The Interdependence of Business Cycles and Economic Growth

In macroeconomics, business cycle fluctuations and long-term growth perspectives are usually studied separately. Thus, when attempting to indentify business cycles, business cycles and growth are generally considered to be independent of each other. Standard theoretical models usually look exclusively at either business cycle fluctuations or long-term growth.

This strict separation is a result of the prevalent view held in macroeconomics that business cycle fluctuations do not affect long-term growth and vice versa, which implies that monetary and fiscal policy stabilization measures have no medium- or long-term effects. This view has, however, never really been substantiated. The consequences of this view are that highly relevant macroeconomic questions are rarely studied and that there are no appropriate tools with which to study these questions theoretically. Examples of such questions are: to what extent can the stagnation in the large continental European economies be attributed to monetary policy, to what extent can the increase in unemployment in these economies in the 1980s and the early 1990s be attributed to the strong and sustained decrease in inflation during that period, and to what extent did monetary policy engender the prolonged boom in the U.S. in the 1990s, on the one hand, and deflation in Japan during the same period (called the lost decade in Japan)?

Knowing the answers to these questions is of great importance for achieving such macroeconomic goals as long-term growth, full employment, and stable prices. Thus, this project aims at providing a unified framework with which to analyze the interdependence between the business cycle and growth, and thus to provide a framework with which to be able to answer these questions.

To do so, we will first examine the interdependence between the business cycle and growth empirically. We will estimate the extent of this interdependence in an international context using empirical methods, whereby we will give special attention to the empirical analysis of developments during the Great Recession, as numerous countries were obviously affected simultaneously during this recession by large fluctuations in the business cycle and changes in their long-term growth perspectives. The goal of the project, from a theoretical point of view, is to develop a model framework that will make it possible to analyze the business cycle and growth in a unified manner using modern macroeconomic theory. Using this framework, we intend to analyze the effects of monetary and fiscal policy stabilization measures on the business cycle and growth with a view to answering the above questions.