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Two very different theories of the business cycle

Uncertainties about the future development of the US economy run deep.
There are two opposing views of what has happened to it since the early 1990s,
which originate in two very different theories of the business cycle.

Paul de Grauwe, FT 16/7 2007

The first runs as follows.
The information technology revolution led to big changes that boosted US productivity growth.
Consumers saw this happening and correctly inferred that their permanent income had increased.
This optimistic view is steeped in the “real business cycle” theory, which is nowadays the dominant academic one.

There is an alternative view, though, with very different implications for the future.

This view starts from the idea that people find it difficult to understand how the economy functions. They follow the lead of opinion-makers who pretend to know the truth.

The excessive optimism is unsustainable and leads to a correction. Doubts about the rosy picture set in. This easily degenerates into pessimism

If the business cycle is driven by waves of optimism and pessimism, it is much less clear that the slowdown of the US economy is a short-term phenomenon to be corrected soon

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