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Business Cycles: Theory, History and Indicators Term Paper

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Updated: Jun 2nd, 2020

Business cycle refers to the contraction and expansion of aggregate economic activities for several years. This phenomenon is measured through total employment, real income, and real expenditure. Economists have noted that the phenomenon involves the interaction of several economic processes. The roles of these processes vary and evolve over time. Business cycle occurs nationally, and is depicted by the fluctuating levels of economic activities. Michael T. Belongia, an economist, suggests in his book, “Business cycles manifest themselves through co-movements of interactions among many economic variables” (7). This paper seeks to identify the features and causes of business cycles.

Economists assert that business cycles comprise of five stages, namely, expansion, peak, contraction, and recovery. Massive investments and economic prosperity characterize the expansion period. On the other hand, the peak period indicates the end of the expansion period and the onset of contraction period. During the peak period, GDPs stop rising and stagnate marking the height of the economic booms. The end of the peak period marks the onset of the contraction period. During the contraction period, several economies experience reduced wages, business profits, productions, GDP growth rates, and increased unemployment rates. In the recovery period, final phase, economies are at their lowest levels. At this stage, GDPs stop falling and stagnate. Several factors contribute to the different phases of business cycles. Business investment spending, as a factor, affects business cycles in a number of ways. An increase in business investments signifies a boost in aggregate demand leading to an expansion in an economy. In addition, interest and credit rates offered in an economy affect business cycles. It is a fact that when interest and credit rates are lowered companies, organizations and individuals borrow more money from money lending institutions leading to the creation of more jobs. On the other hand, when the interest rates are high few people have access to loans and credits leading to a reduction in the creation of jobs in an economy.

Features and causes of business cycle

Economists can attest to the fact that the signs and characteristics of business cycle vary, and that its aspects are still difficult to understand. A number of economists have contributed to the current knowledge on business cycles. However, due to its complexity, its fundamental aspects, features, and causes are still a matter of debate among several economists. Before the World War I, there were little data on economic statistics leading to the ambiguity on the actual cause of the phenomenon. Over time, the public became more concern about the economic crisis, depression, rate of unemployment and inflation. As a result, the nature and cause of business cycle forced the economists to investigate on the phenomenon.

In the 19th century, economists focused on commercial crises such as bankruptcies, boom culmination, fluctuation of money rates, and scramble liquidity. However, with the emergence of the new concepts in the economy such as business cycles, economists had to analyze the events that preceded and followed economic crises. At the onset of these studies, economists suggested that natural forces, psychological factors, and acts of monetary and banking systems led to the phenomenon. During the early 20th century, interests on the phenomenon focused more on unemployment, capital goods, and industries fluctuations. This shift in focus reflected the transformations in manufacturing and transportation industries.

In the subsequent decades, economies developed numerous theories on the features and the causes of business cycles. During theses decades, economists focused on the relationship between the phenomenon and the investments. Economies correlated several factors associated with the investment processes. These factors included population growths, new technologies, innovations, and fluctuations in interest rates. These theories varied in their points of focus, and thus, supplemented one another. Notably, Thomas Cooley asserts, “The courses of business cycle crises are just stages of recurring, wavelike variations in business activities” (74). Similarly, Mikhail Tugan became the first economist to state that a country’s fluctuating rate of growth in fixed capital causes business cycle. On the other hand, Joseph A. Schumpeter suggested that economic growth was a cyclical event attributed to business cycles. Through this, Schumpeter argued that new technologies and innovations were the causes of business cycles. As such, new technologies and innovations led to difficult readjustments in all sectors leading to effective applications of existing resources.

John Maynard Keynes made a major breakthrough in economics when he developed a model indicating that investments altered the level of national income. Through his model, Keynes devised a consumption function that suggested, “Consumer spending varies directly with the national income” (Zarnowitz 9). This hypothesis implied that with an expansion in national income consumer spending would increase. Consequently, a decrease in the national income will lead to a decline in consumer spending. With the aid of his model, Keynes explained that an increase in the levels of investments would enhance the growth of national income. In response to this, Keynes stated that consumer spending would increase. This implies that the levels investments determine the fluctuations in consumer spending.

Recession and its occurrence

As stated earlier, the significant part of every business cycle is recession. Economists assert that without recession stages, no economy will experience a business cycle. Before the year 1945, recession periods were common to most economies. Notably in the 1930s, the world experienced the worst depression period in the 20th century. During this period, economic policy makers did little to thwart the situation. Instead, they allowed the economy to follow its own course. As a result, the world underwent through a long period of recession. The effects of Great Depression prior the year 1945 led to the World War II.

Thereafter, business cycles in Organization for Economic Co-operation and Development countries were contained with the implementation of appropriate fiscal policies. Between the year 1945 and 2008, there was no major economic downturn experienced in the world economy. In the early 2008, with the onset of global economic crises, recession plunged the world economies into a state of depression. To counteract its effects, economic policy makers recommended appropriate guidelines using both fiscal and monetary policies. However, these mitigation measures worsened the business cycles excesses. Through the recession period, there was an increase in social disorders such as mental health and crime rates. Most people lost their jobs, and more often, the governments were under pressure to legislate the necessary policies aimed at reducing the situation. Throughout the period, central banks were cautious in implementing appropriate decisions.

Conclusion

It would be inappropriate to conclude that vulnerability of business cycles occurred only in the past. Currently, business cycles have become milder due to the increase in its understanding. With better understanding, the necessary structural changes have been put in place. Notably, in the 20th century globalization was a major event in the world economy. During the past two decades, the features of business cycles in both the developing and the developed countries have varied. China and India have exhibited decoupling business cycles leading to increase in their economies over the last decades. With the recent global financial crises, the co-movements in the global business cycles have tremendously increased. This implies that the GDP growth rates in major world economies are experiencing setbacks due to the changes in the phenomenon. Several implications on business cycles have resulted from the changing new structures in the world economies.

Emerging countries across Asia, Africa, and South America have enhanced the global growth rates. In all these emerging countries, business cycles are independent of each other. However, with the recent effects of global economic crises, economists have noted that the business cycles in these countries are not entirely autonomous. This is true because the current global economic meltdown experienced has had a significant impact on these economies. Óscar Dejuán asserts, “The recession offers an opportunity to revive economic theories in order to identify their flaws, to compare different economic paradigms, and to find the one that provides a more plausible explanation and more credible cure” (1). This implies that economic experts are expected to investigate the events that led to the current economic crises. Through their studies and researches, economists should comprehensively investigate on the features and causes of business cycles. By doing so, they should remain watchful to identify the developments and policies that led to the current global economic crises. Similarly, researchers should recommend acceptable pathways to economic prosperity in the future.

Works Cited

Belongia, Michael T., and Michelle R. Garfinkel. The business cycle: theories and evidence : proceedings of the Sixteenth Annual Economic Policy Conference of the Federal Reserve Bank of St. Louis. Boston: Kluwer Academic, 1992. Print. “Business cycles manifest themselves in through co-movements of interactions among many economic variables.”

Cooley, Thomas F. Frontiers of business cycle research. Princeton, N.J.: Princeton University Press, 1995. Print. “The courses of business cycle crises are just stages of recurring, wavelike variations in business activities.”

Dejuán, Óscar. The first great recession of the 21st century: competing explanations. Cheltenham, UK: Edward Elgar, 2011. Print. “The recession offers an opportunity to revive economic theories, to identify their flaws, to compare different economic paradigms, and to find the one that provides a more plausible explanation and more credible cure.”

Zarnowitz, Victor. Business cycles: theory, history, indicators, and forecasting. Chicago: University of Chicago Press, 1992. Print. “Consumer spending varies directly with the national income.”

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