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Recessions and Depressions: Understanding Business Cycles

Author(s):Knoop, Todd A.
Reviewer(s):Glasner, David

Published by EH.NET (October 2005)

Todd A. Knoop, Recessions and Depressions: Understanding Business Cycles. Westport, CT: Praeger, 2004. xiv + 289 pp. $55 (hardback), ISBN: 0-8018-8203-6.

Reviewed for EH.NET by David Glasner, Federal Trade Commission.

Like its subject matter, the study of business cycles is itself something of a cyclical phenomenon. Not surprisingly, attention to this branch of economics varies countercyclically with the overall rate of economic activity and procyclically with measures of economic distress such as unemployment, bankruptcies, and the like. Thus the volatile 1920s and the disastrous 1930s were a boon to business cycle theory and stimulated the first serious empirical studies of business cycles. Attention wandered in the prosperous decades after World War II, but the troubled period from the mid-1970s to the early 1980s stimulated another burst of intellectual activity focused on business cycles. But that stimulus, too, wore off and interest flagged in the late 1980s and most of the 1990s, with only an evanescent stock market crash and a short and shallow recession in 1991-92 to keep interest from evaporating totally. More recently, the rapid succession of crises in Mexico, East Asia and Argentina, followed by the bursting of the U.S. stock market bubble and the subsequent mild but lingering recession in the United States, with the intractable Japanese recession casting a lengthening shadow on the overall landscape have combined to cause another upturn in interest in business cycles. This useful book by Todd Knoop of Cornell College (in Mt. Vernon, Iowa, not Ithaca, NY), provides a historical survey of business cycles and of important business-cycle theories, as well as an up-to date (2003) survey of recent cyclical events.

The author explains in the preface that the book grew out of an upper-level undergraduate class in business cycles that he has been teaching for some time. Because there was no text available for such a course, Knoop began to type out and disseminate his class notes to students and eventually those notes were developed into the book under review, which is therefore aimed primarily at an audience of upper-level undergraduates. Specialists or advanced graduate students will find little in the volume that they don’t know already, but researchers in other areas who want a quick introduction to basic approaches to cycle theories or the main empirical issues related to business cycles may find the text to be of some value.

Knoop begins in Part I (Chapters 1-2) with a general descriptive overview of business cycle facts and terminology. In Part II (Chapters 3-9), Knoop turns to a survey of the leading business-cycle theories. In chapter 3, lightly touching on a number of the pre-Keynesian monetary and real cyclical theories, he presents at greater length a stylized version of a Classical macroeconomic model which, owing to its adherence to Say’s Law, can account for periods of generally falling employment and output, only by attributing them to misguided government policies or adverse economic shocks. In successive chapters, Knoop surveys the contributions of Keynesian, Monetarist, Rational Expectations, Real Business Cycle, and New Keynesian theories. Part III concludes with an excellent survey of macroeconomic forecasting. Part III is devoted to an historical and empirical survey of the Great Depression (chapter 10) and post-war business cycles (chapter 11), and then considers (chapter 12) whether our “new economy” is substantially less vulnerable to the business cycle than the “old economy.” Part IV surveys recent international business cycle experience: the East Asia crisis (chapter 13), the Argentine Crisis (chapter 14), and the Great Recession in Japan (chapter 15). Some concluding observations are offered in chapter 16.

Although the book is generally well written, it does suffer from sloppiness in thinking or editing, so that the exposition at times is obscure or confusing. On a more substantive level, I was troubled by tendency to present the basic business-cycle models in terms of overly simplified assumptions and categories. The resulting theoretical paradigms, particularly the Classical, Keynesian, and Monetarist models turn out to be strawmen rather than realistic presentations of historical models that real people actually believed in.

For example, the “Classical model” is characterized by perfect competition, a vertical short-run aggregate supply curve that determines real output with the price level determined by the quantity theory of money. Under the usual interpretation of Say’s Law, such a model pretty much rules out business cycles. This interpretation, by the way, is one of the most persistent misconceptions in the history of economic thought. No Classical theorist ever denied, as belief in Say’s Law presumably would have required, that there could be and were periods of acute and general economic distress, but there is no hint in Knoop’s presentation that there is a disconnect between his version of the “Classical model” and what Classical theorists actually thought about business cycles. And they really did think hard about business cycles or financial crises or periods of acute economic distress. Moving on to Keynesian theory, Knoop would have us believe that Keynes’s fundamental contribution was to recognize that the “classical” assumptions of perfect price and wage flexibility and continuous market clearing (neither of which were entertained by any classical theorist of whom I am aware) were not really valid, inasmuch as labor markets are only imperfectly competitive and workers are reluctant to accept piecemeal wage reductions. Keynes, of course, went to great lengths in the General Theory to prove (whether successfully or not is another issue) that even perfectly flexible wages could not achieve macroeconomic equilibrium under conditions of deficient aggregate demand. In the process, Knoop elides two decades of debate about the nature of the Keynesian model and the conditions under which a Keynesian underemployment equilibrium may or may not hold. It is not Knoop’s failure to summarize these debates that is troubling, but that he provides not even a hint of their existence. Instead we are told (p. 49) “Keynes believed that wages were not fixed, only sticky. If given enough time, workers will gradually reduce their nominal wage demands as they observe other similar workers taking nominal wage cuts. This will reduce real wages and move the economy back toward full employment. The problem with this approach, however, is that there are no assurances about how long the process will take. … In Keynes’s opinion, policymakers cannot afford to wait patiently for this process to work itself out in the long run because, in his words, ‘in the long run we are all dead.'” One is at a loss to know whether Knoop really believes that this is the key theoretical contribution of the General Theory, in which Keynes believed that he had advanced far beyond the insight of his famous observation (published twelve years before the General Theory in the Tract on Monetary Reform) about mortality in the long run, or whether such details of intellectual history simply don’t matter to the author.

According to Knoop, the Monetarist model assumes that wages and prices are perfectly flexible, but, since expectations are adaptive not forward-looking, wage and price adjustments are slower than required to maintain output and employment at their “natural” levels. It is possible to interpret Monetarism in this way, but it surely does not accurately reflect how most Monetarists believed that markets actually work. It appears that Knoop has projected backwards onto earlier paradigms a style of theorizing associated with more recent Rational Expectations, Real Business Cycle, and New Keynesian theories. In a way, this projection allows Knoop to highlight certain differences among his simplified paradigms. But in doing so, he mischaracterizes what the earlier models and disputes were actually about. Now it may be that Knoop’s evident sympathy for the New Keynesian explanations for sluggish wage and price adjustment have led him to overstate the importance of wage and price rigidity in the original Keynesian paradigm. Nevertheless, the belief that wages and prices are not flexible was not, as Knoop implies, the key difference that distinguished Keynesian from Classical or Monetarist economists.

Knoop’s discussion of the development of Rational Expectations, Real Business Cycle, and New Keynesian models seems to me generally more accurate, and more helpful than his treatment of the earlier paradigms. While his presentation of the newer models is even-handed, he does not conceal his preference for the New Keynesian models over the other two paradigms. While acknowledging that there are many New Keynesian models that focus on the macroeconomic implications of various sorts of market failure, Knoop attributes a greater degree of consensus about theory and policy than I think is warranted. In particular, I doubt his assertion (p. 109) that New Keynesians accept that there is single natural rate of unemployment and that there is no long-run tradeoff between inflation and unemployment. I would also observe in passing that, by demonstrating the link between market failure at the micro-level and aggregate demand failures that require remedial macroeconomic policy, the New Keynesians have unwittingly vindicated the insight embedded in the much reviled Say’s Law. It is, precisely as Say’s Law teaches, a failure of supply at the micro-level that triggers a cumulative failure of demand at the macro-level.

Although Knoop’s discussion of the Great Depression correctly highlights the recent research that shows that the Great Depression was largely the result of a breakdown of the international gold standard, he fails to note that this view of the Great Depression was espoused by a number of important economists at the time, most notably Ralph Hawtrey and Gustav Cassel. In fairness, however, it should be acknowledged that the early interpretations of the Great Depression as a breakdown of the gold standard have by now been largely forgotten. However, the exposition would have benefited greatly if it had included an explanation of the fragility of the post-World War I reconstruction of the gold standard and had discussed the destabilizing role of the huge post-war international transfers (repayment of U.S. loans to its wartime allies and reparations imposed on Germany).

To close on a positive note, Knoop’s discussion of the problems of macroeconomic forecasting, whether through the use of leading economic indicators, market indicators, or econometric models, is highly informative and insightful. The final chapters on recent international business-cycle experience are also generally well done. Despite occasional lapses in exposition, this book should be accessible to students, and they will gain a good deal of information about, and a fair understanding of, business cycles from reading it. However, this could easily have been a much better book than it is.

The views expressed by the reviewer do not necessarily reflect the views of the Federal Trade Commission or the individual commissioners.

David Glasner is editor of Business Cycles and Depressions: An Encyclopedia (1997). Later this year Cambridge University Press will publish the paperback edition of his book Free Banking and Monetary Reform.

Subject(s):Macroeconomics and Fluctuations
Geographic Area(s):General, International, or Comparative
Time Period(s):20th Century: WWII and post-WWII