Introduction
Macroeconomic research
Why haven’t you heard?
Business-cycle model
Discussion
Haavelmo’s macroeconomics: endogenous cycles
André Anundsen, Tord Krogh, Ragnar Nymoen and Jon Vislie
University of Oslo
Haavelmo Centennial Symposium
14 December 2011
1 / 23
Introduction
Macroeconomic research
Why haven’t you heard?
Business-cycle model
Discussion
Haavelmo’s themes
Titles of all published works and lectures
2 / 23
Introduction
Macroeconomic research
Why haven’t you heard?
Business-cycle model
Discussion
Career lasting
Contributions to macroeconomics
His books in English on growth and evolution and investment
theory became well known, Haavelmo (1954,1960)
But Haavelmo took an even broader interest in
macroeconomics. His written work include:
Studies in the joint determination of the price level, inflation
and the interest rate (Wicksell heritage)
Monetary policy analysis with deregulated credit markets
A model with an inflation target, from 1951!
1970s: A theory of inflation, interpretable as a model with
bargaining and monopolistic competition, which can be
specified as an error-correction form not unlike Sargan (1964),
see Bårdsen et al. (1998)
A macroeconomic model with regimes and switching between
growths period and intermittent depressions—his “business
cycle theory”
3 / 23
Introduction
Macroeconomic research
Why haven’t you heard?
Business-cycle model
Discussion
Career lasting
Capital markets and macroeconomic cycles
In this talk we concentrate on the business cycle model, from
Studies in Macroeconomics, Haavelmo (1969), in Norwegian.
It brings together several of his main themes:
Role of financial markets for investments and for
macroeconomic performance: stability vs crisis and depression
Role of monetary policy in a model with liberalized credit
markets—at a time when monetary policy (in Norway) was all
about regulations
Investment as a system property, not an autonomous
equation, so link to “Investment” from 1960
4 / 23
Introduction
Macroeconomic research
Why haven’t you heard?
Business-cycle model
Discussion
Why haven’t you heard?
5 / 23
Introduction
Macroeconomic research
Why haven’t you heard?
Business-cycle model
Discussion
Model Building Blocks
The model Haavelmo discusses in his 1960s-lectures has standard
elements
Aggregate production function
A given supply of labour
Consumption determined by a consumption function
In addition he discussed
how the private sector would allocate its wealth
and how the implied required rate of return plays a role for
the determination of the activity level
6 / 23
Introduction
Macroeconomic research
Why haven’t you heard?
Business-cycle model
Discussion
The law of indifference on capital markets
Financial market equilibrium
Consider a closed economy with a private sector that can invest its
wealth in:
Capital, yielding a return rK (from renting it to firms)
Deposits, yielding a return i
Since the private sector is free to choose an optimal portfolio, we
get an equilibrium condition between the two rates of return:
rK∗ = G (i )
This is the law of indifference in the capital market
Given a money market interest rate, i, it defines the capital
owners’ required rate of return to capital to retain the existing
stock
7 / 23
Introduction
Macroeconomic research
Why haven’t you heard?
Business-cycle model
Discussion
The law of indifference on capital markets
Actual rate of return
Haavelmo’s thesis was that the economy’s investment
response depends on the relationship between the required
rate of return and of the marginal productivity of capital
The marginal product is defined in the classical way:
rK = FK0 (K , N ) − δ
FK0 (K , N ) is the derivative of the production function in
capital (K ) and labour (N), and δ is the depreciation rate
8 / 23
Introduction
Macroeconomic research
Why haven’t you heard?
Business-cycle model
Discussion
Investment response and macroeconomic regimes
Equilibrium and disequilibrium I
Haavelmo found it most realistic to consider the case where
price rigidity prevented market clearing from being a necessity
For simplicity: Take the price level as fixed
In this setting there is no guarantee that the marginal product
of capital is equal to the required rate at each point in time
The idea: Differences between rK∗ and rK will have
consequences for investment activity
9 / 23
Introduction
Macroeconomic research
Why haven’t you heard?
Business-cycle model
Discussion
Investment response and macroeconomic regimes
Equilibrium and disequilibrium II
There are three cases to consider:
a: rK > rK∗ = G (i ), “very high investments”
b: rK < rK∗ = G (i ) “no investments”
c: rK = rK∗ = G (i ) “stable investments”
Case c, with equality rK = G (i ), and endogenous interest rate i is
the “classical equilibrium”
If the government fixes i autonomously:
c can only hold by coincidence and
the idea of a stable classical equilibrium cannot be maintained
10 / 23
Introduction
Macroeconomic research
Why haven’t you heard?
Business-cycle model
Discussion
Investment response and macroeconomic regimes
Over-determinedness and regimes
The model is over-determined, if i is given from outside the capital
markets.
In the light of this, a and b are disequilibria, where the laws of
classical economic theory tells us little about the outcome.
Haavelmo hypothesized disequilibrium behaviour, which then drives
his business cycle model.
a: rK > G (i ), GDP is supply determined: full
employment,and full capacity utilization
b: rK < G (i ), GDP is demand determined: gross investment
is zero, and there is unemployment
We get two regimes—with persistence in each of them. Anundsen
et al. (2011) gives the full account of the models equations, here
we focus on the interpretation of the model with the aid of graphs.
11 / 23
Introduction
Macroeconomic research
Why haven’t you heard?
Business-cycle model
Discussion
Investment response and macroeconomic regimes
Regimes and switching
12 / 23
Introduction
Macroeconomic research
Why haven’t you heard?
Business-cycle model
Discussion
Investment response and macroeconomic regimes
Regimes and switching
12 / 23
Introduction
Macroeconomic research
Why haven’t you heard?
Business-cycle model
Discussion
Investment response and macroeconomic regimes
Regimes and switching
12 / 23
Introduction
Macroeconomic research
Why haven’t you heard?
Business-cycle model
Discussion
Investment response and macroeconomic regimes
Regimes and switching
12 / 23
Introduction
Macroeconomic research
Why haven’t you heard?
Business-cycle model
Discussion
Investment response and macroeconomic regimes
Regimes and switching
12 / 23
Introduction
Macroeconomic research
Why haven’t you heard?
Business-cycle model
Discussion
Investment response and macroeconomic regimes
Regimes and switching
12 / 23
Introduction
Macroeconomic research
Why haven’t you heard?
Business-cycle model
Discussion
Investment response and macroeconomic regimes
Regimes and switching
12 / 23
Introduction
Macroeconomic research
Why haven’t you heard?
Business-cycle model
Discussion
Business cycles
Business cycles I
Assume that the initial situation is in a and that the interest
rate and the labour stock are constant over the period of
consideration
The economy is pushed to full employment, and stays there
for several periods since rK > G (i )
As the flow of investment is added to the capital stock, the
marginal product of capital will gradually fall and once we
reach a point such that the actual return to capital, rK , is
slightly less than rK∗ , investment activity drops to zero
But then employment will fall as well. This implies a further
drop in the marginal product of capital
13 / 23
Introduction
Macroeconomic research
Why haven’t you heard?
Business-cycle model
Discussion
Business cycles
Figure: Evolution of marginal product of capital
14 / 23
Introduction
Macroeconomic research
Why haven’t you heard?
Business-cycle model
Discussion
Business cycles
Business cycles II
Depreciation of the stock of capital will imply that the
marginal product of capital, at some point, starts growing
again
When we are back at the case where rK = rK∗ , employment
will pick up, due to higher investment activity, and we jump
back to the full employment regime
And so it goes
15 / 23
Introduction
Macroeconomic research
Why haven’t you heard?
Business-cycle model
Discussion
Business cycles
Figure: Regime switching business cycles
16 / 23
Introduction
Macroeconomic research
Why haven’t you heard?
Business-cycle model
Discussion
Business cycles
Financial crisis
The law of indifference equation that determined the required rate
rK∗ = G (i )
is more generally a complex relationship.
For example: the required rate depends on transactions costs
and liquidity
In a situation with low liquidity and with little trust: rK∗ is
higher for a given i
Experience shows that there is no guarantee that a reduction
of i gives the same reduction in the required rate as before
liquidity disappeared
A financial crises can become a job and income crisis in this
model
17 / 23
Introduction
Macroeconomic research
Why haven’t you heard?
Business-cycle model
Discussion
Characterization
Haavelmo’s theory is more like a model of intermittent
depressions, than of ordinary business cycle model
The downward switching point he called the “point of
catastrophe”
With grim realism he stated that, while we enjoy full
employment and stability (and, in an extension, rapid growth),
a catastrophe may be just around the corner
18 / 23
Introduction
Macroeconomic research
Why haven’t you heard?
Business-cycle model
Discussion
What about prices? I
Only making the model over-determined is not impressive. It
is the way Haavelmo deals with the issue that deserves a
second look
How prices will adjust is a matter Haavelmo gave a good deal
of thought
If price adjustments are always local equilibrium paths, the
model economy will never move far away from the classical
equilibrium—but real life economies do
In the full employment regime: Inflation. Enough to make that
regime?
In depression regime: Deflation. Increases the “drag” of
depressions
19 / 23
Introduction
Macroeconomic research
Why haven’t you heard?
Business-cycle model
Discussion
What about prices? II
In a model with consumer goods and capital goods producing
sectors, Haavelmo (1960) showed that investments was
determined by the price of the predetermined capital stock
and cost.
Investment is determined by the producers of capital goods.
Overdeterminancy could remain in this type of model as well.
This characteristic feature [overdeterminancy] is a far
more general feature than our particular model may
suggest. It has little to do with the level of aggregation
or disaggregation we use. It applies even if capital is
perfectly mobile and all prices are perfectly flexible.
Haavelmo (1960, p 200)
20 / 23
Introduction
Macroeconomic research
Why haven’t you heard?
Business-cycle model
Discussion
What about prices? III
Has Wicksell left the building?
Not at all.
Assume that the inflation-process is proportional to rk − rk∗
Now, even if the authorities are unable to observe G (i ), one
policy prescription could be to target inflation!
But Haavelmo has added a twist: Even if inflation targeting
will move the economy towards ’classical equilibrium’ locally,
the adjustment process has the risk of over-shooting, thus
rapidly causing a new downturn
21 / 23
Introduction
Macroeconomic research
Why haven’t you heard?
Business-cycle model
Discussion
What about prices? IV
What is the relation to New Keynesian macro?
In NK models, inflation is an equililbrium phenomenon
Prices are sticky, but it does not prevent market clearing since
agents are adjusting their behavior to the institutional
framework (which includes in what way prices are sticky)
Business cycles are thus deviations from the long-run steady
state, but the economy is nevertheless always in equilibrium
Sharp contrast to Haavelmo’s model, where price rigidity must
be interpreted as a breakdown of the universal auctioneer who,
in a classical model, serves as the market clearing mechanism
22 / 23
Introduction
Macroeconomic research
Why haven’t you heard?
Business-cycle model
Discussion
References
References
1
Anundsen, A. K., Krogh, T. S., Nymoen, R. and Vislie, J. (2011): Overdeterminacy and endogenous
cycles: Trygve Haavelmo’s business cycle model and its implications for monetary policy, Memorandum fra
Økonomisk institutt, Universitetet i Oslo, 03/2011.
2
Bårdsen, Fisher, P. G. and Nymoen, R. (1998): Business Cycles: Real Facts or Fallacies? Econometrics
and Economic Theory in the 20th Century: The Ragnar Frisch Centennial Symposium, Cambridge
University Press,
3
Haavelmo, T (1954): A Study in the Theory of Economic Evolution. Contributions to Economic Analysis
III, North Holland Publishing Company, Amsterdam, 1954 (second edition 1956, third edition 1964), 114
4
Haavelmo, T (1960): A Study in the Theory of Investment. The University of Chicago Press.
5
Haavelmo, T (1969): Orientering i Makrokønomisk Teori. [Studies in Macroeconomic Theory].
Universitetsforlaget, Oslo.
6
Moene, K. O. and A. Rødseth (1991): Nobel laureate: Trygve Haavelmo, The Journal of Economic
Perspectives, 5(3), 175-192.
7
Sargan, J. D. (1964): Wages and prices in the United Kingdom: a study in econometric methodology, in
P.E. Hart, G. Mills og J.K. Whitaker: Econometric analysis for national economic planning. Butterworths,
London.
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