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6.6 Business Cycles: Main Features and Stylized Facts

As we noted earlier, the main objective of macroeconomic analysis is to

provide coherent and robust explanations of aggregate movements of output,

employment and the price level, in both the short run and the long run. We

have also drawn attention to the major research programmes, or schools of

thought which attempt to explain such movements, that emerged following

the publication of Keynes’s (1936) General Theory (Snowdon and Vane,

1997a). Any assessment of a particular theory must take into account its

ability to explain the main features and ‘stylized facts’ which characterize

macroeconomic instability (see Greenwald and Stiglitz, 1988).

By ‘stylized facts’ we mean the broad regularities that have been identified

in the statistical property of economic time series. The identification of the

major ‘stylized facts’ relating to business cycle phenomena is a legitimate

field of enquiry in its own right (see Zarnowitz, 1992a, 1992b). In the USA

the National Bureau of Economic Research, founded in 1920, pioneered

research into business cycle phenomena, the landmark work being Measuring

Business Cycles by Arthur Burns and Wesley Mitchell, published in 1946. In

this book Burns and Mitchell provide their classic definition of business


Business cycles are a type of fluctuation found in the aggregate economic activity

of nations that organise their work mainly in business enterprises. A cycle consists

of expansions occurring at about the same time in many economic activities,

followed by similarly general recessions, contractions, and revivals which merge

into the expansion phase of the next cycle; this sequence of changes is recurrent

but not periodic, in duration business cycles vary from more than one year to ten

or twelve years.

The identification by Burns and Mitchell and subsequent research of comovements

of economic variables behaving in a predictable way over the

course of the business cycle led Lucas (1977) to claim that ‘with respect to

the qualitative behaviour of co-movements among series (economic variables)

business cycles are all alike’. This is an attractive characteristic for the

economic theorist because ‘it suggests the possibility of a unified explanation

of business cycles grounded in the general laws governing market economies,

rather than in political or institutional characteristics specific to particular

countries or periods’ (Lucas, 1977, p. 10). Although many economists would

not go this far, it is obvious that theoretical explanations of business cycle

phenomena must be generally guided by the identified statistical properties of

the co-movements of deviations from trend of the various economic aggregates

with those of real GDP. The co-movement of many important economic

variables in a predictable way is an important feature of business cycles.

While business cycles are not periodic (that is, they vary in their length and

do not occur at predictable intervals), they are recurrent (that is, they repeatedly

occur in industrial economies). How well a particular theory is capable

of accounting for the major stylized facts of the business cycle will be a

principal means of evaluating that theory. As Abel and Bernanke (2001,

p. 284) have argued, ‘to be successful, a theory of the business cycle must

explain the cyclical behaviour of not just a few variables, such as output and

employment, but of a wide range of key economic variables’.

Business cycles have been a major feature of industrialized economies for

the last 150 years. The textbook description of a typical business cycle

highlights the phases of a business cycle, from trough through the expansionary

phase to peak, followed by a turning point leading to a recessionary phase

where aggregate economic activity contracts. Within this general cyclical

pattern, what are the key business cycle ‘stylized facts’ which any viable

macroeconomic theory must confront? Here we present only a brief summary

of the research findings (for a more detailed discussion see Lucas, 1981a;

Table 6.1 The ‘stylized facts’ of the business cycle

Variable Direction Timing


Industrial production* Procyclical Coincident


Consumption Procyclical Coincident

Business fixed investment Procyclical Coincident

Residential investment Procyclical Leading

Inventory investment ** Procyclical Leading

Government purchases Procyclical Undesignated

Labour market variables

Employment Procyclical Coincident

Unemployment Countercyclical No clear pattern

Average labour productivity Procyclical Leading

Real wage Procyclical Undesignated

Money supply and inflation

Money supply Procyclical Leading

Inflation Procyclical Lagging

Financial variables

Stock prices Procyclical Leading

Nominal interest rates Procyclical Lagging

Real interest rates Acyclical Undesignated


* Durable goods industries are more volatile than non-durable goods and services.

** Investment expenditures are more volatile than consumption expenditures.

Source: Abel and Bernanke (2001, p. 288).

Blanchard and Fischer, 1989; Zarnowitz, 1992a; Danthine and Donaldson,

1993; Simkins, 1994; Els, 1995; Abel and Bernanke, 2001; Ryan, 2002).

Within macroeconomics there is a great deal of controversy about the

causes of aggregate fluctuations in economic activity. However, according to

Abel and Bernanke (2001), there is a reasonable amount of agreement about

the basic empirical business cycle facts. Even though no two business cycles

are identical, they do tend to have many features in common. The main

‘stylized facts’, as summarized by Abel and Bernanke, are classified according

to both direction and timing relative to the movement of GDP. With

respect to the direction of movement, variables that move in the same direction

(display positive correlation) as GDP are procyclical; variables that

move in the opposite direction (display negative correlation) to GDP are

countercyclical; variables that display no clear pattern (display zero correlation)

are acyclical. With respect to timing, variables that move ahead of GDP

are leading variables; variables that follow GDP are lagging variables; and

variables that move at the same time as GDP are coincident variables.

Table 6.1 indicates that the main stylized facts, as set out by Abel and

Bernanke (2001), show that output movements tend to be correlated across

all sectors of the economy, and that industrial production, consumption and

investment are procyclical and coincident. Government purchases also tend

to be procyclical. Investment is much more volatile over the course of the

business cycle than consumption, although spending on consumer durables is

strongly procyclical. Employment is procyclical and unemployment countercyclical.

The real wage and average labour productivity are procyclical,

although the real wage is only slightly procyclical. The money supply and

stock prices are procyclical and lead the cycle. Inflation (and by implication

the price level) and nominal interest rates are procyclical and lagging while

the real interest rate is acyclical. As we shall see, this ‘agreement’ about the

stylized facts has implications for our assessment of the competing theories.

However, deciding what are the ‘facts’ is certainly not uncontroversial (see

Ryan and Mullineux, 1997; Ryan, 2002).