Understanding business cycles

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Understanding Business Cycles*1

Why is it that, in capitalist economies, aggregate variables undergo repeated fluctuations about trend, all of essentially the same character? Prior to Keynes' General Theory, the resolution of this question was regarded as one of the main outstanding challenges to economic research, and attempts to meet this challenge were called business cycle theory. Moreover, among the interwar business cycle theorists, there was wide agreement as to what it would mean to solve this problem. To cite Hayek, as a leading example: [T]he incorporation of cyclical phenomena into the system of economic equilibrium theory, with which they are in apparent
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Yet the situation is symmetric. If the business cycle theorists were correct, the short-term manipulation on which much of aggregative economics is now focused only diverts attention from discussion of stabilization policies which might actually be effective; such postponement is, moreover, accompanied by the steady and entirely understandable erosion in the belief on the part of noneconomists that aggregative economics has anything useful to say.


u naersrn na mg tHtsnzess Lyctes In the next section, I will review some of the main qualitative features of the events we call business cycles, and then turn to the Keynesian response to these facts, to the progress made along the line Keynes and Tinbergen initiated, and finally to the severe limits to this progress which have now become apparent. The remainder of the essay will consider the prospects of accounting for cyclical phenomena by an economic theory, in the narrow sense in which Hayek and other business cycle theorists have used that term.

R. E. Lucas, Jr.


II Let me begin to sharpen the discussion by reviewing the main qualitative features of economic time series which we call "the business cycle." Technically, movements about trend in gross national product in any country can be well described by a stochastically disturbed difference equation of very low order. These movements do not exhibit uniformity of either period or amplitude, which is to say, they do not resemble the

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