The Accelerator Principle

There is another reason why investment is associated with booms. Investment can be a source of feedback to keep a boom (or bust) going over a longer time period.

Suppose that aggregate demand has increased -- for any reason at all, it doesn't matter. Businessmen find that, in order produce the increased output, they need to invest in expansions of their factories, workshops and warehouses. In other words, the amount of investment will depend on the rate of increase of production -- not just on the amount of production. So, when production is growing rapidly, businessmen have to invest a lot, and keep investing a lot, just to keep up with orders. This is called the "Accelerator Principle."

The Accelerator Principle is not, itself, a part of the Keynesian model. Economists had written about it before Keynes' work, and Keynes had his doubts about it! But Keynesian economists of the generation after Keynes, especially Paul Samuelson, put the accelerator and the multiplier together. Let's see what happens:

Because production is increasing, businessmen have to invest more to keep up with their orders. But this greater investment also has a multiplier effect, so it causes production to increase further -- which requires a still higher rate of investment -- which brings about still more increase in production via its multiplier effect -- and so on.

Of course, this mutual reinforcement of the multiplier and the accelerator cannot go on forever, but it could explain why booms can go on for several years at a time. It can also explain why a "bust" comes when production levels off. With production steady, businessmen don't need to invest much at all -- just enough to replace their production capacity as it wears out -- and this means investment could drop almost to zero, even though production is stable at a pretty high level.

On this reasoning, economists like Samuelson felt that economic fluctuations could be quite predictable and cyclical. This is where the term "business cycles" comes from.

The accelerator probably is one of the factors influencing investment, and for practical applications, we should keep it in mind. However, it isn't central to modern macroeconomic theory, so we will have little more to say about it in this textbook.

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