Posted by: Dirk | April 13, 2020

The Enigma of Business Cycles – Wicksell on Inventory Fluctuations

The last ten years have brought Knut Wicksell, a Swedish economist born in the 19th century, closer to the spotlight. His “Interest and Prices” (1898) should be understood as the birth of a new idea of how to explain monetary systems. (I have written about this elsewhere.) While some still pretend that Wicksell was a neoclassical economist, this has never been true. Just like Keynes worked in the paradigm of his time, so did Wicksell. And he found interesting spins to these old theories, like this:

The objection that a further reduction in rates of interest cannot be to the advantage of the banks may possibly in itself be perfectly correct. A fall in rates of interest may diminish the banks’ margin of profit more than it is likely to increase the extent of their business. I should like then in all humility to call attention to the fact that the banks’ prime duty is not to earn a great deal of money but to provide the public with a medium of exchange—and to provide this medium in adequate measure, to aim at stability of prices. In any case, their obligations to society are enormously more important than their private obligations, and if they are ultimately unable to fulfil their obligations to society along the lines of private enterprise—which I very much doubt—then they would provide a worthy activity for the State.

This is so interesting that I thought his “The Enigma of Business Cycles” would be worth reading. It is a short article published somewhere – really, I got no idea how I got it! – with page numbers 223 to 235. The problem with the article: It it is not interesting, at least from my point of view. Whereas Wicksell wrote interesting stuff about real estate markets and interest rates and, like above, low interest rates and credit, the article on business cycles does not follow up on these themes.

Here are some quotes to bring across this point. On p. 229, he writes about “the size and fluctuations of inventories between good and bad times”. Wicksell says he will develop a “working hypothesis” (p. 230), to be found on p. 232: “As soon as the rate of increase in output begins to lag, a hitch will immediately occur in the development of the economy. For my part, until I am shown something better, it is in this that I discern the real source of economic fluctuations and crises, which, in their present form, belong entirely to modern times”. He finishes his articles with the question: “Is overproduction an evil or a good thing; are accumulating inventories characteristic of prosperous times as a sort of by-product of such times and the inventories themselves cause of depressed times; or, on the contrary, do inventories increase during depressed times, and is this increase, taken in conjunction with technical and economic improvements, a necessary prerequisite for prosperous times?”

It took Keynes some time to develop his General Theory, which is based in the idea that business cycles are caused by fluctuations of aggregate demand. Wicksell stops short of this insight – inventories moving up and down are the consequence of demand fluctuations, not the cause. I think that this answer has been firmly established.


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