A Long-Commodity-Cycle Model of the World Economy Over a Century and a Half making bricks with little straw

This paper explores the world business cycle using un ltered data from 1870 and looks for a theory that could account for the long wave commodity cycle in the world economy. We build a simple DSGE model that includes a long time-to-build constraint in the commodity sector. We nd that this model can produce long cycles in output and commodity prices as introduced by Kontradie¤ (1925) and Schumpeter (1935). Our ndings show that these long business cycles are produced by the long gestation of commodity capacity which causes very large swings in commodity prices. Keywords: Long waves; commodities; DSGE model; Indirect Inference JEL classi cation: E10; E32; E52 1 Introduction: the world business cycle and the long wave The goal of this paper is to consider the world business cycle and speci cally relate it to two main shocks: from materials productivity, and from money supply policy. Most macroeconomists think of the business cycle as of fairly short duration, perhaps between 5 and 10 years from peak to peak. This could well be true at a national level because of the variety of shocks that can trigger recession for a smaller, national, unit. One can use data lters, such as the Hodrick-Prescott lter, with a lter window such that cycles are generated at such frequencies. Such lters can do the same thing at the level of the world economy. However, if one looks at un ltered world data from around 1870 to the present day, which is our data sample here, one can discern a series of very long output cycles, with the length on the upswing of some 20 years length. Figure 1 shows world output annual growth from 1870; if one takes uninterrupted spells of positive annual growth (i.e spells with no year of negative growth) there are four such upswings in the sample, 1877-1892, 1894-1907, 19471974 and 19832008. The omitted periods are two downswings, 1973-1982 and 2009-2012; and also the period including the two world wars, 1908-1945, a period of sharp and mostly short swings, including the 1930s Great Depression. What we see from this data, excluding that war period, is that on this admittedly crude de nition of a recession as annual negative growth, we have an average upswing of 21 years and an average downswing of about 7 years, a total average cycle length of 28 years. The war period, with its several short cycles, brings down this average. However, what we draw attention to here is the presence of several long cycles. Two prominent economists in the past two centuries have urged the presence of long cycles; both have been largely ignored in recent macroeconomics. One, Kondratie¤ (1925; see also Kondratie¤ and Stolper,1935), wrote in the Soviet Union. The other, Schumpeter (1935), was for many years professor at Harvard where he wrote several books about growth and the business cycle. Two of his big macroeconomic ideas were the role of creative destruction in productivity growth and the e¤ect of commodity long waves on the business cycle. One can see creative destruction at work in commodity innovation where new materials simply push aside the old one, as iron and steel pushed away wood, or polypropylene sisal and jute; but here we do not focus on this idea about the source of growth as our productivity LeVP@cardi¤. ac.uk; Cardi¤ Business School, Cardi¤ University, Colum Drive, Cardi¤, CF10 3EU, UK MeenaghD@cardi¤. ac.uk; Cardi¤ Business School, Cardi¤ University, Colum Drive, Cardi¤, CF10 3EU, UK MinfordP@cardi¤. ac.uk; Cardi¤ Business School, Cardi¤ University, Colum Drive, Cardi¤, CF10 3EU, UK.