Long Dark Shadows or Innovative Spirits? The Effects of (Smoothing) Business Cycles on Economic Growth: A Survey of the Literature

Abstract

It is argued that fiscal policy can play a part in preventing a possible downward spiral or be instrumental in achieving a higher long-term path of growth. Never before has this argument been advanced as frequently as in the current economic crisis. However, the economic literature -an overview of which is given here -does not provide an unambiguous answer, either theoretically or empirically, to the question of the relationship between (the smoothing of) cyclical fluctuations and long-term growth. In this context, two main contrasting explanatory paradigms can be identified: Schumpeter's concept of creative destruction and the learning by doing hypothesis. Even if it were possible to identify the relationship more clearly on this basis, it is important not to lose sight of the problems associated with the real-time assessment of the current economic situation, time lags and political economic incentives even in difficult times.

Unemployment Insurance and the Business Cycle: Should Benefit Entitlement Duration React to the Cycle?

“…Learning by doing. Productivity can depend on the state of the economy or the labor market due to some hysteresis or "learning-by-doing" mechanism as described in, for example, Aghion and Saint-Paul (1998), Ball (2009) or Priesmeier and Stähler (2011). Indeed, if this mechanism is strong enough, we find that procyclical policy may be optimal even for an economy with a fairly flexible labor market, such as the United States.…”

Macroeconomic Stabilization and Long-Term Growth: The Role of Policy Design

“…However, the endogenous growth literature provides an ambiguous answer to the question of the relationship between (the smoothing of) cyclical fluctuations and long-term growth. In this context, one can identify two contrasting explanatory paradigms, both reflecting the two different approaches for the modeling of endogenous technological change: the one following Schumpeter's concept of creative destruction and the other based on the learning-by-doing hypothesis (see Priesmeier and Stähler (2011)).…”

“…Inspired by this new perspective, a strand of the subsequent growth literature dealt with the question of whether stabilization policies reduce or enhance long-term growth (see Priesmeier and Stähler (2011), for a literature survey). However, there has been no consensus in this literature regarding the sign of the relation between short-term stabilization and long-term growth.…”

Volatility in European regions

“…Interest in GRV derives both from its negative relationship with long–run growth (for a review see Priesmeier and Stahler ), and from the welfare cost associated with business cycles (for a review see Imrohoroglu 2008). However, while the GRV of countries has been investigated by many researchers (starting from the pioneering contribution by Ramey and Ramey ), the volatility of European regions has received limited attention, despite potential key policy implications as follows: the opportunity to support the dynamics of regional output specialization deriving from European integration (Krugman and Venables ); the effectiveness of public expenditure and monetary policy in stabilizing business cycles (Hansen ; Goodfriend and King ); the role of European Monetary Union (EMU) in exacerbating regional shocks (De Grauwe ); the design of more flexible European labour markets in order to increase the capacity to absorb shocks (Nickell and Layard ); and, finally, the effects of increasing financialization of European economies, which is held by some scholars to lead to deep negative fluctuations (Epstein ; Freeman ).…”