A Linear Model of Cyclical Growth Author(s): Hyman P.

Minsky Reviewed work(s): Source: The Review of Economics and Statistics, Vol. 41, No. 2, Part 1 (May, 1959), pp. 133-145 Published by: The MIT Press Stable URL: http://www.jstor.org/stable/1927795 . Accessed: 12/03/2012 14:49
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A LINEAR MODEL OF CYCLICAL GROWTH

Hyman P. Minsky* path-breakPROFESSOR SAMUELSON's
ing article on the "Interaction Between the Multiplier Analysis and the Principle of Acceleration" appeared in this REVIEW almost twenty years ago. A large literature has developed in which the basic ideas of that article have been applied to both business cycle and economic growth problems. In a considerable portion of that literature,Samuelson'swarningthat "the representationis strictly a marginal analysis to be applied to the study of small oscillations"has been overlooked.' Samuelson's warning can be interpreted as meaning that the time series generated by any particular solution of the model will determine actual income for only a short time. Given the mathematical model, the relevant particular solution can change due either to (i) the accelerator or the multipliercoefficientschanging (as Samuelson suggests), or (2) the imposition of new initial conditions. Goodwin2has examined various models in which the accelerator coefficient is a variable. These non-linearmodels are mathematically complex, and the specific limit cycles that Goodwin derives obviously are due to the special assumptions he makes about how the path of income affects the accelerator coefficient. Hicks3 has investigated how an otherwise explosive acceleratormodel will be affected by floors and ceilings. In this paper such floors and ceilings will be interpretedas imposing new initial conditions, and therefore this paper can be considered a reinterpretation of Hicks's setup.4
* The major portion of this article was completed while the author was a Visiting Associate Professor at the University of California, Berkeley, and he wishes to thank those graduate students who patiently sat through the presentation of this material, as well as Professors Irma Adelman and Roger Miller. IP. A. Samuelson, "Interactions Between the Multiplier Analysis and The Principle of Acceleration," this REvIEw, xxi (May I939), 78. Reprinted in Readings in Business Cycles (Philadelphia, I944), 269. 2R. M. Goodwin, "The Non-Linear Accelerator and the Persistence of Business Cycles," Econometrica, xix (January I951), I-I7. 'J. R. Hicks, A Contribution to the Theory of the Trade Cycle (Oxford, I949). 'References to the influence of initial conditions upon the time series generated by an accelerator process are scarce.

We will work with a slightly modifiedversion of Samuelson'smodel, and assume that

Ct=
It -/

ao + alYt-1)
(Yt-1
-

Yt-2)

(2)

so that
Yt (al + P) Yt-1 Yt-2 + ao (3)

where Ct, It, and Yt are the tth day's consumption, investment, and income; ao is the "zero income" consumption; a, is the marginal propensity to consume; and /8 is the accelerator coefficient.5The solution to equation (3) is (4) t= Al1t+ A2+k0 where the roots ,tj and U2 depend upon a, and 8, the coefficientsA1 and A2 are determinedby the initial conditions, and ko [ = ao/(i - a,) ] is determined by the "zero income" consumption. In the solution equation (4), ko has a natural interpretationas the income at which consumption equals income." The a, and /8 coefficientswill be assumed to be constants with values such that an explosive time series will be generated, i.e., in equation (4) /k > 12 > I.7 As a1 and / are constants, so
One such is "But he [Hicks] (correctly) argues that disinvestment is limited to the size of the depreciation allowances. This implies that after a downswing we do not follow the course of the cycle which produced the previous upswing. Instead we start a new cycle on the basis of new initial conditions." J. S. Duesenberry, "Hicks on the Trade Cycle," Journal of Economics,Lxiv (February I950), 465. Quarterly is Ct = a, Yt-l and his equa6 Samuelson's equation (i) tion (2) is It = f3(Ct - Ct1). The modification of equation (2) does not change the essential character of the results and it is mathematically convenient. The modification of equation (i) will enable us to introduce the effects of changes in ko (either through a Duesenberry ratchet effect or a TobinPigou asset effect) into our analysis. For the mathematical details of the derivation of equation (4) see either W. J. Baumol, Economic Dynamics (New York, i95i) or R. G. D. Allen, Mathematical Economics (London and New York,
I956).

'In equation (3), if Yt = Yi- = Yt-2, then Yt = ko. 7Thea, and j2 in the solution equation Y = A At + A2 t ko are the roots of the characteristic equation f(x) =x2 - (al + p)x + p to the second-order difference equation yt = (a, +P)yt- - pyt -2. The roots are determined by setting f(x) = o. The following is known about f(x): (i) (2) f(i) = i-a,>o, f(o)=P, (3) f(al +,8) =j, (4) the minimum value of f (x) is f

(asi+8)
2

,(5) for o < x < '

2

ai?P3
2

f(x) is decreasing, (6) for o<

<x<<P,

f(x) is in-

[ I33 ]

I34

THE REVIEW OF ECONOMICS AND STATISTICS the fundamental assumption is that the accelerator-multiplierapparatus can be used to represent the intertemporalgenerationof aggregate demand. The validity of this assumption depends upon whether this apparatusyields satisfactory interpretationsor predictions of events. No further argument for the validity of the accelerator hypothesis is offered in this paper. The other economic assumptions made are: i. The consumption function can be represented by a straight line, Ct = ao+ a, Yt-1. The value of a, is constant and the value of ao depends upon factors which, in turn, can be represented as depending upon past income. By assuming that ao changes intermittently and increases more readily than it decreases, a ratchet is built into the consumptionfunction. 2. At each date there exists an exogenously determined ceiling to income which depends upon population growth and technological change, and which does not depend upon the existing capital stock. 3. During each time period, there exists a maximumpossible amount of net disinvestment, which depends upon the capital stock and a technologically determined depreciation rate. The consumption function is a determinant of aggregate demand,whereas the ceiling and floor to income are determinantsof aggregatesupply. The assumption that ao, the zero income consumption level, depends upon past incomes is based upon two, not necessarily mutually exclusive, hypotheses. One is the Duesenberrychanging preference system hypothesis,9which in our interpretationhas ao dependupon previous peak income. The other is the Tobin-Pigou type of asset (wealth) consumption relation,'0which in our interpretationhas ao depend upon the real value of assets. As far as the mechanics are concerned either interpretation would suffice. However, the Duesenberry ratchet is insensitive to changes in the relative prices of assets and income, whereas a Tobin-Pigou ratchet reacts to such changes. Thus, a Tobin-Pigou ratchet can transmit financial market developments to the real sector. As both preference systems and

are ul and t2. Rather than assume that the accelerator and multiplier coefficients change, the marginal nature of the formulation will be taken into account by intermittently imposing new initial conditions. The initial conditions will be interpretedas reflecting effective supply constraints. The particularformulationto be used has the aggregate supply of income increase at an exogenously given rate and the floor to income depend upon the capital consumption rate. The nature of the time path of income generated by the model depends upon whether the rate of growth of ceiling income is greater than, equal to, or less than the minor (smaller) root of the solution equation. By also taking into account a "ratchet" in the consumption function, the apparatus to be developed can generate either (a) steady growth, (b) cycles, (c) booms, or (d) long depressions. Formally, it will be shown that the simple linear accelerator-multipliermodel can be used as a flexible frameworkfor the analysis of both economic growth and business cycles and that there is no analytical need to separate the two problems: that is, the model generates both the trend and the cycle.8 Economic Assumptions In order to use a linear accelerator-multiplier model as a flexible framework for the analysis of growth and cycles, the flexibility must be built into the economic assumptions. Of course
creasing. For two distinct real roots to exist it is necessary that f(
2

) <o.

(Two identicalroots exist if f(

2

f(I) = (I-a,) >>o will be on either =o.) With o<ai<I, the negatively or the positively sloped arm of f(x). If it

is on the negatively sloped arm, then >

i

cai+P
2

>

and both

and

g2> i.

If it is on the positively sloped arm,

<
I

then -

ai+P
2

< I and both o <

ando

< I,2 < I.

It is

4P> 0 impossibleto have Al> i and A2 < i; (ai+P)'and p > i are the conditionsfor g > > I. >U2 8A. Smithies, "Economic Fluctuations and Growth," xxv (January I957), I-52, has a similar perEconometrica, spectiveand uses many of the sameingredients. S. S. Alexander, "The Acceleratoras a Generator of 9J. S. Duesenberry, Income, Saving and the Theory of Steady Growth," Quarterly Journal of EconoMics, LxM Consumer Behavior (Cambridge, I949)'. 10 Tobin, "Relative Income, Absolute Income and Sav(May I949), I74, demonstratedthat such an accelerator J. apparatuscould not be used to generateboth steady growth ing," in Money, Trade and Econo-mic Growth (New York, and the businesscycle without additionalstabilizingfactors. I951), I35-56; A. C. Pigou, Employment and Equilibrium, results. 2nd ed. (London, I949), I3I-34. This papernegatesAlexander's

A LINEAR MODEL OF CYCLICAL GROWTH asset holdings do change over time, an eclectic interpretationof the ratchet in the consumption function is both useful and defensible. As the accelerator-multiplier apparatus is here interpreted,it is simpler to considerchanges in the relative prices of income and wealth as exogenous factors which influence the generation of aggregatedemandby affectingao.Therefore, in the formal model, ao will be assumed to depend upon the previous peak income. In interpretingevents, any developmentwhich raises (lowers) the ratio of consumingunits' wealth to income will tend to increase (decrease) ao. In more concrete terms, a large increase in the ratio of monetary assets to income (such as took place during World War II) will tend to raise ao, whereas a large fall in the market price of assets relative to income (such as took place in the fall of I929) will tend to lower ao. It will be shown that by feeding financial and money market developments into the formal model through the ratchet in the consumption function, booms and depressions of varying amplitude and length can be generated. The form adopted for the consumption function implies that there is a positive equilibrium level of income at which consumptionequals income. If there is a trend in peak income and if ao is a linear function of peak income, the equilibriumincome will exhibit the same trend. By appropriateassumptions with regard to depreciation, the same trend can be introduced into the floor to income. With these trend assumptions a model is constructed which generates a constant relative amplitude cycle. It will be shown that if these trends are not postulated, the model generatescycles with increasing relative amplitude. At each date, the ceiling real income is the income which that date's labor force could produce, given the date's technology, if the optimum capital stock existed. As the actual capital stock is less than or equal to the optimum capital stock, the ceiling income is not necessarily the existing capacity income. Ceiling income will change due to changes in the labor force and technology. It is assumed that a technologically progressive society is being considered and that the labor force is growing. As a result, the ceiling real income, Yt(c), is always growing independently of what the actual income and
capital stock may be. That is, y(c) = rY(c)

where X > i and is also greater than the rate at which the labor force is growing. In the formal analysis, the assumption will be made that X is a constant." The validity of the assumption about the behavior of the income ceiling is questionable. This paper, at a formal level, can be interpreted as an examination of the joint implications of the accelerator-multiplierand the ceiling hypotheses. However, as will be shown, the rate of growth of ceiling income can vary within considerable limits without affecting the qualitative characteristics of the model. Therefore, if desired, this rigid assumption can be relaxed. The maximum possible disinvestment during any period is determined by the technical fact that at least a portion of the capital stock, fixed capital, is long lived. Hence, during any period only a small part of such capital can be consumed. We will assume that the ratio of capital consumption to peak income capital stock is a constant. Thus, given the capital stock being consumed, the maximum disinvestment which can take place per period is determined. To determine the floor to income, this maximumpossible disinvestment has to be joined to behavior assumptions which determine the behavior of equilibriumincome, ko, when income is falling. This maximumpossible disinvestment is a supply condition, since it determines the greatest possible excess of consumptionover income. The disinvestmentassumptionis quite heroic. The ratio of possible disinvestment per period to the capital stock certainly depends upon the compositionof the capital stock. As an example, the higher the ratio of working to fixed capital, the higher can be the ratio of a period's disinvestment to the capital stock. It can be expected that the ratio of working capital to fixed capital will be higher at the beginning than dur1 R. F. Harrod, Towards a Dynamic Economics (London, defines a natural rate of growth which is the rate of growth of the labor force. Our rate of growth of ceiling income can be interpreted as a "converted" natural rate, to allow for technological change. However, Harrod's result, that there is a knife-edge equilibrium rate of growth, when the "natural" rate is equal to the "warranted" (full-employment savings equal investment) rate of growth, is not borne out by our analysis. R. M. Solow, "A Contribution to the Theory of Economic Growth," Quarterly Journal of Economics, LXX (February 65-94, also negates the Harrod conclusion of a knifeI956), edge equilibrium rate of growth of income.
I948),

136

THE REVIEW OF ECONOMICS AND STATISTICS ticular solution equation. As long as aggregate demand generated by a particular solution equation falls in the range determined by the ceiling and floor to income, actual income will be generated by this particular solution equation. However, it is assumed that /ju, the dominant root of the solution equation, is very large comparedwith possible rates of growth of ceiling (decline of floor) income. Hence, income as generatedby a particularsolution equationwill, in time, exceed (fall below) the ceiling (floor) income; whenever this happens, supply conditions will determineactual income. Such actual incomes determined by supply conditions will be the initial conditions in determining new values of A1 and A2 and this new particular solution will generate successive aggregate demands. It will be shown that the qualitative behavior of the model depends upon the relative values of the minor (smaller) root of the solution equation and the rate of growth of ceiling (decline of floor) income. If the rate of growth of ceiling (decline of floor) income is equal to or greater than the minor root of the solution equation, then aggregate demand as determined by the particular solution equations will continuously press against the ceiling (floor) so that steady growth (decline) of actual income will take place. If the rate of growth of ceiling (decline of floor) income is smaller than the minor root, then actual income will bounce off the ceiling (floor), that is, a turning point will be generated. A succession of such bounces between the ceiling and the floor generates a cycle in actual income. When the ceiling becomes the effective determinantof income, a portion of real aggregate demand is not realized. This cut-back can be effected by (i) investment falling proportionately more than consumption, (2) consumption falling proportionately more than investment, or (3) investment and consumption falling to the same extent. If investment is cut back proportionately more than consumption, a capital goods deficiency tends to be created. This could increase ,B. If consumptionis cut back proportionately more than investment, a deficiency in final demand occurs, which could decrease /3. Such endogenously determined changes in j3 make the model non-linear, of the type which

ing the later part of a downturn. Thus, there is some expectation that the maximum possible disinvestmentper period decreases as a depression wears on. In addition, the size of the capital stock being consumed during any period is open to debate. Is the maximum possible capital consumption during a period based upon the largest amount of capital which existed during any previous period, or is it based upon the capital stock in existence at the beginning of the period? If the first assumption is made, the maximumpossible disinvestment will not decrease when net disinvestment is taking place, whereas the second assumption implies that net disinvestment per period will decrease as a depression continues. Once again, since the mechanics of the model is independent of which assumption is made, we will assume that the disinvestment ceiling is determinedby the maximumprior existent capital stock. The qualitative impact of variation in the amount of maximum disinvestment will be considered in the verbal discussion. of GeneralCharacteristics the Model In the models to be considered, the accelerator-multiplier process in conjunction with the initial conditions determinesaggregate demand. Actual, or realized, income is determinedby the interaction of aggregate demand and supply. We will assume that aggregate supply is a limitational factor determinedeither by the autonomously growing ceiling or the floor to income. Aggregate demand determines actual income unless the income so determinedis inconsistent with the aggregate supply conditions. Whenever this occurs actual income is determinedby aggregate supply, and simultaneously a new relation will be determined which generates subsequent aggregate demand. Given that the accelerator and the consumption coefficientsare constants, the two roots, Pul and /2, of the solution equation are also constants; and we assume that pl.and /2 are real and greater than one. With ko (the consumptionequals-income income) known, two observed incomes are needed as initial conditions to determine A1 and A2 in the solution equation. A solution equationwith A1 and A2 determinedby specific initial conditions will be called a par-

A LINEAR MODEL OF CYCLICAL GROWTH Goodwinhas studied. We will not examine the case of changing,Bin detail. However, it can be shown that d,l/d,8 > o and d,d/3,8 < o, so that if hitting the ceiling increases ,B,the minor root of the solution equation decreases; this makes the conditions for steady growth easier. On the other hand, if ,B decreases, the condition for steady growth becomes more difficult to satisfy.12

137

In the third case, where investment and consumption fall to the same extent, the reasons given above for ,Bchanging do not apply. However, the manner in which the adjustment between the demand and ceiling incomes is effected can be assumed to depend upon financial arrangements. If all investment and consumption demand is financed, money income will equal demand income even though real income is equal to the ceiling income. We can assume that consumption and investment are reduced proportionately. The difference between demand income and ceiling income will be adjusted by a price rise. By assuming that the succeeding period's real demand for consumption and investment depends upon the change in real income, such price level changes can be ignored in our analysis.'3 Throughout the body of this paper it is assumed that the roots of the characteristicequation are real and greater than one. If the roots are conjugate complex numberswith a modulus greater than one, the solution path is inherently oscillatory; and if the modulus is greater than
We have that /Ll = ai?+ ai+8 + ?(ai+?P)2
2 -

4p8 4J8

andt2 =
= so that df8
d1A:L

\/(aL+,8)2
2

?
1 -a

(a,?+1-2)

\(ai+?1)2-413
1(a,?+1-2)

and

dIA2
-

d,B
As
1>
t2> I,

V\/(ai+?1)2- 4A8
>

I and as \(aL+?)2

- 41>0,
>1,

d,ul
dj6
(a? +P-

> o. Also
2) >

U2 =

~~al?+ ,-V/(cz+i? )2- 4I

2

\/(ai?3,8)2-4,l > i.

so that

a,+,8-2

Therefore,

dp2
-

< 0.

d,8 '8 For an examination of monetary factors and such accelerator models see Hyman P. Minsky, "Monetary Systems and Accelerator Models," American Economic Review, XLVII (December I957), 859-83.

_\/(a,+,B) 2 _ 4.)

the rate of growth of ceiling income, in time the ceiling will become the effective determinantof income. In the Appendixit is shown that in this case income will always bounce off the ceiling, so that the qualitative characteristics of the time series are not affected by the existence of the ceiling. The rich results we obtain by assuming the roots to be real and greater than one are not available in the explosive oscillatory case. The income floor is determined by the consumption-equals-incomeincome and the maximum possible capital consumption per period. The maximum capital consumption per period is determined by the capital necessary to produce the previous peak income. With an invariant consumption-equals-income income, the relative amplitude of the cycle generated by income bouncing between the ceiling and the floor will increase: the cycle is really explosive. However, by adopting the Duesenberry hypothesis that the consumption-equals-income income shifts upward whenever income turns down from a peak, the income floor is raised and a constant relative amplitudecycle results. The accelerator-multiplierprocess generates income as a deviation from the consumptionequals-income income, and the rate of growth of income as generated by any solution equation refers to income so measured. The natural interpretation of the rate of growth of ceiling income refers to income measured from its natural origin, i.e., from zero. It will be shown that a given rate of growth of ceiling income must be multiplied by the ratio of income measured from the natural origin to income measured as a deviation from equilibriumincome before being comparedwith the smaller root of the solution equation to determine whether income will continuously press against or bounce off the ceiling. If the rate of growth of ceiling income so multiplied is equal to or greater than the smaller root of the solution equation, steady growth of income measured from the natural origin will result. If the constant term in the consumption function only increases intermittently, as the Duesenberry hypothesis suggests, then the ratio of income measured from the natural origin to income measured as a deviation from the consumption-equals-incomeincome decreasesduringa period of steady growth. At some date, given that the rate of growth of

I38

THE REVIEW OF ECONOMICS AND STATISTICS librium position. The possibility of booms of different lengths and amplitudes depends upon the interpretation of the constant term in the consumption function. The possibility that either steady growth or a turning point will result when the ceiling (floor) income constrains an otherwise explosive accelerator process follows from imposing initial conditions at the ceiling (floor) income rather than at the consumption-equals-incomeincome. We must distinguish between actual, aggregate demand (as generatedby a particularsolution equation), ceiling, and floor incomes. These different incomes will be identified by superscripts, thus: y(a) is the tth date'sactualincome, income, demand Y(d) is the tth date'saggregate
y(c) is the tth date's ceiling income, Y(f) is the tth date's floor income.

ceiling income is smaller than the smaller root of the solution equation, the state of steady growth will come to an end and income will turn down. Hence, it is possible for actual income to press against the ceiling for a number of periods and then turn down. This generatesa cycle with a long boom and the greater the ratio of income measured from natural origin to income measured as a deviation from the consumptionequals-incomeincome at the date the ceiling to income becomes the effective determinant of actual income the longer will the economy be in such a state of steady growth. The above result follows from the introduction of the Duesenberry ratchet in the consumption function. If the Tobin-Pigou effect is interpreted as affecting the ratio of the consumption-equals-income income to ceiling income, then financial market developments will result in the generation of cycles with booms of varying length. If the Tobin-Pigou effect is continuously operative and the ratio of consumption-equals-incomeincome to ceiling income remains constant, steady growth can result. A symmetricargumentapplies to the behavior of the system with respect to the income floor, although the postulate that the income floor is steadily falling is not economically natural. If the income floor is a constant during a depression the only possible result of the process being analyzed is that income bounces off the floor. Note that the prosperityphase generatedby this model can be longer than the depressionphase. Since the ratio of the consumption-equalsincome income to ceiling income can be considered a variable, the model can generate cycles of varying amplitudes and periods. Also, by utilizing the Tobin-Pigou effect this apparatus makes it possible to integrate real and monetary aspects of cycles and growth. The FormalModel Obviously the results stated in the previous section must be derived. It may surprise some that new results can be achieved by looking once again at a formulation that has been as well explored as the accelerator-multiplier model. However, the typical formulations ignored the constant term in the linear consumption function and used the initial conditions only once, to start the solution equation off from the equi-

We also take account of the intermittently imposed initial conditions in our notation by writing the date of the initial conditions in parenthesis after y(d), A1, and A2 and subtracting the date of the first initial condition from t in the solution equation, e.g.,
y(d)

(n,n+I) +

)t-n

A,(2n8Y+I)ytttn

ko (n+ i).

Equation 5 states that the particular solution was derived by using the nth and (n + i)st dates' actual incomes as the initial conditions. By writing Lt4 and iUt the initial conditions dates are the zero and first powers of the roots. The writing of the equilibrium income as ko(n+ i) denotes that the (n+ i)st date's income was the peak income which determined a Duesenberry ratchet in the consumption function. In the next three sections, where the values of the A1 and A2 coefficients and the effects of the income floor and ceiling are derived, the income will be conconsumption-equals-income stant. In these sections, it will be mathematically convenient to measure income as a deviation from the consumption-equals-incomeincome. A lower-case y will be used when income is so measured. Determination of A, and A2. To determine A1 and A2 it is necessary to know the actual incomes of two dates, Y(a) and y(a). We have

A LINEAR MODEL OF CYCLICAL GROWTH

y(a) y(a)

=
=

y(a) y(a)

= A1(o, I) + A2(o, i) = A (o, i)ju + A2(o, i),2u (a)

Assuming ko is known and that y(a) = , have

Ai(o,I) A2(o, I)
=
-

we
(6) (7)

I 1-2

y (a)

(a).

Assuming ya)

> o. since /ul >

i)

/,2,

>
if 1>

then Aj(o,
ja > /2then

< o,
Al (,

A2(o,

I)

if y > 12 > O whereas

I) >
d.)

I) > o,

A2(0,

In any particular solution equation, y(d) = Aj(o, i)/jt + A2(o, i),Pt the income of any period is an average of /ul and I2 with weights As t increases, Aj(o, i)/4t-1 and A2(o, I)U42. A1(o, i)p- i/A2(o, i),t-1 increases so that the weight of /jl in determining aggregate demand increases. In time, /ul dominates the behavior of the time series. Nevertheless, if A2(o, I) I iS very much greater than IA1(o, i)l for small t the behavior of the series will be dominated by A2(o, i)pt2 so that, even with A1(o, I) < o, Yt> Yt-i is possible. Assumey1 > yo > o and /ul > ju > J,2. Then Aj(o, i) and A2(o, i) are both positive, and all incomes generated by this particular solution equation will be positive and the rate of growth of income will increase, approaching pi as a limit. On the other hand, if-2 > f then A1(o, I) is negative. For small t income will be positive and can even be increasing, though at a diminishing rate. However, as t increases, A1(o, I)t takes over, so that income will fall and in time becomes negative [y(d)(o, I) < ko]. Unless constrained, the rate of increase of negative income will increase, approachingul as a limit. Therefore, if y, > yo > o but Yl < I12Y0O A1(o, i), the coefficient of the dominant root, will be negative. This particular solution equa14Note that in equations (6) and (7) only the numerators then IA1(o, < IA2(0,I)I. differ. If Au /21 < Ii,ul )I) It is also obvious that if 92 = A, then Ai(o, i) = o and if ji = #XA2(o, I) = o. Also if ,u > ,1 > ,U2 then Ai(o, i) > o, I) I) A2(0, I) < o with IA1(o, I > IA2(0, I. This leads to the uninteresting case of growth at essentially g.

If yo = o and y1 =
and A2(o,
I) =
/2[1l

a
<

> o, then A1(o,i)

O.

> 0

This special case is the one con-

sidered by all those who, once and for all, impose initial conditions as a deviation from equilibrium.

tion, with roots (uq and I12) large enough to generate an explosive time series, will in fact have one upper turningpoint. As a result of the initial displacementnot being large enough, the explosion will take place in the opposite direction from its "start." Symmetrically,the above holds for y,, < Yn-i <o, i.e., if yn > p2Yn-l1 (,L2 > A) then A1(n- i, n) will be positive and A2(n- i, n) will be negative, so that one lower turning point will be generated. The Ceiling to Income. The task of this section is to examine the relation between particular solution equations that yield a monotonically increasing income and the income ceiling. The larger root of the solution equation is assumed to be greater than the rate of growth of ceiling income, so that in time the ceiling becomes effective. The problem is whether, once the ceiling becomes effective, income will bounce off the ceiling, yielding an upper turning point, or will continue to press against the ceiling resulting in a state of steady growth. Two cases must be examined: (i) when the smaller root of the solution equation is greater than the rate of growth of ceiling income, and (2) when the smaller root of the solution equation is equal to or smaller than the rate of growth of ceiling income. It will be shown that the first case results in income bouncing off the ceiling and the second case results in income continuingto press against the ceiling. i. Smaller Root Greater Than Ceiling Rate of Growth. To make the exposition simpler, we assume that X is a constant rate of growth of the ceiling income measuredas a deviation from ko, i.e., yc)n = Xny(c). We also have that y(d) A /ji + A2P; and we first assume that J > J > X > I. 1 2 Since it does not matter where we break into the time series, we begin with two positive, arand y1a). Both bitrarily dated incomes,y2a) incomes are less than the ceiling of their respective dates and also p, > y(a)/y(a) > 2. These initial conditions determine positive Ao(a, i) and A2(o, i). The particular solution equation thus started will generate a monotonically increasing series with an increasing (approaching -0) rate of increase of income. In time, say at the nth date, the income generated by this particular solution equation will become greater

I40

THE REVIEW OF ECONOMICS AND STATISTICS

p n+i)/,l1+A2(n, n+ I)4tl-n, will generate fu-

than the ceiling income, i.e., y(d)- =Al(o, I)p > 0fy(C) +A2(o, I2 As long as the particular solution equation yields an income less than the ceiling income (or greater than the floor income), the income so determined will be the actual income. Whenever a particular solution equation tends to generate an income inconsistent with the constraint, actual income is equal to the constraint (ceiling or floor) income. And whenever actual income is determined by a constraint, it will be interpreted as imposing new initial conditions. Inasmuch as two initial incomes are needed to determine A1 and A2 such an actual-equalsconstraint income and one other income is needed. This other income will be either the income just prior to or the income immediately following the first income at which the constraint becomes effective. then the actual income Hence, if y(d) > Xnyfc)
will be
y(a)

= Xny(c).

If

y(a)/y(a)

1=i(n,

n-

> tL2 > X then the particular solution equation using y(a) and ya)1 as the initial conditions will

generate an income yd)1

greater than the

(n+i)st date's ceiling income.'5 Therefore, the actual income of (n + i) will be determinedby the ceiling income, and new initial conditionsare imposed. As y(a) and y(a) are both ceiling in- proaches - oo, at a rate determined by /,u. 2. Smaller Root Equal to or Smaller Than comes y(a) /y(a) = X,so that a negativeA ,(n, n+ i) coefficient will be determined. This new par- Ceiling Rate of Growth. Assume that /jl > X ticular solution equation, y(d) (n, n + i) = Al(n, > I.t2> i and that the actual incomes of the nth and (n + i ) st dates are ceiling incomes. A par'5 The ratioof the two initial periodsincome,u ticular solution equation determined by using Al(n-i, n) these dates' incomes as initial conditions will Al(n-i, n) + A2(n-i, n) have positive A1 and A2. This particular soluA2(n-i, n) tion equation will yield only positive and inAi(n-i, n) + A2(n-i, n) is a weightedaverageof j,u and ju2 and the ratio of the creasing incomes and y(d)2 generated by this Ai(n-I, n) equationwill be greaterthan y(c)2. weights of gi and ,U2 is . From the solution A2(n-I, n) As a result of y(a) being determined by the A (n- i, n)t2u + Aa(n-i, n) A2 and equation y( ceiling constraint rather than by the solution A1(n - i, n)pul equation, new initial conditions are effective. n+I / + A, (n- i, n),ul + A 2 (n- I,n),U2 jl2 The new coefficients are A,(n + i, n + 2)
y(d)/y(d) n

ture incomes smaller than the ceiling incomes of the respective dates. Therefore, the ceiling will no longer be an effective constraint and, until such time as the floor becomes effective, actual incomes will be generatedby this solution equation. If /2 > y(a)/y(a)I > X, then the solution equation using y(a)1 and y(a) as initial conditions will determine Al(n - i, n) < o. If the absolute value of Al (n - i, n) is very small, the positive component,A2(n - i, n) can dominate, so that y(d) (n - i , n) > Xn+ly(c) . If this is true, then once again y(a) and y(a1 will be used to determine A,(n, n+ I) and A2(n, n + i ) and this case becomes the same as the one above. On the other hand, if IA1(n- i, n) I is not so small, then (d) n) -Xn+ly(c) , the ceiling is not ef(n-i, fective and this solution equationwill determine the actual incomes of succeedingperiods. Regardless of whether the ceiling income is an effective constraint for one or two periods, as long as /12 > X > I, the "initial conditions" will determinea negative coefficientfor the dominant root. Income will bounce off the ceiling and, unless constrainedby a floor, the solution equation will in time generate an income that ap-

+A2(n-i,n"),U2 A, (n-i,

2 -

i, n)/,L2 so that the ratio of the weightsof u,i and ,12 iS Al(n- ,n)# As /Li>Fu2 the weight of in deterj1
nl)F'i + A2 (n-

[X

h12
=

]Xyn=XA,(n, n + i) and A2(n + i, ]Xy=X A2(n, n+ i ). Therefore,

y,(d)

A2(n - i

n+2)

n)/A2

mining the ratio y(d)/y(d)

determining the ratio As
(a) n+1 y(d)

is greaterthan its weight in

y(d

the new solution equation is

= A[A1(n, n+ i)ul-(fl+l)

(n + i, n +
i)u-(n+1)]

2)

y.

Hence,

y(d)1>

AZy(d)

+A2(n, n+

is a ceiling income, then y(d) > Xy(d) so that

(c)
n+1
(d)Y

This will be repeated as long as the ceiling income is the effective determinant of the actual

A LINEAR MODEL OF CYCLICAL GROWTH income, so that y(d) (n+k, n+k+ I) = Xh[Al (n, n+ I )4+A2 (n, n+ I ) t4-] where t is either h or h + i. By continuously imposing new initial conditions which are determined by a sufficiently large constant rate of growth of ceiling income, steady growth is generated. Note that this steady growth state is not a "knife edge," for the rate of growth of ceiling income can vary between /ul and y2 without causing either "runaway" expansion or a downturn. The Floor to Income. As was argued earlier, a simple disinvestment assumption is that the maximumdisinvestmentper period is some constant percentage,p, of the capital stock required to produce the previous peak income. It has been shown that a peak income is in the neighborhood of a ceiling income so that the capital stock to be depreciated is 3[[ko+ Xny(c)] and the maximum possible capital consumptionper period is pf3[ko+n y(0]. The floor income following a particular peak income is given by As the coefficient of the dominant root is positive, Yn+h+2 will be greater than the floor income, and a monotonicexpansionwill be set off. With a constant floor to income, it is impossible for income to glide along the floor. For income to glide along the floor it is necessary that the rate of decrease of the negative floor income be greater than or equal to /2. This would require either an increase in p, the percentage of capital that can be consumed per period, or a decline in kothe equilibriumincome. To the extent that one wishes to interpret business cycle events using this framework, a deep
depression
-

or a stagnation

could only be

p/3 (n) + (ko

Y (f)

Xny (c))

(n)

-nal = ko(n) -

or
pf3(ko(n) + Xny(c)) y(f)
n+h (n)
-

I - al
a-l

Assume that the income determined by the ruling particular solution equation for the (n+h)th date is lower than the floor income, so that actual income equals the floor income. A new particular solution equation with Y4f)has one of the initial conditions is determined. The p3y (C) argumentsin the previous section examiningthe and and y(a+ could be repeat- from a ceiling income y(c) is ko ratio between Ya)h p18Y,c) ed; however, it is sufficient to argue from the ) assumptionthat both y(ah and Y(a)+ are equal the amplitude of the cycle is Y(c) - (koto the floor income. _ ko. If m periods elapse )y) Pa These two floor incomes determine a new =(I+ particularsolution equation with before the next peak income, the amplitude of
Al(n+k,n+ kI)
= -p/3(k0 + xny(c))

the result of p or ko changing. These assumptions would result in establishing formal symmetry between the floor and the ceiling. Generation of an Explosive Cycle. In this section it will be shown that in the case where income bounces between the ceiling and the floor the assumption that the consumptionequals-income income does not change implies that in time the absolute amplitude of the cycle will be greater than income. It follows that the assumption of an unchanging equilibrium income has to be abandoned,and in the next section the implications of various assumptions as to the behavior of equilibrium income will be derived. The amplitude of a cycle is defined as the difference between a peak income and the succeeding trough income and is approximately equal to the difference between a ceiling and a floor income. The floor income of a cycle which begins by either bouncing off or falling away

the succeeding cycle will be

(i +

a)tmy(c)

b1 -

I-al =
_pp (k o+
AnyO
al )c)

and
A2(n?+h,n+h+I)
- J

-ko where r is the constant rate of growth of ceiling income measured from its natural origin. In time p,8tmY(c)/I
-

a will be greater than ko,

I_

/12

/11

-1

Ial

0. I ~<

so that eventually the amplitude of the cycle will be greater than peak income. The relative amplitude of the cycle, defined

I42

THE REVIEW OF ECONOMICS AND STATISTICS

as the ratio of the amplitude to the beginning tion function liquidates the embarrassing explosiveness of the cycle generated by bouncing In between the income ceiling and floor. peak income, is (I + P ),rmY (c) i-al n If it is desired to consider ao (or y) as deaddition to implying negative income at the trough of the cycle, the assumption that ko is a pending upon financial or monetary phenomena constant implies that the amplitude of the cycle in addition to previous peak income, the relative will be an increasing percentage of an exponen- amplitude of the cycle can be a variable. If a tially growing ceiling income; the cycle gener- downturn in income occurs when assets are a large percentage of income, ko will be high and ated will be truly explosive. The Ratchet in the Consumption Function. the relative amplitude of the cycle that follows The assumptionthat ko, the consumption-equals- will be small. On the other hand, if a downturn income income, does not change leads to an in income is associated with a financial crisis, so economically unacceptable result. Hence, it is that the ratio of the value of assets to income necessary to abandon that assumption, and in falls, then ko will also fall, leading to a cycle this section we shall derive the implications of with a high relative amplitude. By allowing the assumptionthat a ratchet in the consumption financialdevelopmentsto affect the consumption function exists. It will be shown that, depending function, the basic accelerator-multiplierprocupon the assumptions made as to its determi- ess can generatecycles of varying amplitude. Note that if p, the depreciation ratio, is innants, a ratchet in the consumption function leads to a number of interesting results, namely terpreted as a behavior rather than a technical coefficient,it too would be affected by the same cycles with (i) constant relative amplitude, (2) varying relative amplitude, and (3) booms (or monetary and financial factors. That is, if a depressions) of differing length. The first two downturnin income is associated with financial results follow almost immediately from the dif- ease, the carrying costs of excess capacity and fering specificationof how ko changes, the third the need by firms for additional liquidity are result requires an investigation of the relation both low, and p would tend to be small. On the between the rate of growth of income measured other hand, if a financialcrisis occurs, the carryfrom zero and the rate of growth of income ing costs of excess capacity are high and firms measuredas a deviation from the consumption- would need additional liquidity, and p would tend to be high. Hence, financial ease would be equals-income income. associated with low amplitude fluctuations and The specification of the Duesenberry ratchet in the consumption function to be used is that financial stringency with large amplitude fluctuations. This effect of financial developments ao(n) = yY(c) where y1(a) = y(c) , y(a)1 < Y(c) on the depreciationratio would tend to reinforce and Y (a) .Y(c) hk> I> financial developments on the coni.e., that whenever a downturn (or a "falling the effect of sumption function. off" from the ceiling) occurs, ao increases. From In addition to differing in amplitude, cycles this specification it follows that ao is a constant differ in duration. The ratchet in the consumpwithin a cycle, including any periods in which function and the Tobin-Pigou asset effects income glides along the ceiling, but it increases tion can also affect the duration of the boom and,the' wheneverincome bounces off or falls away from depression. the ceiling. In order to examine the determinants of the As a result, ko also changes intermittently, in duration of a cycle, it is necessary to note that y(c). It follows the solution equation always determinesthe rate aO(n) fact ko(n) I - a, i -a, of growth of income as a deviation from the that the amplitude of each cycle is equilibriumincome, ko. The natural interpretay(c) and the relative tion of the rate of growth of ceiling income is as )y(c) PI+ P n n 2 i-al ial the rate of growth of income measured from its' natural origin.' In previous sections we assumed P which is a conamplitude is I+ that there was a constant rate of growth of inI-al I-al stant. The Duesenberryratchet in the consump- come measuredas a deviation from the equilib-

A LINEAR MODEL OF CYCLICAL GROWTH rium income. We will now investigate the relation between T, the constant rate of growth of income measured from the natural origin, and X, the variable rate of growth of income measured as a deviation from ko. The numerical growth of ceiling income between any two dates is the same measured from either origin, i.e.,
y(c)
-y(C)

I43

= y(c)

y(c)

y(c).

In determining whether income will bounce off or press against the ceiling once it becomes the effective determinant of income, it is x, rather than x, that is relevant. Once the income ceiling becomes effective the necessary and sufficient condition for AI o is for X(n, n+ i ) _ L2. Hence, if the income ceiling is the effective determinant of actual income beginningat the nth date, steady growth will continue as long as
X(n+h-I,

Therefore,
andas
Y(c)

t+

y(c)

X-

I
y(C) y(c)
-

y(c)
(T-

n+h)
(7-

y(c) n+h-1

=I

(7-

I) [ y(c)
n+h-1

I)y(C) I +

y(c) + g

I)[

y(c) +

g-2

we have

I+
y(C)

The border between a positive and a negative A1 is

2 (Thl 7-I) - T Y(c) (2 2I ) ylc) T Th-i=

If ko does not change, X is a variable, greater than r. As the limit of yVc)/y(c) is i, the lower Sinceg= limit of Xis r. On the other hand, if ko increases at the same
rate as y(c), which could be the result of interI+(-)

-I )Y()

wehave
(c_v)

y(C)

yfc)
)

preting the Tobin-Pigou effect as reflecting the increase in the net-worth of households that accompaniesinvestment activity, then T = X for
(c) y()
-

h -1 7I

=lg2(

- y('r(

(c)

ytC)

= y(c)YC

y(c)

-ko(t+i)

+ ko(t) -

h=

+1logkO(n)

[2

log

so that (X = (T18 If

i)y(c)
17

= (

I)[Y(c)

ko(t)]
where k is the number of periods after the ceiling first becomes effective that income will press against rather than fall away from (or bounce off) the ceiling. Obviously, with a fixed rate of growth of ceiling income the higher the ratio of the equilibriumto the actual income at the date the ceiling first becomes effective, the longer the boom; and the smaller the minor root of the solution equation, the longer the boom.'8
'The following table gives the proximatevalue of h, the number of periods for which the model will exhibit steady growth after reachingthe ceiling income, for various values of k (n) /IY(', the ratio of equilibriumincome to actual income at the date the ceiling first becomes the effective determinantof income and J2, the smallerroot of the solution equationassumingthat T is I.03.
k(n)) / y(c)
I.0
2

I)y(c)

income grows at three per cent per period (T = I .03) and if the equilibrium income is 2/3 actual income, so that y(c)/y(c) 3, than X = I.O9. That is, a three per cent rate of growth of income in natural units is equivalent to a nine per cent rate of growth of income. measured as a deviation from equilibrium income. "7Note that ko = ao/ (i - a,), so that if ko grows at the same rate. as ceiling income so does ao. Since c") = ao(t-i) +a Y() at a date when actual income equals ceiling income then
a (t - i) + a Y(c6)

C(c)/Y(c) =
t t-l

y(c)
t-1

[a (o) + a Y(C)]TtTt-l y(c)

0

a (o) + a Y(c) o 1 o
y(c) 0

which is a constant. Those authors who write Ct = ao Yt rather than Ct = ao+ al Yt-l can be interpreted as assuming that the equilibrium income increases at the same rate as the ceiling income, which can be identified as following from the specification that equilibrium income is affected by the result of investment activity in increasing the net worth of households.

.8 .6
I.0

I .05 I.05 I .05 I.07 I.07 I .07 I.I0 I.I0 I.I0

33 24

I5
20
I2

.8 .6
I.0

3
I3

.8 .6

6
I

I44

THE REVIEW OF ECONOMICS AND STATISTICS tion, that is, a relatively long period of stable,
low income.

As the length of the period of sustained growth depends upon the ratio of the equilibrium to actual income at the date the ceiling first becomes effective, any phenomenonwhich tends to increase this ratio will tend to stretch out this period. The interpretation of the Tobin-Pigou effect adopted in this paper would result in financial market and monetary developments affecting the equilibriumincome. In particular, a period following a rise in the ratio of the money value of households, assets to income would be characterized by long intervals of sustained growth during which income glides along (or presses against) the ceiling, whereas a period following a fall in this ratio would be characterizedby cycles in which income bounces off the ceiling. The monetary and financial developments which tend to stretch out the boom also tend to decrease the amplitude of the fluctuations and the developmentswhich tend to shorten booms are associated with deep depressions. A deep depression after a long boom can result if the falling away from the ceiling income were associated with a financial crisis. The floor to income becomes effective wherever income generated by a solution equation tends to be lower than the floor. Measuring from the natural origin the floor to income is pf3Y(C P3n 7<f), (n) = kok(n) but the particular solution equation generates income as a deviation from the equilibriumincome at the date it became effective. If at the date the floorbecomes effective, the rate of decline of the floor to income is greater than the smaller root of the solution equation, the new particular solution equation would have negative A1 and A2 coefficients. This lowering of the floor would have to be the result of changes in ko(n) or in p; and this, of course, could be the results of a continuing financial crisis. Hence, long and deepening depressions in this model result from a stretched-outperiod of financialstringency. This model is incapable of generatingstagna-

Conclusion It has been shown that a model which combines the explosive accelerator-multiplierhypothesis and an exogenously determinedrate of growthof ceiling income is capable of generating a wide variety of alternative types of time series. In particular, it was shown that one process is capable of simultaneously generating the trend and the cycle of observable series. The variability among the types of time series generated can be imputed to the effects of presumable observable events. As a result the model does provide a useful framework for economic analysis.

In particular, the model seems capable of serving as an explanatory device for the great postwar boom. Wartime shortages of capital equipment resulted in the ceiling income being much greater than actual income, and the great expansion of the net worth position of households due to the high wartime savings resulted in a relatively high consumption-equals-income income. In addition, the exploitation of various wartime technological changes for civilian use made the rate of growth of ceiling income high. The combination of these factors enabled income to press against the ceiling for considerable periodsof time. Wheneverincomefell away from the ceiling-as in I948 and I954 in the United States -the financial ease, carried over from the war, resulted in a relatively high and nonfalling floor in income, so that recovery was quick. In order for more serious depressions to occur it is necessary for the ratio of equilibrium income to ceiling income to decrease or for depreciation ratios to increase. Within the framework adopted in this paper, this could occur if the downturn were accompanied by a financial crisis or if the preceding boom had been associated with a relatively small increase or even a decrease in the liquid asset position of households and firms.

A LINEAR MODEL OF CYCLICAL GROWTH

APPENDIX
In the text the case where /%I t2> i is examined. y(d) = pt/2 (cos t + 2X - (al+8) > sin t O)y(C). 0 In this appendix the cyclically explosive case, where the roots of the solution equation are conjugate com(al +8) 2 \/4f8plex numbers with a modulus greater than i, is The problem is to determine the relation between y(d) and y(c). examined. The solution equation to Yt= (ai+f3)yt -I-Yt-2 - (al+18)sn2yc. ( y(d)=f(cs2+2X 20@ sin 2 0)y (c) . ,8) (COS + can be written as yt = Mt (A1 cos tO+ A2 sin tO) in the cyclical case, where M, the modulus, is equal to '\/48(al+/8)2 /31and B is defined by the conditions cos 0 = 2f81 and sin 9 = --,84
(ai+8)

We know that if cos 0 =

a1+P
2 -\/ V4X/
al___

. For the cyclically

then cos 20 = (al+/3)2-2 28

and sin 0

explosive case the modulus must be greater than i, so that ,8 > i. Once again A1and A2 are determined by the initial conditions. If ,B1 X the ceiling to income does not affect the time series generated; the interesting case occurs when 81 > X. To examine this case we will assume
that y(a) and y(a) are both ceiling incomes. The problem is whether y(d) > (c) so that y(a) = y(c)

V4-(ai+1)2 2 -\/,

and sin 26
Therefore,
= X2y(c).

(al +

) \/4/32/8

(al +/)2

y(d) = [X(a1+18) Therefore,

-#]y(c).

If the ceiling that y(d) > xy(c)

is to be effective,

it is necessary

and a new particular solution equation based upon > X2y(c) is a necessary condition for the ceiling to y(a) and y(a) as initial conditions is established. It be effective. This yields X2 _ (al+ P)x + f ? 0 will be shown that with a cyclically explosive soluor -2 (al+/3)X + (/3+k) = o (k > o) and tion y(d) < y(c), so that income always bounces off al++/ 4L /(al+1)2 4(G+k) However, x the ceiling. 2 Using the initial conditions we have that y(c) h V/(a al *ai+1 +,8)2-4/ 0/2 (A1 cos o0+A2 sin o?) so that A1=y(c). is real, and since ----is as2 Also, y (c) =Xy (c) =/3 (A1 cos O+A2 sin 0) so
2

y(d) = [X(a1+

]yC

(ai +f8)

,that2A=

y(c). Therefore, the par-

ticular solution equation is

V4,P- (ai+13)2

< o, so that sumed complex, (al+,8)2 4(,8+k) - /3 > A2 contradicts our assumption. X(al+/8) Therefore, < X2y(c) and y(d) ]y(c) [X(af1+#)
< y(c)-