My view is that the answer lies in understanding effective demand... the primary concept of Keynes which has never been given a proper equation. I am researching a new equation that describes Keynes' view of effective demand...
Effective Demand >= Real GDP*effective labor share/(composite utilization of labor and capital)
Thus, effective labor share >= (composite utilization of labor and capital)
Effective labor share is determined by cycle limits of capacity utilization. For the US, effective labor share is 0.762*labor share index (non-farm business sector) since the 60's.
This equation has described the end of all business cycles since the 60's. We are right now again hitting the effective demand limit according to this equation. The limit could rise at this time extending the business cycle, which happened at the end of 90's and a bit before the crisis.
Very few are expecting the end of the business cycle now. The Fed and ECB are trying to keep the BC alive with long run low nominal rates. Will it work? Will the instability be too great? We will see.
In effect, there is an experiment going on right now with this equation of effective demand. If it turns out to identify the end of this business cycle, when few expect it, we will have made progress in understanding recessions. The equation can predict the potential end of a business cycle years in advance.
The equation is doing a great job so far in determining that potential GDP is much lower than the CBO originally thought.
Here is a synopsis.
http://effectivedemand.typepad.com/ed/synopsis-of-the-effective-demand-research.html
He links aprovingly to John Taylor who wanted to raise rates in 2011. LOLWUT?
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