Business cycle

The development of our modern economic life is not an even and continuous growth; periods of rapid progress are followed by periods of stagnation. If we disregard secondary phenomena, like breakdowns, bankruptcies, and panics, the business cycle presents itself as a periodic up and down of general business activity, or, more precisely, of the volume of production. The growth of production does not show a continuous, uninterrupted trend upward but a wavelike movement around its average annual increase.

The 'upward' movement is called a boom and the downwards a bust or a depression. The business cycle is sometimes called a "boom-bust" cycle.

See also: Austrian Business Cycle Theory

Business Cycles and Business Fluctuations

It is important to distinguish between business cycles and ordinary business fluctuations. We live in a society of continual and unending change, change that can never be precisely charted in advance. People try to forecast and anticipate changes as best they can, but such forecasting can never be reduced to an exact science. Entrepreneurs are in the business of forecasting changes on the market, both for conditions of demand and of supply. The more successful ones make profits hand in hand with their accuracy of judgment, while the unsuccessful forecasters fall by the wayside. As a result, the successful entrepreneurs on the free market will be the ones most adept at anticipating future business conditions. Yet, the forecasting can never be perfect, and entrepreneurs will continue to differ in the success of their judgments. If this were not so, no profits or losses would ever be made in business.

Changes, then, take place continually in all spheres of the economy. Consumer tastes shift; time preferences and consequent proportions of investment and consumption change; the labor force changes in quantity, quality, and location; natural resources are discovered and others are used up; technological changes alter production possibilities; vagaries of climate alter crops, etc. All these changes are typical features of any economic system. In fact, we could not truly conceive of a changeless society, in which everyone did exactly the same things day after day, and no economic data ever changed. And even if we could conceive of such a society, it is doubtful whether many people would wish to bring it about. It is, therefore, absurd to expect every business activity to be "stabilized" as if these changes were not taking place. To stabilize and "iron out" these fluctuations would, in effect, eradicate any rational productive activity.

But declines in specific industries can never ignite a general depression. Shifts in data will cause increases in activity in one field, declines in another. There is nothing here to account for a general business depression—a phenomenon of the true "business cycle." Suppose, for example, that a shift in consumer tastes, and technologies, causes a shift in demand from farm products to other goods. It is pointless to say, as many people do, that a farm depression will ignite a general depression, because farmers will buy less goods, the people in industries selling to farmers will buy less, etc. This ignores the fact that people producing the other goods now favored by consumers will prosper; their demands will increase.

The problem of the business cycle is one of general boom and depression; it is not a problem of specific industries.

Characteristics of the business cycle

A major feature of a depression is a sudden general cluster of business errors. Business activity moves along nicely with most business firms making handsome profits. Suddenly, without warning, conditions change and the bulk of business firms are experiencing losses; they are suddenly revealed to have made grievous errors in forecasting.

Another common feature of the business cycle is the well-known fact that capital-goods industries fluctuate more widely than do the consumer-goods industries. The capital-goods industries - especially the industries supplying raw materials, construction, and equipment to other industries — expand much further in the boom, and are hit far more severely in the depression.

A third feature of every boom that needs explaining is the increase in the quantity of money in the economy. Conversely, there is generally, though not universally, a fall in the money supply during the depression.

Boom and Bust

The "boom" is actually a period of wasteful misinvestment. It is the time when errors are made, due to bank credit's tampering with the free market. The "crisis" arrives when the consumers come to reestablish their desired proportions. The "depression" is actually the process by which the economy adjusts to the wastes and errors of the boom, and reestablishes efficient service of consumer desires. The adjustment process consists in rapid liquidation of the wasteful investments. Some of these will be abandoned altogether (like the Western ghost towns constructed in the boom of 1816–1818 and deserted during the Panic of 1819); others will be shifted to other uses. In sum, the free market tends to satisfy voluntarily-expressed consumer desires with maximum efficiency, and this includes the public's relative desires for present and future consumption. The inflationary boom hobbles this efficiency, and distorts the structure of production, which no longer serves consumers properly. The crisis signals the end of this inflationary distortion, and the depression is the process by which the economy returns to the efficient service of consumers. In short, and this is a highly important point to grasp, the depression is the "recovery" process, and the end of the depression heralds the return to normal, and to optimum efficiency. The depression, then, far from being an evil scourge, is the necessary and beneficial return of the economy to normal after the distortions imposed by the boom. The boom requires a "bust."

External links

• Business cycle on Wikipedia