Günter Gabisch

Preface of Mr. Paolo Cecchini

The prospect of the European Community developing by 1992 into an area without internal borders sets the background for all the ongoing debate about the future of Europe. Primarily the aim is to finally honor the pledge undertaken in the Treaty of Rome to implement the four basic Community freedoms of movement of persons, goods, services und capitals. After thirty years of efforts, the 1992 programmme, if successful, will deliver the foundation of the further stages of what Walter Hallstein described as the Community three stages rocket: first stage the common or internal market, second stage the economic union, third stage the political union.

Europa 1992 — Chancen und Risiken

Eines der grosen Themen, die die Menschen in Europa seit langem bewegen und auch noch in Zukunft bewegen werden, ist sicherlich die fortschreitende wirtschaftliche — und naturlich auch politische — Einigung der europaischen Lander. Wie aus den Medien bekannt ist, soll mit Ende des Jahres 1992 der europaische Binnenmarkt im Rahmen der EG vollendet sein, was die Vater der EWG mit den Romischen Vertragen aus dem Jahre 1957 zu erreichen beabsichtigten, soll dann sozusagen seinen kronenden Abschlus finden.

Complex Motion in Business Cycle Models

The models described in the preceding chapters have been analyzed by means of mathematical techniques which belong to the nowadays standard and basic knowledge in the theory of dynamical systems. While the Poincare-Bendixson theorem, the special features of the van der Pol equation or the Lienard equation etc. have been used for a fairly long time especially in engineering problems, it is the introduction of these concepts into economics which is relatively new. In this sense, it may be appropriate to label the techniques used in Chapter 4 as classical methods.

Fluctuations in Major Economic Variables

Business cycle theory deals with approaches to describe and explain observable fluctuations in major economic variables like the national product, the employment rate, or the inflation rate. Its aim is to establish necessary and/or sufficient conditions for the existence of more or less regular oscillations in a model economy. As a theoretical model is always an abstract picture of real life, business cycle theory concentrates only on the modelling of common patterns of empirical fluctuations and attempts to isolate those essential ingredients in a model which are responsible for an oscillating behavior of a model’s variables.

New Developments in the Theory of Dynamical Systems

The models described in the preceding chapters have been analyzed by means of mathematical techniques which essentially belong to the nowadays standard and basic knowledge in dynamical systems theory. While the Poincare-Bendixson theorem, the special features of the van-der-Pol equation or the Lienard equation etc. have been used especially in engineering problems for a fairly long time, it is only the introduction of these concepts into economics which is relatively new. In this sense, it may be appropriate to label the techniques used in Chapter 5 as classical methods.

Shock-Dependent Business Cycle Theories

The common feature of all models in Chapter 3 is that they can generate cyclical movements only for special parameter ranges. This may have two consequences for business cycle theory. Since in most models (at least in those of the linear accelerator-type) permanent oscillations occur only for exactly one parameter constellation, these models should be treated as having a classroom character because usually no empirical evidence for the existence of these magnitudes can be found.1 On the other hand, it is, of course, possible to concentrate on damped oscillations only and to make further assumptions on the occurrence of exogenous shocks. Aside from the argument that this does not provide a complete and consistent theory of the cycle, it should be noted that, abstracting from Hicks’ nonlinear accelerator, the solutions of all models of Chapter 3 behave in a sinusoidal manner with equal frequency and amplitude, which definitely does not fit the empirical facts. Thus a series of exogenous shocks which keeps the cycle alive is either timed in such a way that every single oscillation can fade away, or the shocks appear in such a way that the oscillations overlap in such a manner that it is impossible to trace the time path of an isolated oscillation. While this may be attractive from an empirical point of view, it is theoretically rather unsatisfactory because it leaves too much room for the arbitrary occurrence of exogenous shocks. Though it cannot be ignored that shock-dependent models of the cycle may be useful tools to describe actual cycles from time to time, it is theoretically desirable to construct models that are capable of generating persistent endogenous cycles without restrictive assumptions on singular parameter values.

Business Cycle Theory and Exogenous Shocks

As was just pointed out, the shock-dependent business cycle models of Chapter 3 require some kind of exogenously initiated disturbance of the system’s dynamics in order to generate permanent fluctuations in the face of otherwise damped oscillations. There are basically two ways of treating the occurrence of exogenous shocks: 1) Exogenous shocks are beyond the scope of abstractive economic reasoning and are thus considered as influences from a world outside of economics which cannot be analyzed by economists. While this attitude may be appropriate in many cases of economic theorizing, it is definitely unsatisfactory in business cycle theory because of the essential importance of exogenous influences. Nevertheless, it may be useful to investigate the dynamic behavior of shock-dependent business cycle models under certain assumptions about the occurrence (or anticipation) of exogenous shocks over time. Although the nowadays most popular Rational Expectations business cycle models do not differ from the multiplier-accelerator models in their dynamic structure, it is essentially the incorporation (or neglect) of these exogenous shocks in the individual expectation formation process, which constitutes a real innovation in business cycle theory. This special way of dealing with exogenous influences is the main reason why a single section (cf. Section 4.3.) is devoted to Rational Expectations business cycle models instead of describing those models in the appropriate Chapter 3. Exogenous influences, however, do not only have interesting consequences in the shock-dependent models. If the exogenous shocks do not occur in regular patterns, but can be interpreted as a series of random numbers, then it may be possible that the exogenous shocks themselves display cyclical behavior (cf. Section 4.2.1.) or that the anticipation of probability distributions may influence individual behavior which can lead to fluctuations (cf. Section 4.2.2.). As the stochastic aspect of the exogenous forces plays an essential role in these explanations of business cycles, it is appropriate to term these models “stochastic business cycle models”. 2) While the exogenous forces which drive the system are considered to be given and unexplained in the model at hand, it could be believed that economic theory may provide explanations of these forces using other approaches. This idea of partial theorizing, which is standard in economics, may also be applied to business cycle theory and can be justified in the face of the high complexity of an attempted general and comprehensive approach. For example, the so-called political business cycle models investigate the behavior of governments which try to exploit economically given constraints for re-election purposes. While these models basically provide autonomous explanations of the fluctuating of otherwise stationary economies, they may as well be interpreted as being explanations of exogenous forces in the shock-dependent models above, because the essential result of the political business cycle model is that governmental activities may not be counter-cyclical as proposed by Keynesian income theory. The presentation of these political business cycle models may also be useful because it forcefully demonstrates the difficulties in modeling comprehensive approaches which integrate economic, political, or social aspects of business cycles.