New Classical Approach to Growth-Cycles Interactions)
Despite the contributions we just presented, up to the early 1970s, the great majority of economists had disregarded business cycles as a major issue (see Bronfenbrenner 1969).
Business cycles analysis resurfaced with the successive “oil shocks” and the inability of the then dominant approaches (namely, the Keynesian, Monetarist, and neoclassical synthesis views) to propose an efficient economic policy.
The re-emergence was triggered by Lucas (1972), but the important point in our context is that this work was the starting point for a new macroeconomic approach which deeply affected the way economists analyse the interaction of business and growth cycles.Introducing rational expectations in the sense of Muth (1961), Lucas developed an equilibrium business cycles theory in which the trend - defined as the optimum equilibrium position - is given, and where cycles - interpreted as temporary deviations from the trend - are always (non-optimal but) equilibrium positions. Although this model does not include any growth-cycles interactions, it was a first step in a new approach. In this model, business cycles disturbances are minimized and the necessity for stabilization policies is strongly questioned (see Dal Pont Legrand and Hagemann 2010). Indeed, stabilization policies are useless precisely because fluctuations are determined independently of the trend. Although Lucas’s methodology came to dominate macroeconomics, his business cycles theory was heavily attacked for two main reasons. First, it was difficult to defend the idea that fluctuations could only be caused by (unexpected) monetary shocks, and second, the dynamics of his model could not mimic (or only on an ad hoc hypothesis) the persistence effect of shocks observed at that time.
Part of the solution to critiques addressed to Lucas’s business cycles theory can be found in two papers by Lucas and Rapping (1969) and Brock and Mirman (1972). The former proposed an intertemporal substitution mechanism which acts as a propagation mechanism for shocks compatible with an equilibrium approach with the result that a single shock could initiate recurrent fluctuations, and those fluctuations would be the outcome of the optimal reactions of agents. Brock and Mirman (1972) introduced an intertemporal substitution mechanism but their contribution consisted mainly of providing the first optimal growth model for an economy with stochastic productivity shocks. They proposed a unified framework for growth and cycles (which we describe as shocks and propagation) dynamics, which was the first step towards their joint analysis.