The trend path of output is the long-run path after short-run fluctuations are ironed out. The
business cycle describes fluctuations in output around this trend. Cycles last about five
years but are not perfectly regular.
A political business cycle arises from government manipulation of the economy to make
things look good just before an election.
Persistence requires either sluggish adjustment or intertemporal substitution. Persistence is
necessary but not sufficient for cycles.
The multiplier–accelerator model assumes investment depends on expected future profits,
which reflect past output growth. The model delivers a cycle but assumes that firms are
stupid: their expectations neglect the cycle implied by their own behaviour.
Full capacity and the impossibility of negative gross investment provide ceilings and floors
that limit the extent to which output can fluctuate.
Fluctuations in stockbuilding are important in the business cycle. The need to restore stocks
to original levels explains why output continues to differ from demand even during the
recovery phase.
Real business cycles are cycles in potential output itself. In such circumstances, it is not
desirable for policy to dampen cycles.
Some swings in potential output do occur but many short-run fluctuations probably reflect
Keynesian departures from potential output. Aggregate demand and aggregate supply both
contribute to the business cycle.
Increasing integration of world financial and product markets has made most countries
heavily dependent on the wider world. Business cycles in the rich countries are closely
correlated.
In 2001 central banks cut interest rates to prevent recession from spiralling. Japan’s
difficulty escaping from the deflation trap suggests that dampening business cycles remains
an important aim for other countries.
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