The Frisch Slutsky Paradigm

We have already implicitly discussed the main ideas behind the Frisch-Slutsky paradigm when we drew an analogy between business cycles and reservoirs.6 The Frisch-Slutsky paradigm identifies three components in business cycle fluctuations—as shown in Figure 14.10.

The first component is an impulse or a shock that triggers business cycle fluctuations. In terms of our metaphor, the impulse is the pebble or automobile that is thrown into the reservoir. However, as in our metaphor, the fluctuations that are produced may have a different pattern from the impulse that started them. This is because the impulse acts through a propagation mechanism that converts one-time shocks into persistent business cycle fluctuations—the pebble interacts with the structure of water to produce a wave.

Most economists agree about what business cycles, the third part of the model, look like. Therefore, debate focuses on the first two components of the Frisch-Slutsky paradigm—which shocks are most important and what economic factor converts these shocks into the business cycles we observe. Although economists disagree over which of them is most important in explaining observed output fluctuations, there is broad agreement over which shocks are candidates for causing business cycles. These include monetary and fiscal policy shocks, shifts in desired consumption and investment, terms of

Impulse

Propagation mechanism

Business cycles

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