VictorBuzz

Introduction:

Observing how business conditions evolve reveals substantial but somewhat irRegular fluctuations concerning production, employment, prices, and most other Macroeconomic variables. Movements of these various magnitudes are mutuAlly linked and, to a large extent, due to common causes. The two preceding Chapters indeed concerned the phenomenon and its origins. They bore more Particularly on changes in output and in the rate of inflation. ButBut those two chapters did not exhaustively deal with the full phenomenon. then they did not intend to encompass all relevant variables. They neglected the Cyclical appearance of business fluctuations, an aspect which was on the conTrary often stressed and the focus of attention since long in the past. In order to Now complete our study, we must approach the phenomenon from a different Side.

The first element on economic fluctuations:

Changes in aggregate demand make the most obvious feature of the Business Cycle. In periods of expansion, demand increases strongly, stimulating rapid inCreases in production. Most often lack of equipment or available labor begins to appear after some time in particular industries or regions. The resulting excessive pressure of demand on some markets generates price increases and this tones down demand. Somehow the switchback, which initiates relaxation of the pressure on productive capacities, does not stop there: the reduction in demand accelerates with the onset of the pause, which then turns into a more or less serious depression. Finally, recovery follows when demand becomes firmer.

It has been observed for a long time that, among the different components Of aggregate demand, investment and accumulation of inventories fluctuate the Most4. The changes in these two components, therefore, play an essential role And should feature in any explanation of cycles. The first reason for those flucTuations in investment and inventories comes from the fact that, in the Short Run, the need for equipment and inventory holding is almost proportional to Production. So, firms have to invest and stock a lot when output increases Rapidly; they on the contrary feel little need to invest and they may even try To run stocks down when demand falls. Once started, any fluctuation in output Brings about a change which is relatively much greater in investment and acCumulation of inventories, and this accelerates the initial movement. We shall Devote the following section to a precise study of this.

Limitations of production capacity:

Behavior that affects the formation of aggregate demand thus seems to result in cyclical fluctuations. The above analysis, however, assumes that supply Constantly adapts to demand, without imposing any constraint on the latter This is obviously a simplification, and we must now come back to it. Indeed, We expect that, in phases where expansion is especially rapid, the degree of Utilization of productive capacity rises up to such a level that any additional Increase in output then becomes impossible. At the very least, if an additional Increase occurred, it would give rise to inflationary pressures, which would Interfere with the behavior specified so far.

Distribution of income:

First of all, we are now going to come back to simplifications which concern The distribution of incomes and allow us directly to replace real disposable Income with the volume of production. Assuming moreover consumption to depend only on the evolution of aggregate real disposable income, we could write Equation (4). We are now going to examine the two complications arising reSpectively from the discrepancy between output and real disposable income and from possible differences between the marginal propensities to spend various incomes.

The money market:

Pursuing at length now the tentative exploration of leads and lags implied by Aggregate demand analysis, as conceived in the 1960s, would quickly become Unconvincing. It is, however, interesting to still wonder whether the requireMent of the monetary equilibrium is likely to affect cyclical properties which Were so far based mainly on consideration of the goods market and of the income distribution. The question was approached in the 1950s, for instance by H. Minsky22. In the same spirit, we shall here admit that the money market Determines the nominal interest rate. We shall look, first, at fluctuations in the Demand for money, second, at the implications following from the assumption Of an exogenous and fixed money supply, third, at possible induced fluctuations Of this supply.