Business cycle
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Business cycles are intervals of general expansion followed by recession in economic performance. The changes in economic activity that characterize business cycles have important implications for the welfare of the general population, government institutions, and private sector firms. There are numerous specific definitions of what constitutes a business cycle. The simplest and most naïve characterization comes from regarding recessions as 2 consecutive quarters of negative GDP growth. More satisfactory classifications are provided by, first including more economic indicators and second by looking for more informative data patterns than the ad hoc 2 quarter definition.
Definitions of business cycle fluctuations depend heavily on the specific set of macroeconomic variables examined and on the particulars of the methodology. In the
Business cycles are usually thought of as medium term evolution. They are less related to long-term trends, coming from slowly-changing factors like technological advances. Further, a one period change, that is unusual over the course of one or two years, is often relegated to “noise”; an example is a worker strike or an isolated period of severe weather. This suggests that we remove these two components from the data in estimating the cycle movements. It would be difficult to determine the particular effects of long-term or noisy components by looking at complicated details for each case. However, a statistical approach can provide valuable insight.
Band-pass filters have been developed for economic data to extract mid-frequency fluctuations. Such filters also have the attraction that they offer more information about the state of the business cycle; the statement about the path of cyclical GDP as it comes out of recession adds interesting facts beyond just the labelling of when the switch from recession to expansion occurs. An example of a band-pass filter attempting to isolate business cycles is the Christiano-Fitzgerald filter[2] However, such a fixed filter runs a substantial risk of spurious output, which renders any subsequent business cycle study misleading. The approach is also limited to a single indicator.
Adaptive band-pass filters have been used to extract business cycles coherent with the dynamic properties of the indicators. The filters introduced by Harvey-Trimbur have been applied in numerous studies examining diverse national economies.[3] Unlike a fixed band pass filter that can only be applied to a single indicator, this more flexible approach can use multiple variables as inputs. Further, forecasts can be computed (on a timely basis). Lastly, uncertainty in business cycles can be gauged, making them useful for assessing macroeconomic risk.
The individual episodes of expansion/recession occur with changing duration and intensity over time. Typically their periodicity has a wide range from around 2 to 10 years. The technical term "stochastic cycle" is often used in statistics to describe this kind of process. Such flexible knowledge about the frequency of business cycles can actually be included in their mathematical study, using a Bayesian statistical paradigm.[4]
There are numerous sources of business cycle movements such as rapid and significant changes in the
History
Theory
The first systematic exposition of
Sismondi and his contemporary
Sismondi's theory of periodic crises was developed into a theory of alternating cycles by
Statistical or econometric modelling and theory of business cycle movements can also be used. In this case a time series analysis is used to capture the regularities and the stochastic signals and noise in economic time series such as Real GDP or Investment. [Harvey and Trimbur, 2003, Review of Economics and Statistics] developed models for describing stochastic or pseudo- cycles, of which business cycles represent a leading case. As well-formed and compact – and easy to implement – statistical methods may outperform macroeconomic approaches in numerous cases, they provide a solid alternative even for rather complex economic theory.[12]
Classification by periods
In 1860 French economist Clément Juglar first identified economic cycles 7 to 11 years long, although he cautiously did not claim any rigid regularity.[13] This interval of periodicity is also commonplace, as an empirical finding, in time series models for stochastic cycles in economic data. Furthermore, methods like statistical modelling in a Bayesian framework – see e.g. [Harvey, Trimbur, and van Dijk, 2007, Journal of Econometrics] – can incorporate such a range explicitly by setting up priors that concentrate around say 6 to 12 years, such flexible knowledge about the frequency of business cycles can actually be included in their mathematical study, using a Bayesian statistical paradigm.[4]
Later[when?], economist Joseph Schumpeter argued that a Juglar cycle has four stages:
- Expansion (increase in production and prices, low interest rates)
- Crisis(stock exchanges crash and multiple bankruptcies of firms occur)
- Recession (drops in prices and in output, high interest-rates)
- Recovery (stocks recover because of the fall in prices and incomes)
Schumpeter's Juglar model associates recovery and prosperity with increases in productivity, consumer confidence, aggregate demand, and prices.
In the 20th century, Schumpeter and others proposed a typology of business cycles according to their periodicity, so that a number of particular cycles were named after their discoverers or proposers:[14]
Cycle/wave name | Period (years) |
---|---|
Kitchin cycle (inventory, e.g. pork cycle) | 3–5 |
Juglar cycle (fixed investment) | 7–11 |
Kuznets swing (infrastructural investment) | 15–25 |
Kondratiev wave (technological basis) | 45–60 |
- The Kitchin inventory cycle of 3 to 5 years (after Joseph Kitchin)[15]
- The Juglar fixed-investment cycle of 7 to 11 years. A range of periods rather than one fixed period is needed to capture business cycle fluctuations, which may be done by using a random or irregular source as in an econometric or statistical framework.
- The Kuznets infrastructural investment cycle of 15 to 25 years (after Simon Kuznets – also called "building cycle")
- The Kondratiev wave or long technological cycle of 45 to 60 years (after the Soviet economist Nikolai Kondratiev)[16]
Some say interest in the different typologies of cycles has waned since the development of modern macroeconomics, which gives little support to the idea of regular periodic cycles.[17] Further econometric studies such as the two works in 2003 and 2007 cited above demonstrate a clear tendency for cyclical components in macroeconomic times to behave in a stochastic rather than deterministic way.
Others, such as
The Bible (760 BCE) and Hammurabi's Code (1763 BCE) both explain economic remediations for cyclic sixty-year recurring great depressions, via fiftieth-year Jubilee (biblical) debt and wealth resets[citation needed]. Thirty major debt forgiveness events are recorded in history including the debt forgiveness given to most European nations in the 1930s to 1954.[18]
Occurrence
There were great increases in
Over the period since the Industrial Revolution, technological progress has had a much larger effect on the economy than any fluctuations in credit or debt, the primary exception being the Great Depression, which caused a multi-year steep economic decline. The effect of technological progress can be seen by the purchasing power of an average hour's work, which has grown from $3 in 1900 to $22 in 1990, measured in 2010 dollars.
There were frequent crises in Europe and America in the 19th and first half of the 20th century, specifically the period 1815–1939. This period started from the end of the
Business cycles in
In this period, the economic cycle – at least the problem of depressions – was twice declared dead. The first declaration was in the late 1960s, when the
Various regions have experienced prolonged
Identifying
In 1946, economists Arthur F. Burns and Wesley C. Mitchell provided the now standard definition of business cycles in their book Measuring Business Cycles:[29]
Business cycles are a type of fluctuation found in the aggregate economic activity of nations that organize their work mainly in business enterprises: a cycle consists of expansions occurring at about the same time in many economic activities, followed by similarly general recessions, contractions, and revivals which merge into the expansion phase of the next cycle; in duration, business cycles vary from more than one year to ten or twelve years; they are not divisible into shorter cycles of similar characteristics with amplitudes approximating their own.
According to A. F. Burns:[30]
Business cycles are not merely fluctuations in aggregate economic activity. The critical feature that distinguishes them from the commercial convulsions of earlier centuries or from the seasonal and other short term variations of our own age is that the fluctuations are widely diffused over the economy – its industry, its commercial dealings, and its tangles of finance. The economy of the western world is a system of closely interrelated parts. He who would understand business cycles must master the workings of an economic system organized largely in a network of free enterprises searching for profit. The problem of how business cycles come about is therefore inseparable from the problem of how a capitalist economy functions.
In the United States, it is generally accepted that the National Bureau of Economic Research (NBER) is the final arbiter of the dates of the peaks and troughs of the business cycle. An expansion is the period from a trough to a peak and a recession as the period from a peak to a trough. The NBER identifies a recession as "a significant decline in economic activity spread across the economy, lasting more than a few months, normally visible in real GDP, real income, employment, industrial production".[31]
Upper turning points of business cycle, commodity prices and freight rates
There is often a close timing relationship between the upper turning points of the business cycle, commodity prices, and freight rates, which is shown to be particularly tight in the grand peak years of 1873, 1889, 1900 and 1912.[32] Hamilton expressed that in the post war era, a majority of recessions are connected to an increase in oil price.[33]
Commodity price shocks are considered to be a significant driving force of the US business cycle.[34]
Along these lines, the research in [Trimbur, 2010, International Journal of Forecasting] shows empirical results for the relation between oil-prices and real GDP. The methodology uses a statistical model that incorporate level shifts in the price of crude oil; hence the approach describes the possibility of oil price shocks and forecasts the likelihood of such events.[35]
Indicators
Series used to infer the underlying business cycle fall into three categories:
A prominent coincident, or real-time, business cycle indicator is the Aruoba-Diebold-Scotti Index.
Spectral analysis of business cycles
Recent research employing spectral analysis has confirmed the presence of Kondratiev waves in the world GDP dynamics at an acceptable level of statistical significance.[42] Korotayev & Tsirel also detected shorter business cycles, dating the Kuznets to about 17 years and calling it the third sub-harmonic of the Kondratiev, meaning that there are three Kuznets cycles per Kondratiev.[jargon]
Recurrence quantification analysis
Recurrence quantification analysis has been employed to detect the characteristic of business cycles and economic development. To this end, Orlando et al.[43] developed the so-called recurrence quantification correlation index to test correlations of RQA on a sample signal and then investigated the application to business time series. The said index has been proven to detect hidden changes in time series. Further, Orlando et al.,[44] over an extensive dataset, shown that recurrence quantification analysis may help in anticipating transitions from laminar (i.e. regular) to turbulent (i.e. chaotic) phases such as USA GDP in 1949, 1953, etc. Last but not least, it has been demonstrated that recurrence quantification analysis can detect differences between macroeconomic variables and highlight hidden features of economic dynamics.[44]
Cycles or fluctuations?
The Business Cycle follows changes in stock prices which are mostly caused by external factors such as socioeconomic conditions, inflation, exchange rates. Intellectual capital does not affect a company stock's current earnings. Intellectual capital contributes to a stock's return growth.[45]
Unlike long-term trends, medium-term data fluctuations are connected to the monetary policy transmission mechanism and its role in regulating inflation during an economic cycle. At the same time, the presence of nominal restrictions in price setting behavior might impact the short-term course of inflation.[46]
In recent years economic theory has moved towards the study of economic fluctuation rather than a "business cycle"
Proposed explanations
The explanation of fluctuations in aggregate economic activity is one of the primary concerns of macroeconomics and a variety of theories have been proposed to explain them.
Exogenous vs. endogenous
Within economics, it has been debated as to whether or not the fluctuations of a business cycle are attributable to external (exogenous) versus internal (endogenous) causes. In the first case shocks are stochastic, in the second case shocks are deterministically chaotic and embedded in the economic system.
This debate has important policy consequences: proponents of exogenous causes of crises such as neoclassicals largely argue for minimal government policy or regulation (
The view of the economic cycle as caused exogenously dates to Say's law, and much debate on endogeneity or exogeneity of causes of the economic cycle is framed in terms of refuting or supporting Say's law; this is also referred to as the "general glut" (supply in relation to demand) debate.
Until the
Mainstream economists working in the neoclassical tradition, as opposed to the Keynesian tradition, have usually viewed the departures of the harmonic working of the market economy as due to exogenous influences, such as the State or its regulations, labor unions, business monopolies, or shocks due to technology or natural causes.
Contrarily, in the heterodox tradition of Jean Charles Léonard de Sismondi, Clément Juglar, and Marx the recurrent upturns and downturns of the market system are an endogenous characteristic of it.[51]
The 19th-century school of under consumptionism also posited endogenous causes for the business cycle, notably the paradox of thrift, and today this previously heterodox school has entered the mainstream in the form of Keynesian economics via the Keynesian revolution.
Mainstream economics
Mainstream economics views business cycles as essentially "the random summation of random causes". In 1927,
While economists have found it difficult to forecast recessions or determine their likely severity, research indicates that longer expansions do not cause following recessions to be more severe.[56]
Keynesian
According to Keynesian economics, fluctuations in aggregate demand cause the economy to come to short run equilibrium at levels that are different from the full employment rate of output. These fluctuations express themselves as the observed business cycles. Keynesian models do not necessarily imply periodic business cycles. However, simple Keynesian models involving the interaction of the Keynesian multiplier and accelerator give rise to cyclical responses to initial shocks. Paul Samuelson's "oscillator model"[57] is supposed to account for business cycles thanks to the multiplier and the accelerator. The amplitude of the variations in economic output depends on the level of the investment, for investment determines the level of aggregate output (multiplier), and is determined by aggregate demand (accelerator).
In the Keynesian tradition, Richard Goodwin[58] accounts for cycles in output by the distribution of income between business profits and workers' wages. The fluctuations in wages are almost the same as in the level of employment (wage cycle lags one period behind the employment cycle), for when the economy is at high employment, workers are able to demand rises in wages, whereas in periods of high unemployment, wages tend to fall. According to Goodwin, when unemployment and business profits rise, the output rises.
Cyclical behavior of exports and imports
Exports and imports are large components of an economy's aggregate expenditure, especially one that is oriented toward international trade. Income is an essential determinant of the level of imported goods. A higher GDP reflects a higher level of spending on imported goods and services, and vice versa. Therefore, expenditure on imported goods and services fall during a recession and rise during an economic expansion or boom.[59]
Import expenditures are commonly considered to be procyclical and cyclical in nature, coincident with the business cycle.[59] Domestic export expenditures give a good indication of foreign business cycles as foreign import expenditures are coincident with the foreign business cycle.
Credit/debt cycle
One alternative theory is that the primary cause of economic cycles is due to the
A primary theory in this vein is the
Post-Keynesian economist Hyman Minsky has proposed an explanation of cycles founded on fluctuations in credit, interest rates and financial frailty, called the Financial Instability Hypothesis. In an expansion period, interest rates are low and companies easily borrow money from banks to invest. Banks are not reluctant to grant them loans, because expanding economic activity allows business increasing cash flows and therefore they will be able to easily pay back the loans. This process leads to firms becoming excessively indebted, so that they stop investing, and the economy goes into recession.
While credit causes have not been a primary theory of the economic cycle within the mainstream, they have gained occasional mention, such as (Eckstein & Sinai 1990), cited approvingly by (Summers 1986).
Real business-cycle theory
Within mainstream economics, Keynesian views have been challenged by
Product based theory of economic cycles
This theory explains the nature and causes of economic cycles from the viewpoint of life-cycle of marketable goods.[60] The theory originates from the work of Raymond Vernon, who described the development of international trade in terms of product life-cycle – a period of time during which the product circulates in the market. Vernon stated that some countries specialize in the production and export of technologically new products, while others specialize in the production of already known products. The most developed countries are able to invest large amounts of money in the technological innovations and produce new products, thus obtaining a dynamic comparative advantage over developing countries.
Recent research by Georgiy Revyakin proved initial Vernon theory and showed economic cycles in developed countries overran economic cycles in developing countries.
Highly competitive market conditions would determine simultaneous technological updates of all economic agents (as a result, cycle formation): in case if a manufacturing technology at an enterprise does not meet the current technological environment – such company loses its competitiveness and eventually goes bankrupt.
Political business cycle
Another set of models tries to derive the business cycle from political decisions. The political business cycle theory is strongly linked to the name of Michał Kalecki who discussed "the reluctance of the 'captains of industry' to accept government intervention in the matter of employment".[62] Persistent full employment would mean increasing workers' bargaining power to raise wages and to avoid doing unpaid labor, potentially hurting profitability. However, 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.[63] 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. It then adopts an expansionary policy in the lead up to the next election, hoping to achieve simultaneously low inflation and unemployment on election day.[64]
The partisan business cycle suggests that cycles result from the successive elections of administrations with different policy regimes. Regime A adopts expansionary policies, resulting in growth and inflation, but is voted out of office when inflation becomes unacceptably high. The replacement, Regime B, adopts contractionary policies reducing inflation and growth, and the downwards swing of the cycle. It is voted out of office when unemployment is too high, being replaced by Party A.
Marxian economics
For Marx, the economy based on production of commodities to be sold in the market is intrinsically prone to
Some Marxist authors such as Rosa Luxemburg viewed the lack of purchasing power of workers as a cause of a tendency of supply to be larger than demand, creating crisis, in a model that has similarities with the Keynesian one. Indeed, a number of modern authors have tried to combine Marx's and Keynes's views. Henryk Grossman[66] reviewed the debates and the counteracting tendencies and Paul Mattick subsequently emphasized the basic differences between the Marxian and the Keynesian perspective. While Keynes saw capitalism as a system worth maintaining and susceptible to efficient regulation, Marx viewed capitalism as a historically doomed system that cannot be put under societal control.[67]
The American mathematician and economist
Austrian School
Economists of the heterodox
One of the criticisms of the
The Austrian explanation of the business cycle differs significantly from the mainstream understanding of business cycles and is generally rejected by mainstream economists. Mainstream economists generally do not support Austrian school explanations for business cycles, on both theoretical as well as real-world empirical grounds.[77][78][79][80][81][82] Austrians claim that the boom-and-bust business cycle is caused by government intervention into the economy, and that the cycle would be comparatively rare and mild without central government interference.
Yield curve
The slope of the yield curve is one of the most powerful predictors of future economic growth, inflation, and recessions.[83] One measure of the yield curve slope (i.e. the difference between 10-year Treasury bond rate and the 3-month Treasury bond rate) is included in the Financial Stress Index published by the St. Louis Fed.[84] A different measure of the slope (i.e. the difference between 10-year Treasury bond rates and the federal funds rate) is incorporated into the Index of Leading Economic Indicators published by The Conference Board.[85]
An inverted yield curve is often a harbinger of recession. A positively sloped yield curve is often a harbinger of inflationary growth. Work by Arturo Estrella and Tobias Adrian has established the predictive power of an inverted yield curve to signal a recession. Their models show that when the difference between short-term interest rates (they use 3-month T-bills) and long-term interest rates (10-year Treasury bonds) at the end of a federal reserve tightening cycle is negative or less than 93 basis points positive that a rise in unemployment usually occurs.[86] The New York Fed publishes a monthly recession probability prediction derived from the yield curve and based on Estrella's work.
All the recessions in the United States since 1970 (up through 2017) have been preceded by an inverted yield curve (10-year vs. 3-month). Over the same time frame, every occurrence of an inverted yield curve has been followed by recession as declared by the NBER business cycle dating committee.[87]
Event | Date of inversion start | Date of the recession start | Time from inversion to recession Start | Duration of inversion | Time from recession start to NBER announcement | Time from disinversion to recession end | Duration of recession | Time from recession end to NBER announcement | Max inversion |
---|---|---|---|---|---|---|---|---|---|
Months | Months | Months | Months | Months | Months | Basis points | |||
1970 recession |
December 1968 | January 1970 | 13 | 15 | NA | 8 | 11 | NA | −52 |
1974 recession |
June 1973 | December 1973 | 6 | 18 | NA | 3 | 16 | NA | −159 |
1980 recession | November 1978 | February 1980 | 15 | 18 | 4 | 2 | 6 | 12 | −328 |
1981–1982 recession | October 1980 | August 1981 | 10 | 12 | 5 | 13 | 16 | 8 | −351 |
1990 recession | June 1989 | August 1990 | 14 | 7 | 8 | 14 | 8 | 21 | −16 |
2001 recession | July 2000 | April 2001 | 9 | 7 | 7 | 9 | 8 | 20 | −70 |
2008–2009 recession | August 2006 | January 2008 | 17 | 10 | 11 | 24 | 18 | 15 | −51 |
2020–2020 recession | March 2020 | April 2020 | |||||||
Average since 1969 | 12 | 12 | 7 | 10 | 12 | 15 | −147 | ||
Standard deviation since 1969 | 3.83 | 4.72 | 2.74 | 7.50 | 4.78 | 5.45 | 138.96 |
Estrella and others have postulated that the yield curve affects the business cycle via the balance sheet of banks (or bank-like financial institutions).[88] When the yield curve is inverted banks are often caught paying more on short-term deposits (or other forms of short-term wholesale funding) than they are making on long-term loans leading to a loss of profitability and reluctance to lend resulting in a credit crunch. When the yield curve is upward sloping, banks can profitably take-in short term deposits and make long-term loans so they are eager to supply credit to borrowers. This eventually leads to a credit bubble.
Georgism
Henry George claimed land price fluctuations were the primary cause of most business cycles.[89]
Mitigating an economic downturn
Many social indicators, such as mental health, crimes, and suicides, worsen during economic recessions (though general mortality tends to fall, and it is in expansions when it tends to increase).[90] As periods of economic stagnation are painful for the many who lose their jobs, there is often political pressure for governments to mitigate recessions. Since the 1940s, following the Keynesian Revolution, most governments of developed nations have seen the mitigation of the business cycle as part of the responsibility of government, under the rubric of stabilization policy.[91]
Since in the Keynesian view, recessions are caused by inadequate aggregate demand, when a recession occurs the government should increase the amount of aggregate demand and bring the economy back into equilibrium. This the government can do in two ways, firstly by increasing the money supply (expansionary monetary policy) and secondly by increasing government spending or cutting taxes (expansionary fiscal policy).
By contrast, some economists, notably
However, even according to
Additionally, since the 1960s
Software
The Hodrick-Prescott [5] and the Christiano-Fitzgerald [2] filters can be implemented using the R package mFilter, while singular spectrum filters [6][7] can be implemented using the R package ASSA.
See also
- Dynamic stochastic general equilibrium
- Economic Cycle Research Institute
- Information revolution
- Inventory investment over the business cycle
- List of commodity booms
- List of financial crises in the United States
- Market trend
- Skyscraper Index
- Welfare cost of business cycles
- World-systems theory
- Benner Cycle
Notes
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- ^ Friedman, Milton. "The 'Plucking Model' of Business Fluctuations Revisited". Economic Inquiry: 171–177.
- S2CID 18902379.
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- JSTOR 2550326.
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- ISBN 978-1108003612)
- S2CID 51729569.
- ISSN 2210-4224.
References
- Harvey, Andrew; Trimbur, Thomas (2003), "General model-based filters for extracting trends and cycles in economic time series" (PDF), The Review of Economics and Statistics, 85 (2): 244–255, S2CID 57567527
- From (2008) The New Palgrave Dictionary of Economics, 2nd Edition:
- Christopher J. Erceg. "monetary business cycle models (sticky prices and wages)." Abstract.
- Christian Hellwig. "monetary business cycles (imperfect information)." Abstract.
- Ellen R. McGrattan "real business cycles." Abstract.
- ISBN 978-0226304533.
- Summers, Lawrence H. (1986). "Some Skeptical Observations on Real Business Cycle Theory" (PDF). Federal Reserve Bank of Minneapolis Quarterly Review. 10 (Fall): 23–27.
External links
- The Conference Board Business Cycle Indicators – Indicators of Euro Area, United States, Japan, China and so on.
- Historical documents relating to past business cycles, including charts, data publications, speeches, and analyses