Business cycle

Business cycles are widely considered to be an inevitable consequence of free markets (or of "capitalism"), in which periods of relatively rapid economic growth alternate with periods of relative stagnation or decline. The periods of rapid growth are driven by increases in productivity, effeciency, and consumer confidence. These growth periods usually end with the failure of speculative investments built on a bubble of confidence that bursts or deflates. The periods of stagnation reflect a purging of unsuccessful enterprises as resources are transferred by market forces from less productive uses to more productive uses.

Because the periods of stagnation are painful for many who lose their jobs, there has been pressure for politicians to try to smooth out the oscillations. The first President of the United States to try this was Herbert Hoover. Hoover's efforts are widely, though not universally, believed to have turned what probably would have been a normal downturn of several months to a year into the Great Depression.

This highlights the difficulty of managing the money supply in any free-market society. By some theorists, notably nineteenth-century advocates of communism, this difficulty was deemed insurmountable. Karl Marx in particular claimed that the constant business cycle crises of capitalism were so inefficient as to cause the workers to eventually revolt, instituting some variant of what is now called socialism. It's interesting to note that Marx and Engels' 1848 specific demands in the Communist Manifesto are now almost wholly implemented throughout the once-capitalist world, with the sole exception of the abolishment of rents in land. This suggests that the analysis had merits, and that each business cycle, including the Great Depression which brought the reforms of Franklin D. Roosevelt (the "New Deal"), strengthened social democrats in the political arena, empowering them to reduce the severity of the next cycle - or at least, to try to do so, whether they can do so or not. A result of this has been strong centralization of economic power in all Western democracies, and control of money by their central banks.

The Austrian School tend to reject the business cycle as an inevitable part of capitalist economics. They point to the role of interest rates in setting investment decisions (as a price on investment capital). Governmental control of money supply through Central Banks means that interest rates are artificially set, and so the price of investment capital does not reflect the real demand for it. This means that capital is misallocated and the business cycle is a periodic correction of this misallocation. The Austrian School sees the problem not as capitalism, but a government controlled money supply.

Modern business cycle theory often measures growth by using the flawed measure of gross domestic product, which is not useful for measuring well-being, a flaw often noted by its own originators. Accordingly, there is a mismatch between the state of economic health as perceived by the individual and that perceived by the bankers and economists, which most likely drives them further apart politically.

Business cycle theory has been more effective in microeconomics where it aids in the preparation of risk management scenarios[?] and timing investment, especially in infrastructural capital that must pay for itself over a long period, and which must fund itself by cashflow in late years. When planning such large investments, it is often useful to use the anticipated business cycle as a baseline, so that unreasonable assumptions, e.g. constant exponential growth, are more easily eliminated.

See also: money supply, inflation, measuring well-being