The business cycle : traditional economics account of its central phenomenon is simply wrong

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Business Cycle / Economics

The dynamic of the business cycle is the central mystery of modern society. During the twentieth century we experimented with a variety of techniques to smooth out its ups and down. This century has brought a different problem – so called ‘secular stagnation’ – characterised by consistently lower growth rates. Bizarrely, the core models used by most mainstream economists have long been known by mathematicians to be incorrect, or at least to miss entirely the phenomenon they are meant explain. Cyclical instability, the central phenomenon of the economy, is missing from the economic models used by economists.

In other sciences adding a series of fiddle factors to a failed model to get it past evidential tests would be seen as fraud, in economics cheating leads to a Nobel prize.

Every model has its boundaries. Each covers a certain number of phenomena and leaves others out. The aim of every account of the business cycle should be to explain its characteristic qualities. The business cycle has irregular patterns of oscillations that vary over time in period and amplitude. They are neither completely regular nor entirely random.

For historical reasons conventional economics makes use of models with equilibrium at their heart. If the economic system were entirely self equilibrating then it would not generate cycles of any kind because if it were ever out of equilibrium the system would return directly to its equilibrium state and stay there. Economists have tried to address the problem by introducing the concept of external ‘shocks’. They imagine the equilibrium of the economy is disturbed by a series of external factors generating the kind of wave pattern we see in real world business cycles.

Example Business Cycle

Unfortunately we know that this can not be a correct account. According to mainstream models the shocks on the economy are disordered. They are a random input signal. Mathematics tells us that equilibrium systems can’t generate ordered outputs from random and disordered inputs. The signal might be transformed in some way by the equilibrium system but it would remain random. The only way an equilibrium system can produce an ordered wave output is to have ordered inputs.

The business cycle we are attempting to explain is far from random. We thus have two options: accept that the economy is not an equilibrium system; or assert that the external shocks to the system are ordered.

If we take the second option the mystery of the business cycle shifts entirely outside the model. We can not claim to have explained the business cycle by creating a model essentially incompatible with it and then declaring the phenomenon inexplicable. That is the position of a religious cult not a scientific enterprise.

If we take the first option we have to reject the equilibrium model at the core of most economic models. Mainstream economists are loathe to abandon this metaphor for the economy because their mathematical apparatus depends upon it.

If they jetison the concept of equilibrium the bulk of the books in the standard economics library go with it. So they continue to use them – like the drunk that looks for his car keys under the streetlight rather than where he last saw them – they allow the qualities of the tools available to them to determine how the world must be.

Such is the attachment of mainstream economists to the mathematical apparatus of static equilibrium that the discipline has fought tooth and nail to retain it. The result is a rich theatre of distraction. There have been attempts to replicate the behaviour seen in real economies within equilibrium models by incorporating time delays, dynamics and less than than perfectly rational agents. These are empty auxiliary hypotheses added for the sole purpose of drawing attention away from the discipline’s failure to deliver on its own raison d’etre.

In other sciences adding a series of fiddle factors to a failed model to get it to pass evidential tests would be recognised as the shameless fraud it is. When this cheating becomes the norm it indicates the need for the kind of fundamental change we call a ‘paradigm shift’. In economics on the other hand, these tricks lead to a Nobel prize. Economists continue to put the essential stability of the economy at the centre of the discipline. Nevertheless its the unstable cyclical nature of the economy that remains the burning interest of the tax payers who fund their economics faculties.

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