Business cycle

More or less regular swings or wave-like fluctuations in the pace of a country's economic growth, well above and well below the long-term trend in the growth rate of total production; the ups and downs of overall business activity, as evidenced by surges and declines in GNP and GDP, unemployment rates, and the general price level; the boom-and-bust pattern of recession (or depression) and recovery. In older economic literature (and still today in British usage) the term “trade cycle” is often used as a synonym for “business cycle.”

What causes business cycles has been one of the hottest and longest running theoretical debates in political economy. There is a fair amount of agreement on what at least some of the factors are that are associated with the alternation of economic booms and busts, but different schools of thought differ considerably in the relative weight and the causal priority they assign to these various factors. Some schools of thought emphasize uneven government economic policies as the principal cause of business cycles, while others see government economic policies as the key influences working to even out business cycles allegedly brought on by inherent features of the market economy.

Nearly all of these competing theories key in on one or more of the factors believed to influence the expansion and contraction of total saving by the public and of new capital investment undertaken by business firms as the most immediate causes of booms and busts in the larger economy.

John Maynard Keynes's explanation of the business cycle emphasized periodic shifts in the public's allocation of their incomes between current spending for immediate consumption and savings for future consumption — which leads to shifts in the overall level of demand for consumers' goods, which in turn encourages producers of consumers' goods disproportionately to expand or contract their own purchases of producers's goods like raw materials and machinery (and labor) more or less all at once in response to improvements or declines in their current sales. Keynes believed that the public typically tends to save too much and consume too little, thereby throttling aggregate (total) demand, unless the government steps in from time to time through its fiscal policies to artificially increase aggregate demand by spending more on goods and services than it takes away from consumers' purchasing power in taxes (“running a budget deficit”).

Other non-Keynesian theorists of the business cycle have focussed on other (often psychological) factors besides the growth or decline of their current sales that influence businessmen's optimism or pessimism about future economic conditions (and hence their investment plans). Still other theorists emphasize the role of occasional “supply shocks” — sudden and unexpected changes in the supply of key resources resulting from weather cycles, natural disasters, international conflicts, big regulatory or tax changes by government, etc. (For example, the formation of the OPEC oil producers' cartel and their two massive waves of concerted production cuts/price increases in the 1970s.) Joseph Schumpeter's theory of “creative destruction” stresses the role of waves of massive innovation (major technological breakthroughs, introduction of major new products that create whole new industries) in precipitating major adjustments and reallocation of resources as old industries die and are replaced by new ones. “Monetarist” theories of the business cycle analyze the impact of shifts in decisions of the government monetary authorities (such as the Board of Governors of the U.S. Federal Reserve Banking System) to expand or contract the money supply in their efforts to manipulate short-term interest rates and foreign exchange rates (often for selfish political reasons). “Supply-side” theorists of the business cycle tend to emphasize the impact of periodic changes in government tax policies (especially changes in the marginal rates of taxation on various forms of investment expenditures and business income) as the major precipitant of booms and busts.