E2017004                                                               2017-06-06
Gang Gong Yang Gaoy

Abstract:

We study economic fluctuation and business cycles from the perspective of stabilizing and destabilizing mechanisms. While price adjustment can be regarded as a stabilizing mechanism, are there mechanisms that destabilize an economy? We find that as early as 1939, Harrod discussed adestabilizing mechanism— a firm’s adjustment of its investment— illustrated by the knife‐edge problem. We construct a macro‐dynamic model with investment and price as the core macroeconomic variables. Our analysis shows that the interaction between the stabilizing mechanism (price adjustment) and the destabilizing mechanism (investment adjustment) generates fluctuations and cycles. Yet, due to the stickiness in its adjustment, pricing may not be a sufficient stabilizing mechanism and government policy may be needed to provide further stabilization of the economy.

Key Words:

Stabilizing and Destabilizing Mechanism; Business Cycles; Non‐linear Macro‐dynamic Model; Stability Analysis; Sticky Pricing

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