Creative destruction and business cycles

Economic Modelling, 2010

In this paper we build a basic macroeconomic model aimed to grasp some aspects of the inner functioning of macroeconomic fluctuations. We highlight a mechanism through which the appearance of a product innovation results in an eventual reduction of the aggregate economic activity. When a new product appears, demand moves towards this more attractive product. The ‘creative destruction’ effect in this context is represented by the resources lost when firms producing old varieties exit the market due to the shortage of demand. Because firms producing a given product receive on average the same amount of demand, exits happen to be highly synchronized. We use this fact to explain the fluctuation asymmetries observed in real data. We test the ability of the model to meet features of real data against the United States' GDP in the 1950–1992 period.

2009

The paper analyzes the relationship between creative destruction and cycles in the US capital market. Creative destruction in a year is measured by the number of new firms in the Fortune 500 list. Creative destruction is found to be positively associated with smoothed annual returns based on the Dow Jones Index (DJI), signifying that new entries in Fortune 500 tend to be more during boom than during recession years. Easier financing of innovative ideas during boom is hypothesized as a reason behind such positive association.

History of Economic Ideas, 2018

A number of macroeconomic theories, very popular in the 1980s, seem to have completely disappeared and been replaced by the dynamic stochastic general equilibrium (DSGE) approach. We will argue that this replacement is due to a tacit agreement on a number of assumptions, previously seen as mutually exclusive, and not due to a settlement by 'nature'. As opposed to econometrics and microeconomics and despite massive progress in the access to data and the use of statistical software, macroeconomic theory appears not to be a cumulative science so far. Observational equivalence of different models and the problem of identification of parameters of the models persist as will be highlighted by examining two examples: one in growth theory and a second in testing inflation persistence. JEL classification numbers: B22, B23, B41, C52, E31, O41, O47.

Computational Economics, 2006

In this paper, we present an evolutionary model of industry dynamics yielding endogenous business cycles with 'Keynesian' features. The model describes an economy composed of firms and consumers/workers. Firms belong to two industries. The first one performs R&D and produce heterogeneous machine tools. Firms in the second industry invest in new machines and produce a homogenous consumption good. Consumers sell their labor and fully consume their income. In line with the empirical literature on investment patterns, we assume that the investment decisions by firms are lumpy and constrained by their financial structures. Moreover, drawing from behavioral theories of the firm, we assume boundedly rational expectation formation. Simulation results show that the model is able to deliver self-sustaining patterns of growth characterized by the presence of endogenous business cycles. The model can also replicate the most important stylized facts concerning micro-and macro-economic dynamics. Indeed, we find that investment is more volatile than GDP; consumption is less volatile than GDP; investment, consumption and change in stocks are procyclical and coincident variables; employment is procyclical; unemployment rate is anticyclical; firm size distributions are skewed but depart from log-normality; firm growth distributions are tent-shaped.

Economics of Planning, 1995

This paper extends Solow's vintage capital model by (a) deriving profits as a function of investments, and (b) adding an investment financing equation in terms of profits. It is shown that these extensions lead to a completely endogenous growth model. The dynamic system yields an equilibrium which is a centre and hence the economy cycles perpetually around the equilibrium point, never reaching it.

Business Valuation Review, 2018

In determining terminal value in a discounted cash flow (DCF) valuation, it is usually assumed that a mature company will grow at a constant rate in perpetuity. The impact of creative destruction a...

A model of endogenous growth is developed in which vertical innovations, generated by a competitive research sector, constitute the underlying source of growth. Equilibrium is determined by a forward-looking difference equation, according to which the amount of research in any period depends upon the expected amount of research next period. One source of this intertemporal relationship is creative destruction. That is, the prospect of more future research discourages current research by threatening to destroy the rents created by current research. The paper analyzes the positive and normative properties of stationary equilibria, in which research employment is constant and GNP follows a random walk with drift, although under some circumstances cyclical equilibria also exist. Both the average growth rate and the variance of the growth rate are increasing functions of the size of innovations, the size of the skilled labor force, and the productivity of research as measured by a parameter indicating the effect of research on the Poisson arrival rate of innovations; and decreasing functions of the rate of time preference of the representative individual. Under laissez faire the economy's growth rate may be more or less than optimal because, in addition to the appropriability and intertemporal spillover effects of other endogenous growth models, which tend to make growth slower than optimal, the model also has effects that work in the opposite direction. In particular, the fact that private research firms do not internalize the destruction of rents generated by their innovations introduces a business-stealing effect similar to that found in the partial-equilibrium patent race literature. When we endogenize the size of innovations we find that business stealing also makes innovations too small. the Co-Editor and referees of this journal. 323 324 PHILIPPE AGHION AND PETER HOWITT destruction (1942, p. 83, his emphasis): The fundamental impulse that sets and keeps the capitalist engine in motion comes from the new consumers' goods, the new methods of production or transportation, the new markets,.... [This process] incessantly revolutionizes the economic structure from within, incessantly destroying the old one, incessantly creating a new one. This process of Creative Destruction is the essential fact about capitalism. The present paper constructs a simple model of growth through creative destruction, by modelling the innovation process as in the patent-race literature surveyed by Tirole (1988, Ch. 10) and Reinganum (1989). The expected growth rate of the economy depends upon the economy-wide amount of research. The paper shows that equilibrium in such an economy is determined by a forwardlooking difference equation, according to which the amount of research in any period depends upon the expected amount of research next period, similar to the difference equation that defines equilibrium in the two-period overlappinggenerations model of money (Azariadis (1981), Grandmont (1985)).

1998

This paper examines an overlapping generations version of the Shapley-Shubik market game. We show existence of equilibria for the simple one commodity model and analyze the dynamics of the equilibrium trajectories generated in the model. Because of the non-linearities generated by strategic interaction of agents in the model, we find that complex and chaotic equilibrium dynamics are possible in this model for a much broader range of preferences than those for which found complicated dynamics in the perfectly competitive version of this model. These results, then, provide an alternative to the usual technology-based explanation for the historical fact that business cycles became an important economic phenomenon only with the onset of industrialization.

Studies in Nonlinear Dynamics & Econometrics, 2018

Drawing on Harrod, Kalecki and Kaldor, this paper seeks to revive the view that ceteris paribus firms reduce investment if they have already built up high capacities relative to their assessment of the normal market potential. This reaction establishes a fundamental stabilizing mechanism for the economy. The paper adapts the idea to the growth context of a neo-Kaleckian baseline model, where its destabilizing Harrodian sentiment adjustments are specified in a canonical and microfounded way that introduces a natural nonlinearity into the global dynamics. Supposing local instability, the resulting two-dimensional system is shown to generate persistent self-sustaining cyclical behaviour. In addition, the model is numerically calibrated to period and amplitude of the US business cycle. On the whole, based on an old and almost forgotten conception, the paper advances a most elementary approach to business cycle modelling.

2014

Section 1 will address the first question by providing the historical background of business cycle modeling and the circumstances particular to the inter-war period. Earlier influences on Frisch's 'impulse and propagation' synthesis will be discussed, focusing on how empirical studies during the inter-war period (Kondratiev, 1984:1928a), on 'aperiodicity' and intermittence of cycles of different orders, found support in prevailing theory concerning capital formation (Tugan-Baranovsky, 1898). The influences on Frisch from the theory that 'moderate irregularity' in the oscillation in the propagation mechanism, represented through Knut Wicksell's adaptation of the rocking horse metaphor (Wicksell, 1918), will be introduced. Section 2 will discuss how Frisch distinguishes 'dynamics' from 'statics', and how this contrasted to the definitions used by his predecessors. Frisch emphasized the distinction between 'dynamics' and 'statics' by defining 'dynamics' as a mode of analysis representing different points in time, and 'statics' as mode of analysis representing other things at the same point in time (Frisch, 2010/1930). How Frisch expresses the historical element within his deterministic framework, setting him apart from the endogenous representations of his predecessors, will be analyzed. Question 2 will be answered by the analysis of the debates of his contemporaries. Section 2.1 will discuss how Frisch adapted Walras' 'general equilibrium' to economic fluctuations. Section 2.2 will critique Johan Åkerman's use of conventional 'statistical decomposition techniques' in identifying business cycle turning points, signifying the end to the era of the 'peak to peak' cycle decomposition of the Institutionalists. Section 2.3 will explain how Frisch adapted Eugen Slutsky's random summation (Slutsky, 1937/1927) to achieve 'free but damped' oscillations in the 'impulse and propagation' mechanism. Section 2.4 will discuss the dialogue between Frisch and Schumpeter on the role innovations (Schumpeter, 1911/2008) played in the impulse mechanism in Wickell's rocking horse, and how this culminated in the non-linear representation of Frisch (1933). Section 2.5 will summarize the critique of Schumpeter's 'Business Cycles' in Kuznets (1940), and the difficulty in modeling cycles of different orders of capital formation movements within an equilibrium framework.

SSRN Electronic Journal, 2000

This paper analyzes and compares two alternative policies of determining the service life and replacement demand for vintage equipment under embodied technological change. The policies are the infinite-horizon replacement and the transitory replacement ending with scrapping. The corresponding vintage capital models are formulated in the dynamic optimization framework. These two approaches lead to different estimates of the duration of replacements and the impact of technological change on the equipment service life.

Journal of Economic Theory, 1988

In a model of overlapping generations with production, money, and an endogenous labor supply, general conditions are given for the existence of two different types of cyclical equilibria. The conditions are given in terms of the elasticities of demand for savings and for capital with respect to the interest rate and of the capital-consumption ratio at the golden rule steady state. Examples using CES technologies are also studied.

2004

2005

When business-cycle theory, after dominance of growth theory for more than two decades, entered centre stage again in the 1970s the assumption of continuous market clearing (as a methodological principle) in the New Classical paradigm and real businesscycle models became an issue of heated controversies. That paradigm describes economic fluctuations as a purely equilibrium phenomenon in the monetary or in the real business cycles theory, and more specifically, in the latter one, fluctuations became optimal since they are no more than the expression of the agents’ optimal reaction to exogenous (real) shocks. In the opening passage to ‘Understanding Business Cycles’, one of his mostly read contributions, Lucas asks the question ”Why is it that, in capitalist