An Overview ofAn Overview ofBusiness Cycle TheoriesBusiness Cycle Theories

Dr. Dennis Foster

peak

trough

recoverycontraction

Characteristics & Features

• Rise and fall in Gross Domestic Product Gross Domestic Product (GDP) around some long term trend.

• UnemploymentUnemployment generally lags ∆GDP

• InflationInflation generally inversely relatedand lags during the expansion.

• Four phases:peak, contraction, trough, recoverypeak, contraction, trough, recovery

• Contraction aka “recessionrecession” or “downturn” or “depression” [old days – “panic”]

• Identifies dates of business cycles (here).

• Dec. 2007 peak called in Dec. of 2008 (here).

A recession is a significant decline in economic activity spread across the economy, lasting more than a few months, normally visible in production, employment, real income, and other indicators. A recession begins when the economy reaches a peak of activity and ends when the economy reaches its trough.

• June 2009 trough called in Sept. 2010 (here).

The recession lasted 18 months, which makes it the longest of any recession since World War II.

National Bureau of Economic Research

The Data on U.S. Business Cycles

Problematic Problematic RecoveryRecovery

2001

2008

Ave. = 2.8%Ave. = 2.25%

Thomas MalthusThomas Malthus

• Workers paid less than the value of their production.

• Excess supply develops acrossthe economy.

• Firms/owners reduce employment to liquidate these inventories.

• Depression.

• FYI – long run wages at subsistence.[Economics as the “dismal sciencedismal science.”]

Joseph SchumpeterJoseph Schumpeter• Business cycles form patterns.

• Inventory adjustments – 3 to 5 yrs.

• Fixed investment – 7 to 11 yrs.This is what we call thethe business cycle.

• Infrastructure building – 15 to 25 yrs.

• Major innovations – 45 to 60 yrs.

Karl MarxKarl Marx• Capitalism produces surplus value.

• Production goes unsold.

• Crisis ensues; depression.

• Worsens over time!!

Lord John Maynard KeynesLord John Maynard Keynes

• Lack of confidence reduces spending.

• Normal channel of saving to investment breaks down.

• Wages (and prices) don’t fall.

• Result – depression.

• SolutionSolution – replace privatespending with public spending.

Milton FriedmanMilton Friedman• Emphasizes the role of money.

• Depressions preceded by fall in MS.

• Government controls money supply.

• Government is the source of failure.

• In a depression, raise MS to counter.

• Ben Bernanke as follower.

Ludwig von MisesLudwig von Mises

• The Austrian School – Hayek, too.

• Embrace Say’s Law.

• Depressions due to “credit bubbles.”

• Bubbles perpetuated by the Fed.

• Depression allows reallocation.

• “Solution” – leave it alone.

• Worst case – try to undo it.

Say’s LawSay’s Law

• Casually – supply creates demand.

• Our total purchasing power (spending) comes from our sales (income).

• Excess supply is impossible in every sector of the economy.

• Sectors with excess demand willattract more resources.

An Overview ofAn Overview ofBusiness Cycle TheoriesBusiness Cycle Theories

Dr. Dennis Foster

peak

trough

recoverycontraction