CHAPTER ONE
INTRODUCTION
1.1 Background
Not
until the events of late 1920s in the United States of America (USA) and indeed
the industrial world, characterized by the Great Depression, macroeconomics, as
a branch of economics was non-existent by that title. Before then, it was the
world of microeconomics and the classical economists and business cycle was
seen as a normal fact of life. Expected
to re-occur periodically (say in every seven or eight years) no attempt was
made to curtail business cycles by way of stabilization policies. The events of the 1930s provoked a wave of
new thinking.
By
the mid-1940s, Keynes and Keynesian school of thought had fully emerged,
providing alternative explanations to economic phenomena. Consequently,
economists no longer viewed business cycles as a normal fact of life. To the Classical economists fluctuations are
real essence of a market economy. Thus,
if there is disequilibrium between demand and supply, self-correcting forces
will naturally evolve to stabilize the market.
Government, in this case, need not intervene.
The
Keynesians, on the other hand, were of the view that fluctuations caused by
supply-demand disequilibrium could be and should be controlled. They pointed out that business cycle
characterized by expansions and contractions “are symptoms of underlying
problems of the economy which should be dealt with”. By similar positions,
macroeconomics found its feet in the annals of economists. Today it has become the theoretical and
practical response to the problem of inflation, unemployment, growth and business
cycle. Consequently, business cycle became
an issue, both in theoretical and empirical terms.
To
date literature on business cycle is abundant.
But modern business cycle research is due to the path breaking paper of
Kydland and Prescott (1982). According
to Rebelo (2005: 2), three revolutionary ideas were associated with that paper.
They are that:
“…business cycle
can be studied using dynamic general equilibrium models. These models feature atomistic agents who
operate in competitive markets and form rational expectations about the
future. The second idea is that it is
possible to unify business cycle and growth theory by insisting that business
cycle models must be consistent with the empirical regularities of long-run
growth. The third idea is that we can go
way beyond the qualitative comparison of model properties with stylized facts
that dominated theoretical works in macro economics before 1982”.
Beyond
these revolutionary ideas, another major contribution of Kydland and Prescott
(KP) paper is that supply-side shock due to technological advances are the
driving force behind business cycles rather than variations in demand. It
is apposite to point out that KP (1982) model is recognized and classified as a
real business cycle (RBC) model. And in
the class of business cycle research, RBC has received much attention. The RBCs are models of business cycles that
explain cycles as fluctuations in potential output. The development of such a model is in
response to the disillusion with the Keynesian consumption function or even the
IS-LM framework described as being too simplistic as to take care of the dynamics
underlying macroeconomics particularly intertemporal substitutions and
uncertainties.
Consequently,
the neo-classical economists suggested that theories of RBC must be based on
microeconomic foundation of choice between the present and the future consumption
in an optimal control manner. Hence, the simple consumption model is an
inadequate explanation of business cycle.
In the case of household, “supply of labour and demand for goods both
now and in the future” will ensure that “lifetime spending was financed out of
lifetime income plus any initial assets.
Such plans would then be aggregated to get total consumption spending
and total labour supply” Begg, Fisher and Dornbusch (2000). We can repeat similar process for other
economic agents (firms, government…)
Given
the potential output, and in the RBC explanation, the economy is disturbed by
shocks such as technological breakthrough, changes in government policy, etc
which alter the complicated plans of economic agents and give rise to
equilibrium behavior that symbolizes a business cycle. RBCs also constitute a point of departure for
many theories in which technology shocks do not play a central role (Rebelo,
2005). They have also become
“laboratories” for policy analysis and for the study of optimal fiscal and
monetary policy (Lucas, 1980).
However,
the growing volume of literature is skewed in favor of the industrial
economies. Interest in business cycles
and RBC research, in particular, is gaining ground in the Latin Americas and
South Asian countries. The near
non-existence of RBC research in Africa tends to suggest either the absence of
the phenomenon or lack of interest in this area of research. This apparent lack
of interest could be explained by the belief that there is more serious concern
than business cycles in the African economies.
As a matter of fact, no economy whether developed or developing is
immune to business cycle fluctuations.
In each case, persistence and magnitude of volatility is important. According to Mathias (1969), “analyzing the
nature of … economic fluctuation is important in itself but also gives insights
into the process of growth in the changing structure of the economy and the
social hardship brought by industrialization and economic change”.
What
then is a business cycle? There are
several approaches to this definitional clarification. According to Mitchell (1927) business cycle
is characterized by a “sequence of expansions and contractions particularly
emphasizing turning points and phases of the cycle”. Lucas (1977) as contained in Kydland and
Prescott (1990:2) defined business cycle as the statistical properties of the
co-movements of deviations from the trend of various economic aggregates with
those of real output. Kydland and Prescott (1982) described business cycles as
recurrent nature of events .These definitions underscore the recurrence of
upturns and downturns around the trend of macroeconomic aggregates.
This
study reviews the literature on business cycle and raises some research questions
with a view to exploring the applicability of RBC methodology to the Nigerian
economy given the unequivocal desire to reduce sharp fluctuations and ensure
steady growth. We thus adopt the more comprehensive concept of business cycle
that incorporates growth with fluctuations tagged business cycle phenomenon,
BCP. The latter is defined as “…nothing
more nor less than a certain set of statistical properties of certain set of
important aggregate time series” (Prescott, 1986; 2). Another definition is due to Lucas (1977; 9)
in which BCP is viewed as “the recurrent fluctuations of output about trend and
the co-movements among other aggregate time series”.
In
what follows in this chapter, the study looks into the statement of research
problem in section 1.2. In section 1.3, it considers the scope of the study
while section 1.4 discusses the justification for the study. Sections 1.5, 1.6,
and 1.7 deals with the statement of key research questions, research objectives
and research hypotheses respectively. In sections 1.8 and 1.9 a brief outline
of the methodological approach and the data sources is given leaving detailed
discussion to chapter three of the study.
This chapter ends with plan of the study in section 10.
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