An Exploration into Pigou's Theory of Cycles

This Paper proposes a model of business cycles in which recessions and booms arise as the result of difficulties encountered by agents in properly forecasting the economy's future needs in terms of capital. The idea has a long history in the macroeconomic literature, as reflected by the work of Pigou [1926]. The contribution of this Paper is twofold. First, we illustrate the type of general equilibrium structure that can give rise to such phenomena. Second, we examine the extent to which such a model can explain the observed pattern of US recessions (frequency, depth) without relying on technological regress. We argue that such a model may offer an explanation as to why recession appear to be driven by declines in aggregate demand even in the absence of any significant price rigidities, and may also help understand elements of the recent downturns in Asia.