business cycle - Types of business cycle, Preventing Business Cycles, Alternative Interpretations of Business Cycles, Cycles or fluctuations?

The tendency for the aggregate level of real activity in a country to fluctuate over time rather than growing steadily. Such fluctuations have been observed as far back as economic records reach. They are believed to be due to a variety of causes, including irregular timing of changes in techniques and geographical discoveries, natural catastrophes such as earthquakes, political upsets such as wars and revolutions, and changes in the policies followed by governments or central banks. Business cycles are accentuated by waves of optimism and pessimism, in which upturns lead to expectations of even better times to come, and downturns to panics in anticipation of worse to follow. Simple models of the business cycle suggest that these fluctuations should occur at regular intervals, but historically they have varied greatly in length and scale. This makes it extremely difficult to stabilize them by monetary or fiscal policy, especially since the public authorities themselves are subject to waves of optimism and pessimism about the economy.

The business cycle or economic cycle refers to the periodic fluctuations of economic activity about its long term growth trend. The cycle involves shifts over time between periods of relatively rapid growth of output (recovery and prosperity), alternating with periods of relative stagnation or decline (contraction or recession). One of the government's main roles is to smooth out the business cycle and reduce its fluctuations. Most observers find that their lengths (from peak to peak, or from trough to trough) vary, so that cycles are not mechanical in their regularity. Since no two cycles are alike in their details, some economists dispute the existence of cycles and use the word "fluctuations" (or the like) instead. Others see enough similarities between cycles that the cycle is a valid basis of studying the state of the economy. A key question is whether or not there are similar mechanisms that generate recessions and/or booms that exist in capitalist economies so that the dynamics that appear as a cycle will be seen again and again.

Types of business cycle

Traditional business cycle models

The main types of business cycles enumerated by Joseph Schumpeter and others in this field have been named after their discoverers or proposers:

the Kitchin inventory cycle (3-5 years) - after Joseph Kitchen. the Juglar fixed investment cycle (7-11 years) -- after Clement Juglar. the Kuznets infrastructural investment cycle (15-25 years) -- after Simon Kuznets, Nobel Laureate. the Kondratieff wave or cycle (45-60 years) -- after Nikolai Kondratieff.

Even longer cycles are occasionally proposed, often as multiples of the Kondratiev cycle.

Juglar cycle

In the Juglar cycle, which is sometimes called "the" business cycle, recovery and prosperity are associated with increases in productivity, consumer confidence, aggregate demand, and prices. In the cycles before World War II or that of the late 1990s in the United States, the growth periods usually ended with the failure of speculative investments built on a bubble of confidence that bursts or deflates. In these cycles, the periods of contraction and stagnation reflect a purging of unsuccessful enterprises as resources are transferred by market forces from less productive uses to more productive uses. Cycles between 1945 and the 1990s in the United States were generally more restrained and followed political factors, such as fiscal policy and monetary policy. Automatic stabilisation due the government's budget helped defeat the cycle even without conscious action by policy-makers.

Politically based business cycle models

Another set of models tries to derive the business cycle from political decisions.

The partisan business cycle suggests that cycles result from the successive elections of administrations with different policy regimes. The replacement, Regime B, adopts contractionary policies reducing inflation and growth, and the downwards swing of the cycle.

The political business cycle is an alternative theory stating that when an administration of any hue is elected, it initially adopts a contractionary policy to reduce inflation and gain a reputation for economic competence.

Preventing Business Cycles

Because the periods of stagnation are painful for many who lose their jobs, pressure arises for politicians to try to smooth out the oscillations.

No one argues that managing economic policy to even out the cycle is an easy job in a society with a complex economy, even when Keynesian theory is applied. Karl Marx in particular claimed that the recurrent business cycle crises of capitalism were inevitable results of the system's operations.

Additionally, Neoclassical economics plays down the ability of Keynesian policies to manage an economy.

Therefore, good forecasts of cyclical turning points are critical to improve policy decisions. The Economist noted that the Weekly Leading Index published by the Economic Cycle Research Institute (ECRI) is a successful real-time indicator to watch.

Monetary and fiscal policy help to smooth the cycle out as well.

Alternative Interpretations of Business Cycles

Austrian School

The Austrian School of economics rejects the suggestion that the business cycle is an inherent feature of an unregulated economy and argues that it is caused by intervention in the money supply.

The Austrian theory also predicts that the imposition of artificially low interest rates, and the resulting increase in the supply of fiat credit, generates inflation, which obliges the central bank to increase the supply of credit yet further to maintain the artificially low interest rate, thus prolonging the "boom" and worsening the inevitable "correction."

In the Keynesian view, this Austrian theory assumes that the "natural" rate of interest is unique at any given time and cannot be affected by policy. If the economy is operating with less than full employment, i.e., with high unemployment above the NAIRU, then in theory monetary policy and fiscal policy can have a positive role to play rather than simply creating booms that necessarily collapse on themselves.

Marxist Views

Michal Kalecki's Marxian-influenced "political business cycle" theory blames the government: he argued that no democratic government under capitalism would allow the persistence of full employment, so that recessions would be caused by political decisions: persistent full employment would mean increasing workers' bargaining power to raise wages and to avoid doing unpaid labor, potentially hurting profitability. (He did not see this theory as applying under fascism, which would use direct force to destroy labor's power.) In recent years, proponents of the "electoral business cycle" theory have argued that incumbent politicians encourage prosperity before elections in order to ensure re-election -- and make the citizens pay for it with recessions afterwards.

Milton Friedman's Interpretation

Milton Friedman has stated on a number of occasions that calling the business cycle a "cycle" is a misnomer, because of its' non-cyclicality. He compares it to the seasonal sales cycle that occurs on the average year, where the business cycle is inconsistent and unpredictable.

Cycles or fluctuations?

In recent years economic theory has moved towards the study of economic fluctuation rather than a 'business cycle' - though some economists use the phrase 'business cycle' as a convenient shorthand.

Rational expectations theory states that no deterministic cycle can persist because it would consistently create arbitrage opportunities.

These views led to the formulation of the idea that observed economic fluctuations can be modelled as shocks to a system.

A moving average of a stochastic stationary variable also bears resemblance to a graph of an economic time-series, such as inflation, unemployment, or investment. Such graphs arguably resemble actual events more closely than deteministic cycle formulae. However, the main influence in this direction has been real business cycle models which consider fluctuations in supply (technology shocks). Governments also aim to improve the business cycle so as to provide stability, get re-elected and to ease worries about the state of the economy.

Random Walks and chaotic patterns

In 1900 Louis Bachelier proposed that the fluctuations in share prices follow random walks, being complete random with no cyclic properties.

Problems of Measurement

Some argue that modern business cycle theory often measures growth by using the flawed measure of the economy's aggregate production, i.e., real gross domestic product, which is not useful for measuring well-being and also generates distortions in the perception of economic grow because the price changes of the various products are disproportional. However, unlike with issues of long-term economic growth, the economists and bankers may be right to use real GDP when studying business cycles. economic issues which are their main concern of business cycle experts.

Business cycle theory has been most 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.