Theories of Economic Crises

Yves here. This post and its companion piece on neoliberal ideology illustrate the hold that economic belief systems have on policy. One big one that does not get enough mention is that neoliberal theories posit that economies have a native propensity towards equilibrium….oh, and at full employment! This charming story serves to justify capitalist systems as virtuous and self regulating. The reason this clearly false view has been successfully and aggressively promoted is not just that it suits corporate interests. It also has long served US opposition to Communism by depicting what was once called the free enterprise system as producing better outcomes than public ownership of assets. Of course, the reality that the US and even more social democratic economies are mixed systems, but the propagandists like to obscure pesky details like that.

By Alessandro Roncaglia, Emeritus Professor of Economics at La Sapienza University in Rome, a member of the Accademia Nazionale dei Lincei in Rome and the author of many books and articles. This essay is adapted from a presentation at a conference at the Lincei that will be published in Italian later this year. Originally published at the Institute for New Economic Thinking website

1. Introduction

There are different understandings of economic crises. Distinguishing between them is essential for an orderly debate, both for the interpretation of crisis situations and for making judgments about possible economic policy interventions.

In the following, I will attempt to briefly sort out the main conceptions of crises: as a normal phase of the economic cycle; as an unexpected shock that moves (transiently) away from an equilibrium position, considered as the center of attraction of the economic system; as the result of the systemic instability of market economies, in particular of the game of financial expectations. The first two conceptions – the first two groups of theories – consider crises as accidents of the road with no lasting effects on the economy, whose long-term course depends essentially on developments in technology and resources, including the working-age population. The third conception – the third group of theories – sees crises as manifestations of the endogenous instability of market economies with persistent negative effects on income and employment trends, social coexistence and civil life, and the environment.

The theoretical approaches to analyzing crises have behind them contrasting conceptions of the way the economy works, present both in the history of economic thought and in contemporary debate – despite the attempts of dominant mainstream views to silence the other. On the one hand, we have the marginalist conception of the economy, as a theory of rational choice between alternative uses of scarce resources, with all its variants; this includes the first two lines of analysis of crises, as oscillations around a long-term trend and as a transitory deviation from a position of equilibrium. On the other hand, we have the conception of the ‘classical’ economists of the eighteenth and nineteenth centuries of a circular flow of production, consumption, and exchange: a conception from which is absent the reference, characteristic of the marginalist approach, to equilibrium levels of production and employment corresponding to the full use of the productive forces, and above all the thesis of an automatic convergence towards such equilibria guaranteed by the play of supply and demand in perfectly competitive markets. In the classical conception, we can also include Keynesian theory, if correctly interpreted in its characteristic elements, and its developments concerning the systemic instability of market economies with a high degree of financialization.

2. Crises as Normal Phases of the Economic Cycle

The conception of the crisis as a normal phase of the business cycle, followed by depression, recovery, and boom dominated in the first decades after World War II, during what has been called the Golden Age, characterized by a more rapid development than in the preceding decades (the interwar period marked by the Great Crisis) or in the following ones (the last half century). During that period, the so-called neoclassical synthesis prevailed in the debate on economic theory: a compromise between the foundations of marginalist value theory and a tamed version of Keynesian theory. Of the marginalist theory, this compromise preserves the thesis of a tendency towards full employment equilibrium in the long run; Keynesian theory, reinterpreted as limited to the short run, is used to argue for the usefulness of active fiscal and monetary policies, aimed at countering at least the most extreme manifestations of temporary economic imbalances: expansionary policies to counteract unemployment in crisis and depression phases, and restrictive policies to counteract inflation in recovery and boom phases.

A typical example of this group of business cycle theories is the one proposed by Paul Samuelson, based on the interaction between accelerator and multiplier; but there are several others. These theories consist of mathematical models based on differential or finite-difference equations linking the development of income to that of investment, and the development of investment to changes in income (or expectations of such changes). An appropriate value of the parameters gives rise to a succession of growth, boom, bust, and trough phases (while other values of the parameters give rise to explosive trends or trends toward stationarity). A dense series of exercises then complicated the basic model by introducing taxation and money, international trade and income distribution, and other phenomena to show the limits and potential of active fiscal and monetary policies. The anchorage to marginalist theories of value is given by the fact that fluctuations take place around a long-run equilibrium path corresponding to a normal degree of utilization of available resources, including labor power (hence full employment). According to marginalist theories, in fact, changes in wages (the price of labor power) lead, as for all goods, to equilibrium between supply and demand in the labor market, on the sole condition that this is characterized by perfect competition.

The idea of crises as transient phenomena destined to automatically yield to full resource utilization is present, in the second half of the 19th century and the first half of the 20th century, among Austrian and Swedish economists. An original variant of this tradition is the theory of the business cycle proposed by Schumpeter in the first half of the last century and taken up several times in the most recent debates, which combines the theory of the cycle with that of development. According to Schumpeter, innovations continually upset the static equilibrium characterized by full employment. In addition, innovations tend to appear not as a regular flow but in swarms, thus initiating a phase of growth, generated by the investments of the innovating companies; these take resources away from the traditional companies thanks to the financing available to them and to the inflation produced by a demand that exceeds the availability of resources. When the additional output of innovative firms arrives on the market, price growth turns into a decline; traditional firms are gradually forced out of the market; a crisis and depression phase ensues. Market adjustment mechanisms return to an equilibrium of full utilization of available resources, but with higher levels of output and per capita income, thanks to innovations. This theory reiterates the thesis of the usefulness of crises, which release the resources needed for the development of innovative firms (the ‘creative destruction’ thesis). Obviously, for the validity of this thesis, it is necessary for the assumption to hold that market mechanisms ensure convergence towards equilibria of full use of resources. The same condition must have applied to those who, like Marshall, saw crises as a necessary purge of the speculative excesses of boom phases.

In the face of these positions, the subsequent compromise of the neoclassical synthesis, according to which active monetary and fiscal policies are useful to stabilize economic developments, while it is necessary to rely on market mechanisms to ensure long-run equilibrium, seemed to work in practice in the quarter century after the end of the Second World War. Then it went into crisis with the collapse of the Bretton Woods system and the phase of simultaneous high inflation and unemployment that followed the oil crises of the 1970s. The same period saw the rise of neoliberalism in political and cultural terms, monetarism, and then the theory of rational expectations in economic theory.

3. Crises as Unforeseen Shocks

Let us now consider the conception of crises as unexpected shocks that take the economy out of the equilibrium position, towards which market forces will tend to bring it back. The theoretical foundation of this conception is to be found in the theories of rational expectations, which carry to logical consequences the theses proposed in analytically more rudimentary forms by Friedman’s monetarism. According to these theories, economic agents, perfectly rational and endowed with complete information, take into account every element that exerts a systematic action on the economy. Only random elements, which can cause stochastic deviations from the equilibrium position, are excluded. Net of these stochastic deviations, the system is always in equilibrium: an equilibrium in which the real variables, income and employment, are not influenced by monetary and financial phenomena.

As mentioned above, crises resulting from unforeseen shocks remain possible: for example, an earthquake, a pandemic, but also erroneous economic policy interventions, or errors in the management of large enterprises that are driven to bankruptcy, or sudden financial crises, which can have disastrous consequences. Shocks of this kind can produce a fall in production and employment levels or, conversely, inflationary explosions, as happened during the successive oil crises, which were attributed to political events unforeseeable to economic agents. In each of these cases, the mechanisms of a competitive market then bring the system back into equilibrium.

Proponents of this group of theories are against any kind of government intervention in the economy. Counter-cyclical fiscal and monetary policies accepted by the neoclassical synthesis are considered unnecessary, since they operate in a systematic way and can be predicted by rational economic agents who take them into account in their decisions, thus canceling out their effects. To proponents of this view, the difficulty of precisely regulating the course of the economic cycle, correctly forecasting its development and adopting the appropriate fiscal and monetary interventions at the required time and to the exact extent, makes errors in the management of economic policy likely: this creates shocks that take the economy off its equilibrium path.

If one starts from the traditional marginalist theory of value and distribution, these conclusions follow very logically. Faced with concrete economic events, it is always possible to find ad hoc justifications for crises, in one or another type of shock. Thus, for example, in the face of the financial crisis of 2007-2008, it was argued that it was the introduction of fiscal measures that caused an increase in voluntary unemployment that caused it; an article supporting this thesis was accepted by one of the leading journals in our profession.[1]

The problem with all these theories is that they are based on the automatic adjustment mechanisms towards full employment of marginalist theory, rooted in downward changes in wages in the face of unemployment and upward changes in labor demand in the face of a reduction in wages. This inverse relationship between real wages and employment has been criticized from different perspectives. Keynes pointed out that the prospects of falling demand linked to a reduction in the real wage put downward pressure on consumption and investment, and thus on aggregate demand, output, and employment.[2] Sraffa showed that a reduction in the real wage does not necessarily make the use of more labor-intensive techniques cheaper. A large subsequent debate confirmed the validity of this criticism. General economic equilibrium theories themselves have come to the conclusion that full employment equilibria, in addition to being multiple, can also be unstable.

4. Crises and Systemic Instability in Market Economies

Keynesian theory is based on a sequence of cause-and-effect relationships: what happens in the money and financial markets, over which expectations dominate, in a very short-term perspective that favors instability, affects interest rates and more generally the conditions under which investments can be financed. Decisions on the latter are taken from a long-term perspective, but the timing of realization can then be adapted to the evolution of the financial markets and to expectations on sectoral and aggregate demand. As a result, investments fluctuate over time, both because expectations of returns change and because it is more or less easy or expensive to obtain the necessary financing; this in turn leads (via the multiplier mechanism) to fluctuations in output and employment. Moreover, there is no reason to assume that these fluctuations occur around any equilibrium level or trend towards full employment.

We thus have two implications of Keynesian theory for the conception of crises: the crisis as a depression, i.e., as the persistence over time of even high levels of unemployment; the crisis as instability, episodes of falling employment.[3]The economic policies prescribed therefore consist of both systematic support for levels of aggregate demand and interventions to reduce instability. In both cases, it is not just a matter of adopting expansive or restrictive monetary and fiscal policies, but of creating an environment of rules and customs conducive to the development of the economy. To give a few examples: control of speculative financial activities (as in Keynes’ hostility to short-term international capital movements), reduction of uncertainties in national economies and international relations (as in Keynes’ choice of fixed exchange rates at Bretton Woods), public investment policies in infrastructure and the environment, support for public education and widespread welfare.

After Keynes, the theory of systemic financial instability was developed in particular by Hyman Minsky. He distinguishes three types of positions adopted by economic agents: hedged positions, in which it is expected that the debt service with which the purchase is made of real or financial assets (e.g. houses, raw materials, machinery, shares, bonds) is more than covered by the expected income; speculative positions, where my expected income is higher than the repayment instalments on the loan under normal conditions, but may not be so if conditions change for the worse (e.g. when a company invests in machinery, which it would not be able to repay if sales of the product collapsed, or when the investment is financed with short-term debt that has to be refinanced, and I am then faced with a credit crunch); ultra-speculative positions, in which one or a few future events are crucial for servicing the debt (e.g. if I use loans to buy an asset, such as gold or silver, that yields nothing, I am betting everything on the fact that its price will rise over time at a rate higher than the interest rate). The ‘financial fragility’ of an economic system depends on the proportion between the three types of positions: it is higher the more widespread are positions of the second and especially the third type. With ultra-speculative operations, all it takes is a reversal in the price of the asset, or an increase in interest rates, to determine the bankruptcy of the operator involved, and if operations of this type are very widespread, there can be a general crisis of the economy. This was the case in 2007-08 when house prices stopped rising, causing a crisis for those who had bought them by taking out mortgages whose installments were paid at least in part by taking out new loans, guaranteed by the increase in the price of the houses themselves; in the wake of the operators with ultra-speculative positions, financial institutions, large and small, which had mortgages that were now in default, went into crisis.

According to Minsky, crises of this type have a repetitive pattern, gradually increasing in intensity. Confronted with a crisis, political authorities adopt rescue measures. When the economy recovers, reassured by public intervention, financial operators start to build up ultra-speculative positions again: they guarantee huge profits if things go well, while the belief spreads that if things go badly, it will be the authorities who will get everyone out of trouble. Thus, from cycle to cycle, crises become heavier, while the interventions of the monetary authorities become more and more substantial until we pass from a situation in which financial institutions are too big to be allowed to fail to a situation in which they become too big to be rescued (from ‘too big to fail’ we pass to ‘too big to be rescued’: what happened in the crisis that started in 2007-8, fortunately only in the case of the Icelandic banks). We are therefore faced with the possibility that sooner or later there will be a crisis of colossal dimensions, such as to determine a real collapse of the world economy.

(The idea of a terminal collapse of capitalist economies recalls, but on a different basis, Marx’s theses, which cannot be discussed here, but which on critical analysis also turn out to be based on an erroneous labor-value theory).

5. Crises: Opportunity or Calamity?

As we have seen, according to Schumpeter’s theory, taken up in partially different forms in the more recent theory of expansive austerity, crises are not only an inevitable phase of the economic cycle but also a necessary phase for economic development. In fact, the bankruptcy of the least efficient firms that occurs in the crisis phase is necessary to free up the resources used by firms that invest in introducing innovations, and thus realize technical progress. Crises are therefore an opportunity to help the economic system get rid of the dross – the less efficient firms – and move forward.

This thesis, however, is only correct if the marginalist approach, into which Schumpeterian theory falls, is correct. For only in this case does the economic system automatically tend towards the full utilization of available resources, so that what entrepreneurs invest must necessarily be taken away from someone else. But this is a mistaken assumption, as we have seen, without which the sacrifices imposed by the crisis are useless if not counterproductive.

There is, in fact, a substantial difference between the two types of crises. On the one hand, both the crises theorized by the neoclassical synthesis, as phases of an oscillatory trend around an equilibrium path, and those considered the effect of unexpected and transitory shocks by the theory of rational expectations, are seen as episodes, all in all compensated by phases of recovery in the long-term trend of an economic system that grows in line with the available resources, therefore at the maximum possible rate. On the other hand, both Keynesian crises and the financial crises theorized by Minsky are instead downward deviations from the levels of full use of resources and full employment, towards which the system does not automatically tend: it is therefore a matter of a pure loss of production and employment.

Not only this: the presence of links between production levels and growth rates on the one hand, and technical progress on the other (static and dynamic economies of scale, learning by doing, etc.) mean that crises also entail a loss of technical progress, which is not recovered over time, and thus move the economic system onto lower growth paths than would have occurred in their absence.[4]

Social cohesion can also be challenged by high levels of unemployment, income losses, and even uncertainty about job and income security. There has been a long debate, particularly in the 18th century, between those who argued that poverty and deprivation stimulate active reactions, which are also sources of improvement for the economy as a whole, and those who argued that both labor skills and ingenuity are negatively affected by conditions of deprivation and economic insecurity; with Adam Smith, the latter position has prevailed, confirmed by various empirical works in more recent decades. Moreover, the spread of education, which is increasingly important for economic and civic development, is correlated with income and employment levels.

Even in the face of the – extremely serious – environmental problem, unless we follow the path of degrowth, which is unlikely to be ‘happy’, or want to reach a situation of ecosystem collapse, the path of sustainable development requires technological changes, investment in infrastructure and regulation of production techniques which, in addition to requiring the state to drive and direct it, have a cost and are therefore more easily achievable in a situation of good economic performance.[5]

All in all, it can be said that economic crises are not an opportunity, but a great trouble for our societies. The opposite can only be argued on the basis of economic theories that are wrong in their foundations. The economic policy choices made on the basis of such theories have in fact led to serious and growing problems; a cultural renewal in the debate on economic theory is needed to meet the serious challenges on the horizon.


[1] L.E. Ohanian, “The economic crisis from a neoclassical perspective,” Journal of Economic Perspectives, vol. 24, 2010, pp. 45-66. Again, in order to avoid acknowledging what are in fact normal market dynamics, the entire responsibility for crises has been attributed from time to time to errors or corruption on the part of regulators (which do exist and can increase problems, but do not cause them).

[2] According to rational expectations theory, on the other hand, the fall in consumption caused by the reduction in real wages would be accompanied by an increase in investment, because more capital-intensive techniques would become cheaper. However, it was precisely the inverse relationship between real wages and capital intensity of techniques that was conclusively criticized in the 1960s debates on capital theories. On these issues and the surrounding debates see A. Roncaglia, The Age of Fragmentation, CUP, Cambridge 2019.

[3] Keynes argues the first point mainly in the General Theory, the second mainly in earlier and later works (see M. Tonveronachi, J.M. Keynes. Dall’instabilità ciclica all’equilibrio di sottoccupazione, NIS, Rome 1983).

[4] Some exponents of the neoclassical synthesis have pointed to something similar to the phenomenon of hysteresis, whereby long-run equilibria are modified by short-term fluctuations. In this way, they emphasize the importance of active policies to counteract crisis and depression phases of the cycle, while retaining the basic reference to a persistent tendency towards resource-full equilibria, which is the subject of the criticism mentioned above.

[5] The sustainable development theses referred to here are distinct from the neo-Malthusian theses of the Club of Rome, which were based on the thesis of a scarcity of natural resources (it was predicted in the early 1970s that oil would run out within 18 years). As with Jevons’ earlier thesis, according to which British manufacturing development would be halted by the depletion of coal, these theses do not take into account the effects of technical progress, which in the long run have proved decisive, and whose active exploitation is at the heart of the sustainable development thesis.

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  1. PlutoniumKun

    Of all the many intellectual failures of modern economics as a science, the most obvious one is its complete inability to develop and validate a coherent theory to explain and predict cyclical and/or structural recessions. Keynes of course came pretty close as a macro theorist, and Minsky provided the best structural explanation, but of course both are sidelined by modern mainstream economists. It should be said that many non-mainstream left wing/Marxist economists haven’t covered themselves with glory either in this regard. In Ireland, the only economist who correctly predicted the 2008 property crash was an academic specialist in medieval urban economics, and was generally ignored or even ridiculed by his colleagues and ex students. He dryly observed one time that he knew the economy was screwed when he heard some of his ex students, now banking specialists, calmly telling everyone in media interviews around 2007 that there was nothing to worry about.

    1. JonnyJames

      In the US, only a handful of academic economists predicted the crash with any detail: Michael Hudson was one of the few, and likely the most accurate. Yves’ intro to this piece roughly corresponds to Hudson’s outlook. Yves’ book ECONned also outlines the role of academic economists/economics. Hudson calls neoliberal economics “junk economics”

      Simply speaking, since ‘mainstream economics’ is dominated by neoclassical/neoliberal ideology, and the vast majority of academic economists are neoclassical, (as opposed to classical economics) we can conclude that there are major flaws in the theory/ideology. (I call it ideology, not theory). The rhetorical question I have is: if a theory is “internally valid” yet is externally invalid, and has little predictive qualities, what good is it? Can it be considered a “scientific” theory? Whose interests does this ideology serve? Why are so few non-neoclassical economists promoted, and why are virtually all professional economists neoclassical/neoliberal?

      In my crude way, I liken neoclassical/neoliberal “mainstream” economics as a self-serving ideology to “rationalize” oligarchy.

    2. Kouros

      It is not a failure. They were very succesful in entrenching and enlarging a certain type of economic & political system. Everything else is secondary.

  2. Birch

    Thorstein Veblen pointed out that free market economies tend toward equilibrium, and that equilibrium is abject depression. Events like gold rushes or government spending can pick things up for a while, but the equilibrium will always return.

    1. King

      Veblen sounds like he was familiar with noneconomic definitions of equilibrium. The physical sciences and engineering would use the term steady state and not equilibrium. Making sure freshmen understand the difference is quite important. It’s one of those basic methodology things like defining a system’s boundaries with the necessary rigor.

  3. The Rev Kev

    My own prejudice is to have economic theories based on empirical evidence back by historical data but I guess that is why I never became an modern economist. /sarc

    I still can’t believe that they still take things like trickle down theory seriously after all these decades of failure but economic studies have been borked for a long time. Back in high school in the 70s I had a mate studying economics there. He told me how they would learn one theory but then the teacher would say that that didn’t work in reality. And this happened again and again in his class.

    So I guess that what I am saying is that modern economics is not fit for purpose as it fails to match real world experience but that is by intent and all for the financial furtherance of a select few.

    1. eg

      Neoclassical/orthodox economics isn’t a science — it’s the cant of a priest class which justifies arrangements privileging property and capital at the expense of labor. All the fancy “mathiness” is for gulling the rubes.

      1. chuck roast

        Equilibrium Theory satisfies our desperate human need to achieve and maintain stability and predictability. Really quite brilliant in that regard. And rational choice attached…brilliant does not do it justice. The fact that it falls on its face at every opportunity is neither here nor there…it is a priestly structure with minimum epicycles that serves that most basic human need. No more accurate a predictor than the Oracle of Delphi, but entirely fit to serve the same purpose. Good luck deposing it.

    2. vao

      modern economics is not fit for purpose as it fails to match real world experience

      The most stupendous aspect of all that is that it even fails to have internal theoretical consistency. Two famous examples are the Sonnenschein-Mantel-Debreu theorem, and the Cambridge capital controversy.

      In other words: it does not work in practice, and it does not even work in theory!

  4. dao

    The closest thing I have ever found to an explanation of the economy the way it actually works is the model described by C.H. Douglas.

    In a nutshell, the final market prices obtained are higher than the sum of the input prices (labor, rent, materials, etc) The profit motive ensures this.

    In such a system, it is impossible to have equilibrium. There is a continual need to either produce other goods and services elsewhere in the economy to pay for the difference (a continually expanding economy) or else pay for the difference with credit (which requires constantly expanding credit).

    Neither solution is sustainable or results in equilibrium.

    1. Acacia

      Thanks for this pointer to Douglas.

      Doesn’t Marx make a similar argument about the extraction of surplus value?

      1. dao

        Marx’s model is similar, but Douglas’s explanation is more obvious and easily understandable.

        (btw, the thing that enables a seller to sell for more than cost is bargaining power, even if ever so slight.)

      2. digi_owl

        Kinda, but i think Marx got sidetracked by trying to prove that the only “real” source of value was the blue collar worker by way of exploitation.

        This then resulted in mental contortions to avoid acknowledging the effect of factory machinery.

        This, and the horrors performed in his name after his death, made him easy to dismiss.

        1. dao

          Marx’s economic model did not address the fact that the worker was also being exploited by his landlord, shop keeper, banker, etc. not just his “capitalist” employer.

          1. digi_owl

            Kinda sorta.

            The posthumous volumes touch on the issue of rentier/finance capitalists, and has a passage about how in times of a capitalist crisis the industrial capitalists would do best to side with their workers against the finance capitalists. But laments that historical data shows them realizing this far too late crisis after crisis.

            And i think shopkeepers were one of those groups of capitalists that Marx struggled to pin down, as part of the vague petite bourgeois.

          2. JonnyJames

            Dao: Vols. 2 and 3 of Marx’s Capital (Critique of Political Economy), the ones most “Marxists” don’t read, deal with these topics. Most “Marxists” seem to focus only on Vol. 1.

            Other classical economic thinkers like David Ricardo, John Stuart Mill talk about unearned income, interest, rent extraction etc. Economic history is important, despite the lack of it in our educational institutions. I didn’t learn about Thorstein Veblen as an undergrad at all, for example. Marx was treated as an anachronistic relic, not to be taken seriously.



    2. vao

      Never read Douglas, but from what you state there is a third possibility: some of the inputs are actually free.

      The major free input is energy of the sun: agriculture, husbandry, fishing, and forestry are entirely dependent upon it. Obviously, free solar energy makes possible a stable primitive, pre-industrial economy, but is not enough to sustain a modern, capitalist industrial society.

      1. digi_owl

        One can take that further and look at how fossil fuels (oil, coal, NG) are basically stored solar energy from millions of years back.

        And then extrapolate that forward and see just how many acres of land would be needed to “feed” your typical F-150.

      2. dao

        None of those inputs are actually “free” (you have to cut down trees to turn them into valuable things which then need to be put into the hands of buyers) but if an input is truly actually “free” it will still wind up being priced higher than free, otherwise it won’t be produced in a “market economy”.

        1. vao

          Energy is an input — actually an essential input in economy (according to Steve Keen, the essential input) — and energy from the sun is free.

          Contrast growing plants (whether tomatos or hemp) outdoors, or inside a building with artificial light.

  5. jackiebass

    A theory is an unproven statement.That is why you have to be cautious about them. Theories seem to be the root cause of so much economic failure.People assume they are correct when often they are shown to be flaued.

  6. Librarian

    I try to look at economics in a very simple way. Let’s start with an over-simplified example in a closed system. In an urban environment: I have a company or a job and I make a product or service to sell to you for one purpose. That purpose is so that I can take that money from the sales, and buy the product or service that you make. Now multiply that by 100,000’s. Guess what? All the aggregate purchasing power generated by all those sales, will never-ever be enough to buy all those products and services! You can take that one to the bank.

    So there will be excess inventory. What to do? Cut production and lay offs. Some call that the deflationary gap, and I have heard economists mention it. But they never follow it to its ends. Something has to raise aggregate income without creating excess inventory, something has to fill that gap, always. That is why it is said that capitalism always has to grow. But I think it is true for all urban economies. (Not for subsistence farming communities though, where all needs comes from the land.)

    Often that gap can be filled by exports. In effect you are exporting your unemployment due to potential lay-offs. (The planet earth is a Closed System!) It can be filled by private investment in factories, tooling, housing or other. But that requires “investor confidence”, which is lacking during crisis periods. It can be filled by government spending on education, health care, pensions, roads, bridges, electrical distribution systems, flood control and many others.

    America and many other countries use government spending for militarization, and armaments. But that requires an enemy or a war. We have our Foreign Minister and his negotiations to supply that for us.

    Probably most important effect (these days), causing business cycles is the desire to correct them, or not. Recession from business cycles brings fear and acquiescence into the population, and makes it easier to co-opt state institutions for you own nefarious ends.

    All these other economic theories are just the “fog of war”.

    1. eg

      The “something” that has been filling the gap for the West since the advent of industrialization is the unequal trade arrangements with the Global South — first via mercantilist colonialism and latterly by debt diplomacy and the post-war global institutions of “the Washington consensus.”

      Why do you think there’s so much ferocity behind maintaining the “rules based international order” where the US makes the rules and orders everyone around?

  7. Altandmain

    As many of the commentators here note, it was never about coming up with an accurate theory as to how the economy really worked, but rather, about coming up with the justification for greed and a very unequal distribution of wealth.

    Roncaglia notes at the end of the article that economic crises are not an opportunity, but there isn’t a chance that he would accept the major reforms to prevent the crises from happening. An example would be a very tightly regulated financial system.

    More equal economies are also more stable.

    The conventional economic profession can’t come to terms with this. They can’t because they exist at the behest of the rich.

    1. Alessandro

      “There isn’t a chance Roncaglia would accept the major reforms … a tightly regulated financial system”: why not a chance? See my forthcoming book, Power and inequality, a reformist perspective, CUP 2023, and see the (freely available) papers by Montanaro and Tonveronachi in PSL Quarterly Review (a journal I edited at the time), 2011, vol. 64, issue 258, 193-226, and 2012, issue 263

  8. russell1200

    The comments are acting oddly.

    My favorite book on business cycles, primarily because the author goes through all the different thoughts/theories that I know of/hear of is Lars Tvede’s Business Cycle Theory and Investment Reality.

    He sources very well, so you also learn a lot by going to his sources.

  9. JonnyJames

    <…"Social cohesion can also be challenged by high levels of unemployment, income losses, and even uncertainty about job and income security…"

    Social cohesion? We don't use that term here in the US, it's much more common in Europe and elsewhere. We don't want no stinkin cohesion over here.

    Social cohesion is considered an "externality" in mainstream (junk) economics. Besides: job/income insecurity, lack of social cohesion (divided, polarized society) and unemployment are good for the "market":

    As Alan Greenspan said "…If the workers are more insecure, that's very healthy for the society, because if workers are insecure they won't ask for wages, they won't go on strike, they won't call for benefits; they'll serve the masters gladly and passively. And that's optimal for corporations…"

  10. John Taylor

    They are all staged and well planned out. Because let’s be real, it really only effects the wages scrubs in the lower 80 percent.

  11. Dick Swenson

    There are many remarks one can make on the INET article; mine is about comment 5 at its conclusion.

    The Club of Rome made NO predictions in its first two volumes. Those volumes simply demonstrated a technique of simulation called System Dynamics.

    This technique (developd by Jay Forrester) was demonstrated by being applied to a number of different world models using different initial values and internal constants. The results had one common characteristic: a cyclic or large growth followd by a collapse. The specific behaviour depended on the value given to the initial values and constants, the so-called “natural rate” of something.

    They specifically denied making any specific predictions.

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