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Shackle on the Business Cycle
Shackle (1938) regards his cycle theory as being more like the one Keynes was moving towards than the 'Keynesesque' neoclassical multiplier-accelerator interaction models (see Shackle 1967, p.266). He attempted to provide an integrated theory of the multiplier and the investment process in a model with interdependent markets and sectors. Shackle (1967, Ch. 14) later drew a strict distinction between the income-expenditure (Kahn) multiplier, the accelerator and the input-output multiplier. He stressed that underlying the Kahn multiplier is the interdependence of all sectors and components of the economy and that this entails a less mechanical multiplier-accelerator interaction than that expounded in Keynesesque models. Goodwin's work, which develops these ideas, is discussed in the next section. By combining the Kahn multiplier with a Schumpeter-like clustering of innovations and a Duesenberry-type consumption ratchet effect, Shackle (1938) is able to derive an essentially endogenous theory of the cycle.
Like many other cycle theorists, Shackle was primarily concerned with explaining the major or Juglar cycle, which seemed to be prevalent in the United Kingdom, and implicitly accepted that the minor or Kitchen cycle was an inventory cycle. At the outset he makes it clear that economic decisions are made under uncertainty, rather than risk, in the sense of Keynes (1936) and Knight (1921). Consequently economic conduct is not completely rational but, he argues, this does not imply that economists cannot theorize rationally about it. Nevertheless, he notes that there is a tendency to draw the opposite conclusion and that this has led to a preference for the Walrasian equilibrium framework. We might add that latterly it has led to the widespread adoption of the rational expectations hypothesis and equilibrium business cycle modelling. In the Shackle tradition, the New Keynesian school is making renewed efforts to develop disequilibrium business cycle models in which decisions are made under uncertainty.
Shackle (1938) in fact presented two theories of the cycle. One is a theory, closely related to the work of Schumpeter, in which a bunching of innovatory investment initiates a cycle in which the income-expenditure multiplier and induced investment also figure prominently as a result of the interdependence of sectors of the economy. The other is an attempt to develop the General Theory's insights using what Shackle calls Swedish sequence analysis. The General Theory had concentrated on explaining underfull employment equilibrium. It had not proceeded to develop a dynamic theory of the cycle, though Keynes believed that he had laid the foundations for one by developing Kahn's income-expenditure multiplier idea.
In 1936, fired by the Myrdallian idea of ex ante and ex post and a belief in the vital role of expectations, Shackle tore up a year's work on the Austrian theory of capital and began to study the new (post-General Theory) Keynesianism in the light of the new Wicksellianism. The resulting doctoral thesis formed the basis of Shackle (1938). Shackle did not regard the two theories contained therein as being mutually exclusive.
Shackle viewed Keynesesque multiplier-accelerator theory as retrograde because it incorrectly attempted to replace the concept of an equilibrium point with an equilibrium trend or cycle and to dispense with the use of outside influences to explain the cycle. However, in a stochastic world, which Shackle clearly believed in, nonlinearities are required to generate an endogenous cycle. What Shackle was probably trying to highlight was that the essence of the General Theory was the instability of investment that resulted from its dependence on unexplainable expectational variables. He stressed that Keynes's system was essentially open in the sense that it was subject to both exogenous shocks and internal shocks which affected functions and parameters. The investment decision was regarded as nonrational (not irrational) because of its dependence on expected profits and the unknowable future, even to the extent that investment can be expressed as a function of the interest rate. Shackle noted that the rate of interest itself is a function of the expected interest rate (1967, p.247) because of the speculative motive for holding money. The General Theory itself, Shackle observed, has little to say about how expectations are formed under uncertainty, regarding them as a free autonomous variable.
Shackle concentrates on investment as the key to understanding the business cycle and stresses the importance of expectations formation under uncertainty as an influence on investment decisions. In this respect his work is consistently Myrdallian. It is a world where:
People must find out, compare and decide before they act; then register results and make fresh plans and decisions. (1967, p.270)
Shackle's Schumpeterian theory is based on the bunching of innovations and its impact via the income-expenditure multiplier. Shackle observes that businessmen are less confident and exact in their expectations following a large scale change wrought by a major investment. Past experience provides little guidance and consequently, following a new investment, businessmen need a learning period to explain new possibilities and develop new plans. In this period they are essentially involved in ensuring that the new system is managed efficiently. Monetary influences are also important. Having undertaken new investment, firms will be highly geared and face financial constraints on further expansion. Individual businesses are, therefore, likely to show alternating periods of growth and constancy of physical equipment, an improvement phase being followed by a testing phase. If the phases of the majority of businesses 'cluster' then cyclical variation of aggregate investment will follow. To explain the clustering, Shackle invokes the interaction of multiplier and induced investment. The latter is not based on a fixed coefficient accelerator, which Shackle rejects as unrealistic, but is influenced by input-output interaction. The clustering of investment activity leads to a rise in construction costs and the price of capital which eventually chokes off the boom.
Shackle believed his Myrdallian theory to be more interesting. Following a rise in autonomous investment, perhaps due to a burst of innovatory investment, there is a multiplier-based expansion leading to induced investment which has further multiplier effects and so on. The process can only continue, Shackle argues, as long as the multiplier effect is unexpected, for once it comes to be expected net investment will have reached a maximum because there will be no further unexpected increase in aggregate income to induce an increase in it. The failure of net investment to accelerate will eliminate the multiplier effect and, with growth reduced, investment will fall and a downswing will ensue. The whole cycle is explained by changes in expectations which are generated continuously by the effects of former changes. Investment is again the key variable. The multiplier-induced expansion, which follows the rise in autonomous investment, causes an unexpected improvement in business outlook and induces a further increase in investment. The accelerator effect therefore does not mechanistically depend on the capital-output ratio, as did Harrod's (1936) 'Relation', but is the consequence of business psychology.
Even though Shackle is not seeking a fully endogenous theory of the cycle, he states:
The business cycle is much more akin to fatigue than to disease in that it is not an exceptional or accidental occurrence but part of the nature of a modern industrial economy. (1938, p.5)
The theory is, however, endogenous in the sense that the most important shocks are the internal ones that lead to shifts in businessmen's psychology, rather than the external or exogenous shocks that drive Frisch-Slutsky-type cycle models.
Shackle's Schumpeterian theory is based on the idea that there is a 'leaping fountain' of investment opportunities due to a continuous stream of inventions which provide innovatory opportunities. At some point some entrepreneurs will act to take advantage of these opportunities because of a shift in their expected profitability. Once autonomous investment increases the multiplier comes into play and causes bunching and the cycle follows. There does seem to be a risk that the cycle could stick at the floor for some time if expectations concerning profitability remain depressed. The Wicksellian theory requires an initial rise in autonomous investment and, to the extent that this is a result of a burst of innovatory investment, the two theories can be integrated. Shackle is more optimistic than Keynes, who sees a 'stagnating pool' of investment opportunities (Keynes 1936, Ch.17). There may, however, be some stagnation in times of recession, when pessimism prevails, and this may lead to a protracted depression.
Expanding on his theory, Shackle identifies two types of industry: one producing consumption goods and the other investment equipment. The expansion phase is initiated by a shift in expectations leading to investment. Workers are taken on, consumption expenditure rises and there is a multiplier effect. This leads to induced investment by the consumption industries and a secondary multiplier effect and then to increased demand for the products of the equipment industries and induced investment by them. A third multiplier effect results and so on. In the Schumpeterian theory the upswing ends when the price of capital rises as a result of bunching and the process goes into reverse, causing a downswing. Alternatively the multiplier loses its impact once it comes to be expected, as in the Wicksellian theory.
Shackle postulates that the downswing is unlikely to witness an equiproportional decrease in the activity of the equipment and consumption industries because a Duesenberry-type ratchet effect will prevent consumption falling as fast as income. Investment will, therefore, fall more rapidly than consumption. He notes that because of the ratchet effect the expansion and contraction phases are likely to be asymmetric. Shackle therefore identified, at an early stage, the importance of nonlinearities for explaining the observed asymmetry of business cycles (see also section 1.3).
As the recession persists two processes are ongoing. Entrepreneurs are gradually overcoming the disappointment of their expectations in previous crises, and foreseen and unforeseen events are changing their economic outlook. To the extent that they influence business outlook, the unforeseen events or external shocks play a role in Shackle's theory. With the accumulation of new apparent opportunities and the return of the desire to exploit them there is an increase in investment and the recovery gets under way. The foreseeable events include demographic changes, improvements in infrastructure, and innovation. The unforeseeable events include political crises, disasters and windfalls, and inventions. Inventions are seen as the primary source of the fountain of continually changing opportunities. Shackle identifies two types of invention: new consumables and technology changes.
Shackle's integrated Schumpeterian-Wicksellian theory, therefore, consists of a boom generated by the interaction of induced investment with the income-expenditure multiplier and the clustering of inventions. It comes to an end as the price of capital rises due to the clustering, the most profitable investment opportunities are exhausted, and the multiplier comes to be expected. The interaction of the multiplier and induced investment, through input-output interaction, can explain the clustering. The Wicksellian theory, Shackle feels, needs help to explain the upturn, while the Schumpeterian theory may need help to explain the downturn. The integration of theories helps to overcome their weaknesses.
Shackle concludes by presenting a number of alternative (to the consumer-expenditure ratchet effect) explanations of asymmetry. One is based on the idea that the marginal propensity to consume will decline during the boom and that as the peak approaches the multiplier will be small for increases in income but large for decreases, with the reverse holding in the trough. Another explanation revolves around the behaviour of the banking system which will have a strong incentive to reduce its outstanding loans when the boom busts. As a consequence banks are likely to raise their interest rates and put pressure on debtors to reduce their expenditure. This will further discourage investment. The boom starts with a return of courage and desire for entrepreneurial activity. During the depression, technical progress will have rendered some capital obsolescent. The equipment industries will initially have spare capacity and the supply of capital goods will be elastic. Individuals will have increased their monetary balances as a result of the speculative motive and banks will be looking for lending opportunities. Credit will, therefore, be cheap and the price of capital will be low and expected to remain so, at least in the short run, and modernisation will be required. Cumulative recovery and boom, based initially on cheap bank credit pending the issue of new securities, can therefore be expected.
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