Numéraire
Volume the Nineteenth · of the table of twenty-six
The Aggregates · Group V · № 19 · Cy

The Cycle

boom, bust, idleness

The cycle is the second of the aggregates, and the dark companion of the first. Growth is the long upward trend of the whole economy, the slow climb of output across the generations; the cycle is the deviation from that trend — the recurring lurch between boom and idleness that the smooth ascent of growth conceals. Pull back to the economy taken whole, and one sees not only that it grows but that it stumbles: that activity surges and then collapses, that factories run flat out and then stand silent, and that the same economy which cannot make enough in the boom cannot, in the slump, find work for the millions who want it. That last fact is the central scandal of the cycle, the thing a theory of it exists to explain: involuntary unemployment, the willing worker who, at the going wage or below it, can find no work at all. For more than a century the orthodoxy held that this could not happen — that supply creates its own demand, that a general glut is impossible, and that the economy left alone returns of itself to full employment. The volume traces how that orthodoxy was overturned: how the multiplier gave demand its leverage over output, how the financial system and the quantity of money were found to drive the lurch, and how, at the last, the economy was shown able to settle into an equilibrium of mass idleness from which no market force can rouse it. The aggregate economy, it turns out, does not behave like a single market that clears; it can come to rest with willing hands idle, and the slump is not nature's doing but a failure of the whole to demand the work that all stand ready to do.

in print · № XIX · 12 of 12 plates
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The argument of the volume

Begin with the orthodoxy the cycle had to overcome, for the modern theory is best understood as its overturning. Jean-Baptiste Say gave his name to the doctrine that supply creates its own demand: that the making of a thing pays out exactly the income needed to buy it, so that production and the power to purchase are two sides of one coin, and the economy as a whole can never lack buyers for what it has made. From this it followed that a general glut is impossible, that the economy tends of its own accord to the full employment of its resources, and that unemployment can only be voluntary or frictional — for a surplus of workers, like a surplus of any good, would drive its price, the wage, down until the surplus was hired. Persistent, mass, involuntary unemployment was a theoretical impossibility. And then the Great Depression set a quarter of the workforce idle for years, desperate for work at any wage, in flat defiance of the theory. The cycle was the anomaly the orthodoxy could not contain, and explaining it would mean dismantling Say's Law.

The dismantling proceeded in stages. Richard Kahn made precise the multiplier — the chain by which a change in spending ripples through the economy, each round becoming income that is partly spent again, so that a small shock swells into a large swing in output and employment; and from it came the paradox of thrift, that if all try to save more at once, demand falls, income falls, and saving itself may not rise, so that the prudence of the household is the ruin of the nation. This is the fallacy of composition, and the reason the economy as a whole is a science apart from its parts. The multiplier explains how a shock is amplified, and debt-deflation, taken up in a later plate, how the slump that follows can feed upon itself; two further plates ask where the shock comes from. Hyman Minsky found it within the financial system itself: in good times confidence builds and debt mounts, finance sliding from safety into fragility, until the tower of leverage topples and the boom reverses into a panic — so that stability itself is destabilizing, and the seed of the slump is planted at the height of the boom. Milton Friedman and Anna Schwartz found it instead in money: the Great Depression, they showed, came with a collapse of the money supply by a third, which the central bank could have prevented and did not, so that the catastrophe was a failure of policy rather than of the market — the great rival to the demand-centered account.

All of this leaves the deepest question, the one Say's Law declared could not arise: why does a shortfall of spending produce idle workers, rather than merely lower wages and prices that restore full employment? John Maynard Keynes answered it, and the answer is the deepest inversion in macroeconomics. Output, he showed, is governed by effective demand, the total spending of the economy, which can fall short of what full employment requires; and where it falls short, firms produce less and hire fewer, the rest of the workforce standing idle — not in a passing disequilibrium but in a settled equilibrium, with no force within the economy to right it. Nor will falling wages cure it, for the wage is not only the firm's cost but the worker's income, and the income of workers is the source of most demand; cut wages across the economy and demand falls with them, so the labor market, unlike the market for any single good, cannot clear by a falling price. The willing worker is idle, then, not by choice nor by friction nor by any wage he refuses, but because the economy together does not demand enough to need his labor — involuntary unemployment in the strict and bitter sense. The cure is to restore the missing demand, and since in a slump no private party will spend, the one actor that can is the government, spending against the tide to fill the gap. So the cycle hands to the family's remaining motions its unfinished questions: what becomes of the value of money as demand swings, which is the level; and how the burden of the bust and the spoils of the boom divide between labor and capital, which is the share.

The argument remains open. What follows is an attempt to fix its exact edges.

The twelve plates of this volume

  1. i The Lawin print Say; supply creates its own demand, so a general glut cannot occur and the willing worker need never be idle for long. Read the plate →
  2. ii The Glutin print the general-glut debate; Malthus against Ricardo, and the question whether demand can fail for the economy as a whole. Read the plate →
  3. iii The Multiplierin print Kahn; a change in spending ripples and multiplies through the economy — and the paradox of thrift, where the prudence of each is the ruin of all. Read the plate →
  4. iv The Maniain print Minsky; stability breeds the fragility that ends it, as debt mounts in the boom until the tower of leverage topples. Read the plate →
  5. v The Contractionin print Friedman and Schwartz; the Great Depression as a collapse of money the central bank could have prevented — the monetary rival to Keynes. Read the plate →
  6. vi The Spiritsin print animal spirits; the volatility of investment under irreducible uncertainty, and what governs it when the future cannot be known. Read the plate →
  7. vii The Stickinessin print wage and price rigidity; why wages do not fall to clear the labor market, and why the classical self-correction fails. Read the plate →
  8. viii The Idlein print the capstone: output is set by effective demand, which can fall short, so the economy can rest at an equilibrium of involuntary unemployment. Read the plate →
  9. ix The Spiralin print Fisher; debt-deflation, where falling prices raise the real burden of debt and force the selling that drives prices lower still. Read the plate →
  10. x The Shockin print real business cycles; the new-classical claim that booms and slumps are the economy's efficient response to real shocks, and idleness a choice. Read the plate →
  11. xi The Stabilizerin print stabilization policy; the state spending against the tide to fill the gap in demand, and the debate of activism against rules. Read the plate →
  12. xii The Scarin print hysteresis; how a deep enough slump can leave a permanent wound, so that the cycle alters the very trend it deviates from. Read the plate →

In closing

This volume took up the second of the aggregates, the cycle — the deviation from growth's long trend, the recurring lurch between boom and idleness, and above all the scandal of involuntary unemployment that the lurch leaves in its wake. Its subject was the question macroeconomics was born to answer and has never fully settled: why a willing worker, ready to labor at the going wage, can find no work; and its starting point was the orthodoxy that held such a thing impossible.

The volume followed the cycle from that orthodoxy to its overturning. Jean-Baptiste Say gave the doctrine that supply creates its own demand, so that a general glut cannot occur and the economy returns of itself to full employment — the view the Great Depression refuted in plain sight. Richard Kahn made precise the multiplier, by which spending ripples and multiplies through the economy, and the paradox of thrift, by which the prudence of all becomes the ruin of all — the fallacy of composition that makes the economy a science apart. Hyman Minsky located the cycle's source in the financial system, whose long calm breeds the fragility that ends it, so that stability is destabilizing and the boom carries the seed of the bust. And Milton Friedman and Anna Schwartz located it in money, showing the Great Depression to have come with a collapse of the money supply that the central bank could have prevented — a failure of policy, not of the market, and the great rival to the Keynesian account. Irving Fisher, finally, traced how a slump deepens once it is under way: the falling prices of the bust raise the real burden of the debt the boom has piled up, forcing the distressed to sell and so pressing prices lower still — the vicious spiral by which a downturn becomes a depression.

And then the volume found, beneath all the mechanisms, the deepest truth of the cycle. John Maynard Keynes showed that output is governed by effective demand, which can fall short of what full employment requires; that the economy can therefore settle at an equilibrium with willing hands idle, and stay there; and that the falling wage which was supposed to cure unemployment instead shrinks the demand that is everyone's income, so that the labor market, unlike any single market, cannot clear by a falling price. The willing worker is idle not by choice but because the economy together does not demand enough to need his labor — and the cure is for the government to spend the missing demand when no private party will. This is the central scandal the cycle exists to confront, and the deepest reframing in macroeconomics: that the whole does not behave like the part, and an economy of rational, market-clearing individuals can nonetheless waste the labor of millions who would gladly work. The cycle is growth's dark companion: growth the long trend, the cycle the tremor around it, and a deep enough tremor can scar the trend itself. Two motions of the aggregate remain. As demand swings between boom and slump, what becomes of the value of money — the inflation of the one, the deflation of the other? That is the level. And as the slump idles the worker while the owner of capital endures it on other terms, how does the burden of the bust, and the bounty of the boom, divide between those who labor and those who own? That is the share.

The cycle's scandal is the willing worker who cannot find work — not for any wage he would refuse, nor for want of trying, but because the economy as a whole is not demanding enough to need his labor. Say held this impossible; Keynes held it the central fact of the slump. So the question the cycle leaves open is the one it was born to ask: why can a willing worker, at the going wage, fail to find a job?