BUSINESS CYCLE

Figure 1: Wholesale price indexes for United States, Great Britain, Germany, and France, periodic fluctuation in the rate of economic activity, as measured by the levels of employment, prices, and production. Figure 1, for example, shows changes in wholesale prices in four Western industrialized countries over the period from 1790 to 1940. As can be seen, the movements are not, strictly speaking, circular, and although some regularities are apparent, they are not exactly wavelike. For these reasons, some economists prefer the term business fluctuation over business cycle. There are many types of economic fluctuations. Because of the complexity of economic phenomena, it may be that there are as many types of fluctuations or cycles as there are economic variables. There are daily cycles in commuter traffic or the consumption of electricity, to cite only two examples. Almost every aspect of economic life displays seasonal variations: sales of coal or ice, deposits in savings banks, monetary circulation, agricultural production, purchases of clothing, travel, and so on. As one lengthens the span of observation, one finds new kinds of fluctuations such as the hog cycle and the wheat cycle, the inventory cycle, and the construction cycle. Finally, there are movements of general economic activity that extend over periods of years. periodic fluctuation in the rate of economic activity, as measured by the levels of employment, prices, and production. Because these movements are neither so regular nor so predictable as the term cycle might suggest, some authors prefer to avoid the term. The advanced economies of the world have long faced regular economic crises, marked by stock market crashes, bank failures, corporate and personal bankruptcies, and severe unemployment. It was commonly thought that these periods were the economic equivalent of disease, with growth and prosperity seen as the normal condition of health. Clment Juglar, a French physician of the mid-19th century, was probably the first to propose that periodic variations were a normal feature of economies. Other investigators, developing Juglar's work, have identified recurring 8- to 10-year cycles, each of which consists of three phases: prosperity, crisis, and liquidation. Smaller cycles, such as the approximately 40-month cycle in the levels of business inventories, have been identified within the larger Juglar cycle. Agricultural commodities are subject to periodic changes in the relationship of supply and demand, such as hog cycles (three to four years) and cotton cycles (two years). Longer cycles have also been proposed, most notably by the Russian economist Nikolai Kondratieff, who argued that market economies were subject to broad 50-year cycles of expansion and contraction. Attempts to subject economic data to rigorous statistical analysis are complicated by their sheer complexity, by events such as wars, revolutions, and natural disasters, as well as by noncyclical developments such as technological progress and changes in economic organization. Much work has been done to create models of a typical business cycle through the study of past cycles. Econometrics, the study of economic activity on the basis of elaborate statistical models, has identified groups of leading and lagging indicators, which are statistical series that respectively anticipate and follow changes in the direction of economic activity. Examples of leading indicators are stock prices and building permits. But characterizing business cycles does not explain them. Aside from random shocks (wars, disasters, technological changes, etc.), two of the major influences on the level of economic activity are investment and consumption. An increase in investment, such as building a factory, will generate more income than the original expenditure itself, because the workers who build the factory will spend their wages. Conversely, increases in consumer demand will eventually require that new factories be built to satisfy the demand. These ripple effects, called respectively the investment multiplier and consumption accelerator, reinforce each other until the economy reaches its full capacity. At this point there is little free capital, no new demand, and thus neither a need for nor sources of new investment. The process then reverses itself and contraction ensues. Many theories have been proposed to explain what causes these changes in investment or consumption in the first place. The oldest theories rely on changes in agricultural markets, which are influenced by meteorological and other natural cycles, spreading throughout the economy. Psychological theorists have argued that, because individuals tend to imitate each other, a follow-the-leader mentality influences economic activity, particularly the periodic booms and busts of the financial markets. Wars and technological and demographic changes have important and obvious effects on business conditions, but such events are not strictly cyclical and may themselves actually be caused by economic pressures. Besides these essentially external factors, many analysts stress the importance of internal factors in business cycles. Underconsumption theories hold that production expands too rapidly for consumers to purchase all the goods manufactured, so that a bust inevitably follows a boom. Monetarists hold that changes in the money supply (cash and bank credits) are the principal determinants of economic activity: easy credit, low interest rates, and plentiful cash stimulate business; tight credit, high rates, and a shortage of cash depress it. Some economists hold that the supply of capital for investment is the key to economic activity; booms end when all available capital is invested. Since World War II government policy with respect to spending, taxation, and the money supply has become an important influence on the economy. Such policy aims to prevent the extremes of inflation and depression by stimulating the economy in slack times and restraining it during expansions. Much of this so-called countercyclical policy is almost automatic. During a recession, tax receipts fall and welfare spending rises, preventing a disastrous slide by limiting the decline in personal income; in an expansion, tax receipts rise faster than general prosperity, thus cooling a potentially dangerous boom. Business cycles have indeed moderated economic extremes since World War II, although the recessions from the 1970s on have tended to be more severe than those of the 1950s and '60s. It used to be claimed that centrally planned economies, such as that of the former Soviet Union, were not subject to such cyclical fluctuation, because there was no free market and the agencies that devised the economic plan controlled its long-range execution as well, but such was not always the case. In part, trade and financial ties to the West made the socialist countries subject to the fluctuations of market economies. But, also, the socialist planners might overinvest, causing underconsumption crises similar to those described above. Natural disaster and political unrest could also frustrate the designs of planners. It may be that cyclical fluctuations are the price of economic growthin either capitalist or socialist economies. Additional reading Good introductions to the study of business cycles include Erik Lundberg (ed.), The Business Cycle in the Post-War World (1955, reprinted 1986); R.C.O. Matthews, The Business Cycle (1959, reissued 1967); Robert Aaron Gordon, Business Fluctuations, 2nd ed. (1961); Alvin Harvey Hansen, Business Cycles and National Income, expanded ed. (1964); and Henri Guitton, Fluctuations et croissance conomiques, 3rd ed. (1970). Famous surveys of business cycle theories are Joseph A. Schumpeter, Business Cycles: A Theoretical, Historical, and Statistical Analysis of the Capitalist Process, 2 vol. (1939, reprinted 1982); and Gottfried Haberler, Prosperity and Depression, 5th ed. (1964). J. Tinbergen, Statistical Testing of Business-Cycle Theories, 2 vol. (1939, reissued 2 vol. in 1, 1968), attempts to verify by econometric analysis the theories surveyed in Haberler's work. The nontheoretical approach to business-cycle research is set forth in Arthur F. Burns and Wesley C. Mitchell, Measuring Business Cycles (1946); and further developed in Geoffrey Hoyt Moore, Business Cycle Indicators, 2 vol. (1961). Important articles are collected in American Economic Association, Readings in Business Cycle Theory (1944, reprinted 1980), and Readings in Business Cycles (1965). History and politics are dealt with in Vivian Walsh and Harvey Gram, Classical and Neoclassical Theories of General Equilibrium: Historical Origins and Mathematical Structure (1980); Dennis C. Mueller, Public Choice II (1989), which provides equilibrium-model-based analyses of the intersection between politics and economics; and James E. Alt and Kenneth A. Shepsle (eds.), Perspectives on Positive Political Economy (1990).The basic principles of the modern theory of income analysis, often called macroeconomics, may be found in any contemporary textbook of economics. Two good introductions to this subject are George T. McCandless, Jr., Macroeconomic Theory (1991), neoclassical in approach; and Joseph Stiglitz, Economics (1993), Keynesian-oriented. At the intermediate level, the two competing alternatives for reaching a sound understanding of national income theory are Robert J. Barro and Vittorio Grilli, European Macroeconomics (1994), which applies the intertemporal equilibrium approach to macroeconomic analysis; and Rudiger Dornbusch and Stanley Fischer, Macroeconomics, 6th ed. (1994), which follows an IS-LM approach. Three advanced textbooks in macroeconomic theory which exhibit the high degree of formalization that has become characteristic of the macroeconomic literature since the 1970's are Thomas J. Sargent, Macroeconomic Theory, 2nd ed. (1987), and Dynamic Macroeconomic Theory (1987); and Olivier Jean Blanchard and Stanley Fischer, Lectures on Macroeconomics (1989).More specialized or intensive treatments of macroeconomics are John Maynard Keynes, The General Theory of Employment, Interest, and Money (1936, reissued 1991), the classic theoretical work in the field; Seymour E. Harris (ed.), The New Economics: Keynes' Influence on Theory and Public Policy (1947, reprinted 1973), a collection of early essays on Keynes and his ideas, representing the thinking of its time; and Gardner Ackley, Macroeconomic Analysis and Theory (1978), an introductory text. Later evaluations by leading economists of the significance and influence of Keynesian ideas may be found in Roy F. Harrod, The Life of John Maynard Keynes (1951, reissued 1982), offering insight into the genesis of Keynes's ideas; H.G. Johnson, The General Theory After Twenty-five Years, The American Economic Review, 51:117 (1961), providing a retrospective survey from a monetarist point of view; Robert Lekachman (ed.), Keynes' General Theory: Reports of Three Decades (1964); Axel Leijonhufvud, On Keynesian Economics and the Economics of Keynes (1968), an interesting but difficult appraisal of the development of Keynesian ideas; and Herbert Stein, The Fiscal Revolution in America, rev. ed. (1990), examining the relationship between Keynesian thinking and governmental policies in the United States.Some important perspectives on the successes and failures of economic strategies that have resulted in fluctuations are John Kenneth Galbraith, Economics and the Public Purpose (1973), and Economics in Perspective: A Critical History (1987); and Douglass C. North, Institutions, Institutional Change, and Economic Performance (1990). Two other works that offer perspectives on economic theory and its applications are Neil de Marchi and Mark Blaug (eds.), Appraising Economic Theories (1991); and Mark Blaug, The Methodology of Economics; or, How Economists Explain, 2nd ed. (1992). Henri Guitton The Editors of the Encyclopdia Britannica