The relationship between business cycles, saving and profit rates: Theory and application

Since the time when Adam Smith lived, economy theory has not come to an agreement on the sources of cyclical fluctuations in economy. The reasons for cyclical fluctuations are accounted for on the basis of whether economy comes to the equilibrium without the intervention. According to the approach lead by the mainstream economic thought, external shocks, such as technology and supply shocks, are in effect on creating the periods of economic expansion and contraction. In the economic thought held by Keynesians, there are internal reasons for the flactuations seen in economy, like such as total demand, investment, distribution etc. By using the panel data methods for the period between 1990 and 2013 in OECD economies, this thesis has investigated the effects of private sector profit and savings rates playing an important role in creating the cyclical fluctuations. The findings shows that profit and the lagged saving rates have positive effect on the cyclical fluctuations. In other words, an increase in profit and savings rates causes the upward deviations from the trend level. On the other hand, the increases in the variables used in the analysis, like commercial and financial openness, total factor productivity, high-tech exports, domestic credit volume, M2 money supply, real exchange rate and government spendings, give rise to upward deviations (tendency to boom) from the trend level while interest, inflation and unemployment rates have a reverse situation (tendency to recession). Panel ARDL results show that saving and profit rates are procyclical. Key Words: Business Cycles, Business Cycle Theories, Saving and Profit Rates, Panel Data Analysis