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The term business cycle (or economic cycle) refers to economy-wide fluctuations in production or economic activity over several months or years. These fluctuations occur around a long-term growth trend, and typically involve shifts over time between periods of relatively rapid economic growth (expansion or boom), and periods of relative stagnation or decline (contraction or recession).

These fluctuations are often measured using the growth rate of real gross domestic product. Despite being termed cycle, most of these fluctuations in economic activity do not follow a mechanical or predictable periodic pattern.


In 1860, French economist Clement Juglar identified the presence of economic cycles 8 to 11 years long, although he was cautious not to claim any rigid regularity. Later, Austrian economist Joseph Schumpeter argued that a Juglar cycle has four stages: (i) expansion (increase in production and prices, low interests rates); (ii) crisis (stock exchanges crash and multiple bankruptcies of firms occur); (iii) recession (drops in prices and in output, high interests rates); (iv) recovery (stocks recover because of the fall in prices and incomes). In this model, recovery and prosperity are associated with increases in productivity, consumer confidence, aggregate demand, and prices.

In the mid-20th century, Schumpeter and others proposed a typology of business cycles according to its periodicity, so that a number of particular cycles were named after their discoverers or proposers: Interest in these different typologies of cycles has waned since the development of modern macroeconomics, which gives little support to the idea of regular periodic cycles.

Business cycles after World War II were generally more restrained than the earlier business cycles. Economic stabilization policy using fiscal policy and monetary policy appeared to have dampened the worse excesses of business cycles. Automatic stabilization due to the aspects of the government's budget also helped defeat the cycle even without conscious action by policy-makers.


Economic activity in the US 1954–2005
Deviations from the long term growth trend US 1954–2005

In 1946, economists Arthur F. Burns and Wesley C. Mitchell provided the now standard definition of business cycles in their book Measuring Business Cycles:

According to A. F. Burns:

In the United Statesmarker, 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".

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. For Milton Friedman calling the business cycle a "cycle" is a misnomer, because of its non-cyclical nature. Friedman believed that for the most part, excluding very large supply shocks, business declines are more of a monetary phenomenon.

Rational expectations theory states that no deterministic cycle can persist because it would consistently create arbitrage opportunities. Much economic theory also holds that the economy is usually at or close to equilibrium. These views led to the formulation of the idea that observed economic fluctuations can be modeled as shocks to a system.

In the tradition of Slutsky, business cycles can be viewed as the result of stochastic shocks that on aggregate form a moving average series.


The explanation of fluctuations in aggregate economic activity is one of the primary concerns of macroeconomics. The most commonly used framework for explaining such fluctuations is Keynesian economics. In the Keynesian view, business cycles reflect the possibility that the economy may reach short-run equilibrium at levels below or above full employment. If the economy is operating with less than full employment, i.e., with high unemployment, Keynesian theory states that monetary policy and fiscal policy can have a positive role to play in smoothing the fluctuations of the business cycle.

There are a number of alternative heterodox economic theories of business cycles, largely associated with particular schools or theorists. There are also some divisions and alternative theories within mainstream economics, notably Real Business Cycle theory and credit-based explanations such as debt deflation and the Financial Instability Hypothesis.

Exogenous vs. endogenous

Within mainstream economics, the debate over external (exogenous) versus internal (endogenous) causes of the economic cycle is centuries long, with the classical school (now neo-classical) arguing for exogenous causes and the underconsumptionist (now Keynesian) school arguing for endogenous causes. These may also broadly be classed as "supply-side" and "demand-side" explanations: supply-side explanations may be styled, following Say's law, as arguing that "supply creates its own demand", while demand-side explanations argue that effective demand may fall short of supply, yielding a recession or depression.

This debate has important policy consequences: proponents of exogenous causes of crises such as neoclassicals largely argue for minimal government policy or regulation (laissez faire), as absent these external shocks, the market functions, while proponents of endogenous causes of crises such as Keynesians largely argue for larger government policy and regulation, as absent regulation, the market will move from crisis to crisis. This division is not absolute – some classicals (including Say) argued for government policy to mitigate the damage of economic cycles, despite believing in external causes, while Austrian School economists argue against government involvement as only worsening crises, despite believing in internal causes.

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" debate.

Until the Keynesian revolution in mainstream economics in the wake of the Great Depression, classical and neoclassical explanations (exogenous causes) were the mainstream explanation of economic cycles; following the Keynesian revolution, neoclassical macroeconomics was largely rejected. There has been some resurgence of neoclassical approaches in the form of RBC theory, but the mainstream view is largely Keynesian.

Mainstream economists working in the neoclassical tradition of Adam Smith and David Ricardo, 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 (e.g. sunspots for William Stanley Jevons, planet Venus movements for Henry Ludwell Moore).

Contrarily, in the heterodox tradition of Jean Charles Léonard de Sismondi, Clement Juglar, and Marx the recurrent upturns and downturns of the market system are an endogenous characteristic of it.

The 19th century school of Underconsumptionism 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.


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" 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 accounts for cycles in output by the distribution of income between business profits and workers wages. The fluctuations in wages are the 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.

Credit/debt cycle

One alternative theory is that the primary cause of economic cycles is due to the credit cycle: the net expansion of credit (increase in private credit, equivalently debt, as a percentage of GDP) yields economic expansions, while the net contraction causes recessions, and if it persists, depressions. In particular, the bursting of speculative bubbles is seen as the proximate cause of depressions, and this theory places finance and banks at the center of the business cycle.

A primary theory in this vein is the debt deflation theory of Irving Fisher, which he proposed to explain the Great Depression. A more recent complementary theory is the Financial Instability Hypothesis of Hyman Minsky, and the credit theory of economic cycles is often associated with Post-Keynesian economics such as Steve Keen.

Post-Keynesian economist Hyman Minsky has proposed a 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 , cited approvingly by .

Real business cycle theory

Within mainstream economics, Keynesian views have been challenged by real business cycle models in which fluctuations are due to technology shocks. This theory is most associated with Finn E. Kydland and Edward C. Prescott, and more generally the Chicago school of economics (freshwater economics). They consider that economic crisis and fluctuations cannot stem from a monetary shock, only from an external shock, such as an innovation.

RBC theory has been categorically rejected by a number of mainstream economists in the Keynesian tradition, such as and Paul Krugman.

Politically-based business cycle

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. 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.

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.

The political business cycle theory is strongly linked to the name of Michał Kalecki who 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.

Marxian economics

For Marx the economy based on production of commodities to be sold in the market is intrinsically prone to crisis. In the Marxian view profit is the major engine of the market economy, but business (capital) profitability has a tendency to fall that recurrently creates crises, in which mass unemployment occurs, businesses fail, remaining capital is centralized and concentrated and profitability is recovered. In the long run these crises tend to be more severe and the system will eventually fail. 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. Others have contrarily emphasized 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

Austrian school

Economists of the Austrian school argue that business cycles are caused by monetary expansion, which is often created by central banks and fractional reserve banks in modern economies. Austrian business cycle theory, following the work of Ludwig von Mises and Friedrich Hayek, point to the role of the interest rates as the price of investment capital, guiding investment decisions. They argue that in an unregulated (free-market) economy, without a central bank, interest rates reflects the actual time preference of lenders and borrowers. Some follow Knut Wicksell in calling this the "natural" interest rate. Austrian school economists argue that a central bank distorts this natural equilibrium. If the interest rate is held artificially low by the government or central bank, then the demand for loans will exceed the supply of willing lenders, and if the interest rate are artificially high, the opposite will occur. This pricing misinformation leads investors to misallocate capital, borrowing and investing either too much when interest rates are too low or too little when the rates are too high, in long-term projects. Periodic recessions are seen as necessary "corrections" following periods of monetary expansion, when unprofitable investments are liquidated, freeing capital for new investment. Depressions and recessions are positive forces in-so-much that they are the market's natural mechanism of undoing the misallocation of resources present during the “boom” or inflationary phase.

There are various critiques of Austrian business cycle theory, not least of which that the US suffered recurrent economic crises in the 19th century, most notably the Long Depression following the Panic of 1873, prior to the establishment of a US central bank in 1907. The historian Thomas Woods has attempted to explain that these earlier financial crisis are in fact consistent with Austrian theory in his book Meltdown.


Most social indicators (mental health, crimes, suicides) worsen during economic recessions. 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, most governments of developed nations have seen the mitigation of the business cycle as part of the responsibility of government.

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).

However, even according to Keynesian theory, managing economic policy to smooth out the cycle is a difficult task in a society with a complex economy. Some theorists, notably those who believe in Marxian economics, believe that this difficulty is insurmountable. Karl Marx claimed that recurrent business cycle crises were an inevitable result of the operations of the capitalistic system. In this view, all that the government can do is to change the timing of economic crises. The crisis could also show up in a different form, for example as severe inflation or a steadily increasing government deficit. Worse, by delaying a crisis, government policy is seen as making it more dramatic and thus more painful.

Additionally, since the 1960s neoclassical economists have played down the ability of Keynesian policies to manage an economy. Since the 1960s, economists like Nobel Laureates Milton Friedman and Edmund Phelps have made ground in their arguments that inflationary expectations negate the Phillips curve in the long run. The stagflation of the 1970s provided striking support for their theories, defying the simple Keynesian prediction that recessions and inflation cannot occur together. Friedman has gone so far as to argue that all the central bank of a country should do is to avoid making large mistakes, as he believes they did by contracting the money supply very rapidly in the face of the Wall Street Crash of 1929, in which they made what would have been a recession into the Great Depression.

See also



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.

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