Professor Alvin Hansen, one of the most distinguished American students of business cycles, once reported that between 1795 and 1937 there were 17 cycles of an average duration of 8.35 years. A shorter “inventory cycle” of 40 months’ duration was also found, as well as longer cycles associated with building booms (15 to 20 years) and major innovations (40 to 50 years).
Classifying and describing business fluctuations does not account for them. The theory of the business cycle was once treated as a thing apart from the main body of economics; dozens of theories were spawned to explain each kind of real of imagined cyclical regularity. Many of the greatest economists of the 1930s – Gottfried Haberler, Wesley Mitchell, Alvin Hansen, Joseph Schumpeter – wrote books with titles such as Business Cycles and Prosperity and Depression, and the topic was considered a special branch of economic analysis. Today, business fluctuations are treated as part of, not separate from, macroeconomic theory. They are the dynamic aspects of the theory of income determination. While housing expenditures, inventory investment, and investments in new processes may all be cyclical phenomena, they are also forms of expenditure that affect aggregate demand. So, too, is consumption.
Why does the economy undergo business fluctuations? It seems apparent from the behavior of the economy that some elements of aggregate demand must be continuously changing. Such a situation would cause the equilibrium level of national income to be changing continuously and would cause the actual level of national income to be moving in pursuit of this equilibrium income.
What are the possible sources of these continuous disturbances? The theory of income determination suggests four main candidates – shifts in each of the four main components of aggregate demand: consumption, investment, government expenditure, and exports.
What about government expenditure, which is today a large component of aggregate demand? World War II brought a rapid expansion of economic activity, and government spending was a major contributing factor. Wars always result in an enormous increase in federal governmental expenditures as men and materials are shifted from civilian to military purposes, a shift that is then reversed in the postwar period. For example, federal government purchases of goods and services rose from $683 million in 1939 to $4,978 million in 1944 and continual short-term fluctuations around its long-term rising growth trend.
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