the specificity of individual cycles.
The “heretics” themselves (the terminology is due to John Maynard Keynes [1883–1946], who in 1934 claimed to be one of the dissidents) were keen to stress that the “orthodox” assumed cycles and crises away from their premises, and some clearly pointed out that this exclusion regarded the relationship of cycles and equilibrium (e.g., Keynes 1934; Löwe 1987; Bouniatian 1922). Two aspects were involved. One concerned the possible divergence between the individuals’ optimizing behavior and the system’s capacity of reproducing its own state. While most orthodox economists argued that the individuals’ maximization of utility or profit brings an overall satisfactory state of affairs by clearing all markets, a number of heretics argued that this is not necessarily so, and found in this divergence one of the possibility of crises.
The second aspect concerns the stability of equilibrium. The most explicit discussion is due to Adolf Löwe (1893–1995; name changed to Adolph Lowe), who argued that a theory of the cycle is impossible within the premises of equilibrium economics because “the structure of a process which is always in equilibrium over time cannot undergo any change by definition” ( 1997, p. 269); Löwe concluded that the presupposition of the stability of equilibrium should be rejected (see also Kuznets 1930). Friedrich Hayek (1899–1992) agreed that the logic of equilibrium theories (he referred to the general equilibrium theory as developed in Lausanne; the argument, however, applies in a wider sense) requires that the disturbances of equilibrium must come from outside. However, he disputed Löwe’s conclusion by arguing that the proper procedure is to examine how a suitable disturbance of equilibrium—in particular an expansionary banking policy—gives rise, by the operation of the fundamental forces tending to bring the system back to equilibrium, to permanent oscillations (Hayek  1933, pp. 42–43). Roy Harrod (1900–1978) dispensed with Hayek’s concern with the departure from equilibrium and, as Löwe, focused on the possibility and the persistence of disequilibrium. Harrod’s “instability principle,” that is, a destabilizing factor introduced at the outset, is a premise to the “very kind of explanation” required for a “rational account of the trade cycle” (Harrod 2003, p. 304; 1934, pt. 3).
The stability issue, in relation to the necessity of relying on exogenous factors, was also one of the main methodological issues among macrodynamic mathematical theorists, whose contribution was also notable for the introduction of modeling in terms of functional equations, linked to a definition of dynamics as the description of “how a situation grows out of the foregoing” (Frisch 1933, 1936). Michal Kalecki’s (1899–1970) mathematical model producing constant-amplitude fluctuations (1935) is perhaps the best-known case: it was criticized as being structurally unstable and dependent upon a special configuration of parameters (Frisch and Holme 1935). Ragnar Frisch (1895–1973), who had originally postulated that one should distinguish the impulse from the propagation problems (1933), suggested instead that Kalecki’s interesting model should be damped but kept alive by exogenous shocks. Kalecki struggled all his life with this problem, but failed to solve it to his own satisfaction. Nicholas Kaldor (1908–1986) criticized one of Kalecki’s attempts by arguing, similarly to Harrod, that equilibrium must be unstable if the system is to generate endogenous fluctuations (1940).
Richard M. Goodwin (1913–1996) showed that the problem of the persistency of fluctuations, to which Frisch’s proposal was a solution, is rooted in the assumption of linear relationships and incapable of giving rise to fully endogenous sustained cycles (1951). If this assumption is relaxed, it is possible to deal at once with cycles and growth (an issue dear to a number of interwar economists, particularly Robertson [1915, 1926] and Joseph Alois Schumpeter [1883–1950, from 1910]). In addition, persistent cycles consist in oscillations (or chaotic movement) around an unstable stationary state—precisely the point advocated, in more generic and intuitive terms, by the “heretics”—kept within bounds by endogenous or semiexogenous constraints, such as population or resources.
Equilibrium and real business cycle theories took a different route, reviving the “orthodox” approach by taking up two different threads: Hayek’s (Lucas ; who, however, eventually admitted  he had misread Hayek) and the impulse approach (more Slutsky’s  than Frisch’s; see Lines ). The cycle is viewed as the result of the economic agent’s rational reaction to signals, transmitted via the price system (in conditions of imperfect information, in the monetary business cycle theory) triggered by exogenous impulses coming either from the monetary system or the real economy (productivity shocks, in particular), respectively. The cycle is no longer the result of a tendency to equilibrium: each configuration of the system is understood as an equilibrium state—as defined by the rational expectations hypothesis.
The contrasts among contemporary business cycle theories therefore reflect the same fundamental conflict of views on the working of an economic system that has characterized the long history of attempts to explain fluctuations. Some believe depressions to be the result of frictions or to be caused by external forces or by mismanagement of the economy on the part of the government. Others, on the contrary, interpret them as the result of the intrinsic absence (or, at least, serious and systematic failures) of self-regulating properties of economic systems (to which, perhaps, only public intervention can give remedy). It would not seem that these lines of thought, relying not only on different worldviews but also on antagonistic methodologies and having different objects of research, can be reconciled. Perhaps this is all for the good of the discipline, for actual crises have always been the stimulus of fruitful theoretical debates, which can only thrive insofar as different viewpoints are held.
- Aftalion, Albert. 1913 Les crises périodiques de surproduction. 2 vols. Paris: Marcel Rivière.
- Anonymous (Condy Raguet?) 1829. Untitled report datelined Philadelphia, May 9. The Free Trade Advocate and Journal of Political Economy 1 ( 9): 303–304.
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