Saturday, September 27, 2014

Keynes on Inventories and the Business Cycle

Philip Pilkington has an enlightening post here on Keynes’ view of the business cycle.

Keynes discusses the business cycle in Chapter 22 of The General Theory of Employment, Interest, and Money (1936).

At the end of the chapter, Keynes has an important discussion of the role of inventories and cycles:
“Even to-day it is important to pay close attention to the part played by changes in the stocks of raw materials, both agricultural and mineral, in the determination of the rate of current investment. I should attribute the slow rate of recovery from a slump, after the turning-point has been reached, mainly to the deflationary effect of the reduction of redundant stocks to a normal level. At first the accumulation of stocks, which occurs after the boom has broken, moderates the rate of the collapse; but we have to pay for this relief later on in the damping-down of the subsequent rate of recovery. Sometimes, indeed, the reduction of stocks may have to be virtually completed before any measurable degree of recovery can be detected. For a rate of investment in other directions, which is sufficient to produce an upward movement when there is no current disinvestment in stocks to set off against it, may be quite inadequate so long as such disinvestment is still proceeding.

We have seen, I think, a signal example of this in the earlier phases of America's ‘New Deal.’ When President Roosevelt’s substantial loan expenditure began, stocks of all kinds—and particularly of agricultural products—still stood at a very high level. The ‘New Deal’ partly consisted in a strenuous attempt to reduce these stocks—by curtailment of current output and in all sorts of ways. The reduction of stocks to a normal level was a necessary process—a phase which had to be endured. But so long as it lasted, namely, about two years, it constituted a substantial offset to the loan expenditure which was being incurred in other directions. Only when it had been completed was the way prepared for substantial recovery.

Recent American experience has also afforded good examples of the part played by fluctuations in the stocks of finished and unfinished goods—‘inventories’ as it is becoming usual to call them—in causing the minor oscillations within the main movement of the trade cycle. Manufacturers, setting industry in motion to provide for a scale of consumption which is expected to prevail some months later, are apt to make minor miscalculations, generally in the direction of running a little ahead of the facts. When they discover their mistake they have to contract for a short time to a level below that of current consumption so as to allow for the absorption of the excess inventories; and the difference of pace between running a little ahead and dropping back again has proved sufficient in its effect on the current rate of investment to display itself quite clearly against the background of the excellently complete statistics now available in the United States.” (Keynes 1964 [1936]: 331–332).
This seems to be confirmed by modern studies of the business cycle (Knoop 2010: 18; Sorkin 1997: 569).

Certainly in the golden age of capitalism (1946-early 1970s), a number of US recessions, for example, were essentially what can be called “inventory recessions”: recessions caused by businesses’ accumulating excessive inventories which they were unable to sell when the expected demand failed to materialise or demand did not grow at a sufficiently high rate. This excessive accumulation of stock led to cuts in production and investment (basically, for many companies, changes in capacity utilisation) to liquidate inventories, and that in turn induced recessions (Sorkin 1997: 569).

Of course, since the 1980s the business cycle has been driven by other, perhaps more important, factors too: we have seen a return to the familiar 19th-century and pre-1933 pattern of asset bubbles financed by excessive debt, the bursting of these asset bubbles, financial crises, the collapse of business confidence, debt deflation, and so on.

Keynes, J. M. 1964 [1936]. The General Theory of Employment, Interest, and Money. Harvest/HBJ Book, New York and London.

Knoop, Todd A. 2010. Recessions and Depressions: Understanding Business Cycles (2nd edn.). Praeger, Santa Barbara, Calif.

Sorkin, A. L. 1997. “Recessions after World War II,” in D. Glasner and T. F. Cooley (eds.), Business Cycles and Depressions: An Encyclopedia. Garland Pub., New York. 566–569.


  1. Yes, this is called a Kitchin Cycle. I am surprised that Keynes had not read the original work published in the early 1920s.

    By the way, it may be of interest that Kaldor thought that the interest rate should be used to iron out these cycles. This was in contrast to Keynes who thought that there should be low interest rates across the cycle. See second last section here:

    1. Thanks for this comment.. I looked up the "Kitchin Cycle" in my trusty Business Cycles and Depressions: An Encyclopedia, and see I missed that point.

      Do Post Keynesians have a position on the so-called "Kondratieff cycle" of Schumpeter? Just reading about through it, Schumpeter's theory of business cycles looks pretty dodgy to me.

    2. Oh God... I had to sit on a panel with one of the leading experts on so-called 'Kondratieff cycles' over the summer. It is complete rubbish. A typical instance of people treating data as children do clouds and reading patterns into them when there are none there.

      The only component of Schumpeter's business cycle theory that is empirically valid and remotely interesting are the Kitchin Cycle. Apart from that Schumpeter displays himself as what I always portray him to be: a really and truly awful economist who made his name by playing the contrarian.

      Modern day Schumpeterians ignore Schumpeter's awful economic theories and focus on his work on technological change. But this work is just derivative of Marx's work on the same topic; but Schumpeter just gives it a pro-capitalist ideological twist. Joan Robinson once said that Schumpeter's work on technological change was "Marx with the adjectives changed". That is pretty accurate.

      I have no idea why Schumpeter is taken seriously today. Absolutely none.

    3. Nice to see my intuition was right.. It has actually struck me before that Schumpeter's views on business cycles seem oddly reminiscent of real business cycle theory.

    4. Even his prose sucked. The phrase that he is famous for is "creative destruction". Any self-respecting writer would cringe at the term as it embodies two contradictory words that negate one another. Thus the effect it has is to dull thinking and create mystique/authority. Um... didn't a major English prose writer show what this sort of internally contradictory language is used for? I think, of course, of Orwell's 'doublethink'. 'Blackwhite', 'goodbad'... 'creative destruction' fits right in there!

    5. Sorry to continue on this topic, but:

      (1) the so-called "Juglar cycle".. is this simply another imaginary cycle that is just explained by conventional Keynesian explanations?, and

      (2) I just noticed that in The Oxford Handbook of Post-Keynesian Economics (vol. 2), p. 346, there is a chapter that seems to take “Kondratieff cycles” seriously. The author explains the long boom of 1850-1873 and the alleged bust of 1873-1896 as a “Kondratieff cycle”.

      But as I understand it 1873-1896 wasn't some long depression, but was made up of a number of businesses cycles, with output much higher at the end than at the beginning.