Understanding Business Cycles: Perspective from Stabilizing and Destabilizing Mechanism
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| Title | Understanding Business Cycles: Perspective from Stabilizing and Destabilizing Mechanism
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| Author | Gong Gang and Gao Yang |
| Organization | The School of Economics, Nankai University |
| Email | gongg@nankai.edu.cn |
| Key Words | Stabilizing and Destabilizing Mechanism; Business Cycles; Non-linear Macro-dynamic Model; Sticky Pricing |
| Abstract | We study economic fluctuation and business cycles from the perspective of stabilizing and destabilizing mechanism. While recognizing the existence of price adjustment as a stabilizing mechanism, whether there exist other mechanisms to destabilize the economy? We find that as earlier as in 1939, Harrod had already proved the existence of destabilization mechanism—the firm’s investment adjustment—by showing the knife-edge problem. For this, we construct a macro-dynamic model with investment and price as core macroeconomic variables: the investment function introduced in this model is derived from the investment optimization model constructed in Gong Gang and Li Yifu (2007); a dynamic optimization model is also constructed to derive the price function by following the sticky pricing of new Keynesian. Analysis shows that the interaction between stabilizing mechanism (price adjustment) and destabilizing mechanism (investment adjustment) generates fluctuation and business cycles for the economy. Yet, due to the sticky adjustment, the price adjustment as a stabilization mechanism may not be sufficient for the economy to be stabilized. In this case, the stabilization from government policy may become necessary. |
| Serial Number | WP487 |
| Time | 2013-06-26 |
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