Business Cycle:

Ups and Downs of the Economy 📈📉

The business cycle describes the fluctuations that a country or region’s economy experiences over time. These fluctuations consist of phases of growth and recession, which affect variables such as production, employment, consumption, and investment.

At its core, the business cycle reflects the natural rhythms of the economic system as it responds to internal and external factors.

Although it may sometimes seem unpredictable, this cycle is a recurring phenomenon that has been studied and theorized for centuries by economists and experts. 🌍📊

Phases of the Business Cycle ⏳

The business cycle is divided into four key phases: expansion, peak, recession, and bottom. These phases occur continuously, although not always with the same duration or magnitude.

1. Expansion (Growth) 📈🚀

The expansion phase is the period in which the economy grows.

During this stage:

The Gross Domestic Product (GDP) increases.
New jobs are created and unemployment decreases.
Companies invest in increasing their production.
Consumers spend more, which increases the demand for goods and services.
Interest rates are usually low to stimulate investment and consumption.

Growth can last for several years and is often accompanied by wage increases, growth in asset prices (stocks, real estate), and greater economic optimism. However, a prolonged expansion can create imbalances, such as high inflation or speculative bubbles in key sectors, which can lead to the next phase.

2. Peak (top) 🏔️

The peak is the highest point of the economy before it begins to slow down.

In this phase, the economy is firing on all cylinders:

GDP is at its peak.
Employment is high, but businesses may struggle to find additional workers.
Prices for goods and services may begin to rise more quickly, creating inflationary pressures.
Central banks may begin to raise interest rates to curb inflation and cool down an overheating economy.

At this point, the economy may be in an overheating situation, where supply cannot keep up with demand, which usually precedes a contraction.

3. Recession (Contraction) 📉😔

Recession is the period when the economy contracts. In this phase,

the effects of overheating in the previous phase begin to be felt more markedly:

GDP declines for two consecutive quarters or more.
Businesses cut back on production due to falling demand.
Unemployment rises as businesses cut costs and lay off workers.
Business investment and consumer spending decline, negatively affecting the overall economy.

During a recession, consumers become more cautious with their spending, deepening the contraction. Interest rates are often cut to try to revive the economy by stimulating spending and investment.

Recessions can be short and shallow, or long and severe, such as the Great Recession of 2008, which had profound global impacts.

4. Bottom (Depression) ⬇️💥

The bottom is the phase in which the economy hits its lowest level of activity before beginning to recover.

In this phase, business and consumer confidence are at their lowest:

Unemployment is high.
Industrial production is at rock bottom levels.
Consumption and investment are severely depressed.

However, the bottom also marks the beginning of a new cycle, as it is often followed by a recovery phase and eventually a new expansion.

Governments and central banks usually intervene aggressively in this phase with stimulus policies, such as public spending and interest rate cuts, to revive the economy.

Factors that Influence the Business Cycle 🌐🔄

1. Monetary Policy 🏦💵

Monetary policy, managed by central banks, is one of the main tools to influence the business cycle.

Through control of the money supply and interest rates, central banks can stimulate or slow down the economy:

Expansionary policy: When the economy is in recession, central banks lower interest rates and increase the money supply to encourage consumption and investment.
Contractionary policy: When the economy is in expansion phase and inflation is high, central banks raise interest rates and reduce the money supply to prevent the economy from overheating.

The US Federal Reserve and the European Central Bank are examples of key institutions that manage monetary policy in their respective economies, with a significant global impact.

2. Fiscal Policy 🏛️

Fiscal policy, managed by governments, also influences the business cycle through changes

in government spending and taxes:

Government spending:Governments can increase spending on infrastructure, education, or health during a recession to stimulate demand and create jobs.
Taxes: Cutting taxes during a recession puts more money into the hands of consumers and businesses, incentivizing spending and investment.

During the Great Recession of 2008, governments around the world implemented massive fiscal stimulus packages, such as the 2009 U.S. Recovery and Reinvestment Plan, to help mitigate the effects of the recession.

3. Innovation and Technological Progress 🤖💡

Technological innovations and economic progress can also influence the business cycle.

Technological revolutions often lead to prolonged expansions due to increased productivity and the creation of new industries.

Historical examples include the Industrial Revolution of the 19th century and the Digital Revolution in the late 20th century.

However, automation and creative destruction, in which new technologies replace outdated industries, can also lead to temporary disruptions in the economy, affecting employment in certain sectors.

4. External Factors 🌍🔥

The business cycle can also be affected by external events, such as wars, natural disasters, or pandemics.

For example, the COVID-19 pandemic in 2020 triggered a massive global economic contraction due to the closure of economies and mobility restrictions, resulting in the fastest recession in recent history.

However, aggressive intervention by governments and central banks helped the recovery phase to be rapid as well.

Business Cycle Theories 📚💡

The business cycle, that is, the alternating periods of expansion and recession in an economy, has been a topic of great interest to economists throughout the centuries. Various thinkers have developed theories to understand its causes and effects, which has influenced the formulation of public and economic policies around the world.

Let’s delve into some of the most influential theories and the people who developed them, with details about their historical contexts, key places, and how these ideas have shaped the modern economy.

1. Keynesian Theory 📖

John Maynard Keynes (1883-1946) is undoubtedly one of the most influential economists of the 20th century.

His theory on business cycles has shaped much of modern fiscal policy, especially in times of crisis.

Place and context🪪:

Nationality: Keynes was British, born in Cambridge, England, in 1883.
Key period: His business cycle theory emerged during the 1930s, in the midst of the collapse of the world economy due to the Great Depression (1929–1939). In that context, classical economic ideas, which advocated letting markets self-correct, proved insufficient to resolve the crisis.

Business cycle theory📊:

Keynes argued that fluctuations in aggregate demand were the driving force of the business cycle. Aggregate demand is the sum of consumption, investment, and government spending in an economy. When demand falls, a recession occurs; when it rises, the economy expands.
Government intervention: Keynes proposed that, during a recession, the government should intervene through expansionary fiscal policies: increasing public spending and reducing taxes to stimulate demand. This theory was pioneered in Franklin D. Roosevelt’s New Deal in the US, with the aim of lifting the American economy out of the Great Depression.

Impact and legacy🔄:

Keynesian ideas deeply influenced the design of post-war economic policies, especially in Europe and the United States, during the 1940s and 1950s. Even today, economic stimulus fiscal policies are a pillar of economic management in times of crisis, as was the case during the Great Recession of 2008 and the COVID-19 crisis in 2020.

2. Monetarist Theory 💰

Milton Friedman (1912-2006), another giant of economic thought, led the school of monetarism, which offers a different view on the causes of business cycles, based primarily on the behavior of the money supply.

Place and context💳:

Nationality: Friedman was an American economist, born in Brooklyn, New York.
Key era: His most influential work appeared in the 1960s and 1970s, when developed economies faced high inflation rates. Friedman became a prominent voice criticizing excessive government spending and Keynesian policies, arguing that inadequate money management by central banks was the main cause of economic fluctuations.

Business cycle theory📊:

According to Friedman, the business cycle is caused by variations in the money supply controlled by central banks. When there is too much money supply, the economy enters an expansionary phase, but this can lead to overheating and inflation. Conversely, if the money supply is drastically reduced, the economy may fall into recession.
Monetary Rule: Friedman proposed that central banks should maintain stable and predictable growth in the money supply to avoid large fluctuations. His phrase «inflation is always and everywhere a monetary phenomenon» sums up the essence of his approach.

Impact and Legacy🔄:

The monetarist school influenced global economic policy in the 1980s and 1990s, especially in the era of Margaret Thatcher in the United Kingdom and Ronald Reagan in the United States, when policies of tight control of the money supply were implemented to combat high inflation.
His ideas also influenced how central banks, such as the Federal Reserve or the European Central Bank, manage monetary policy today.

3. Schumpeter’s Theory of Creative Destruction ⚙️

Joseph Schumpeter (1883-1950) was an Austrian economist known for his theory of creative destruction, which offers a dynamic view of the business cycle, linked to technological advances and innovation.

Place and context💳:

Nationality: Schumpeter was born in Triesch, Austria-Hungary (now Třešť, Czech Republic).
Key era: Schumpeter developed his theory during the first half of the 20th century, a period of rapid industrial and technological transformations, marked by the late Industrial Revolution and World War II.

Business cycle theory📊:

For Schumpeter, the business cycle is driven by waves of technological innovation. These innovations lead to economic expansions, as they create new industries and products, but at the same time destroy old industries that cannot compete with new technologies.
This process of “creative destruction” means that crises and recessions are a necessary part of economic progress, as they allow new companies and ideas to replace old ones, generating new sources of growth.

Impact and legacy🔄:

Schumpeter’s ideas profoundly influenced thinking about dynamic capitalism and the way economies transform. Today, his theories are applicable to phenomena such as digital disruption, where technology companies such as Apple, Amazon or Google replace traditional sectors.
His ideas are studied in innovation and entrepreneurship courses, and are a central piece in the analysis of economic development in technologically advanced economies.

Other Key Approaches and Figures in the Business Cycle 🔍

Knut Wicksell 📈

Nationality: Swedish.
Theory: Wicksell developed the idea of »natural interest,» arguing that when market interest rates become misaligned from «natural interest,» economic fluctuations occur. His work laid the groundwork for modern theories of monetary policy.

Robert Lucas 🧠

Nationality: American.
Theory: Lucas is known for his work on rational expectations. He criticized Keynesian theories for failing to consider that economic agents anticipate government policies, which influences their behavior. This led to the development of the theory of real business cycles, which suggests that fluctuations in output result from technological shocks rather than changes in aggregate demand or money supply.

And this means🤔: That they did not take into account that people and companies anticipate government policies and adjust their behavior. This led him to create the theory of real business cycles, which says that ups and downs in the economy are caused primarily by technological advances or setbacks, rather than changes in the demand for goods or the amount of money available.🤔
This means that people and companies do not passively wait to see what the government will do; For example, if they think the government is going to raise taxes, they can decide to save more or spend less before the change occurs. This anticipatory reaction affects how government policies work, because people’s decisions influence economic outcomes.

It is as if the government were playing chess and economic agents (people or companies) were trying to predict its next move in order to plan the best strategy♟♖.

Friedrich Hayek 📜

Nationality: Austrian.
Theory: Hayek, a Nobel laureate in 1974, was a proponent of the Austrian School, which argued that business cycles result from misallocation of resources caused by excessive government intervention, especially in monetary policy.

And this means🤔: That periods of growth and recession are caused by errors in the way resources are distributed in the economy. These errors, they say, occur when the government intervenes too much, especially through its management of money, such as when central banks manipulate interest rates or print more money.

Example: Imagine that the central bank decides to lower interest rates a lot to make it cheaper to borrow. This causes businesses and individuals to borrow money to make large investments, such as building factories or buying houses, because it seems like a good opportunity.However, this situation is misleading because low interest rates do not reflect the reality of the economy, but are instead a result of government intervention.

In the long run, when interest rates rise again or the economy does not grow as expected, many of those investments turn out to be bad decisions. Businesses may go bankrupt and loans cannot be repaid. As a result, a recession occurs. Austrian School economists believe that this happens because of money manipulation and that if the government did not intervene so much, these cycles would be less severe or would not occur at all.

In short, according to the Austrian School, business cycles happen because the government artificially alters economic signals, leading to a misallocation of resources.

Key Dates and Events Related to Business Cycle Theories 🗓️

1929-1939: Great Depression 🌍

Context in which Keynes developed his theory.

1970s: Oil Crisis ⛽

Key period for monetarist ideas, as high inflation and economic stagnation led to new proposals to stabilize the economy.

2008: Global Financial Crisis 💥

Time when many of the Keynesian and monetarist approaches were put back into practice, with huge fiscal stimuli and expansionary monetary policies.

Conclusion 🎯

Business cycle theories have been formulated by different economists throughout history, and although they vary in their approach, they all try to understand why economies grow and shrink at regular intervals. From Keynes to Friedman and Schumpeter, each has left a profound legacy that continues to influence economic policies today.

Historical Examples of the Business Cycle 📜

1. The Great Depression (1929-1939) 🌍📉

The Great Depression was one of the most severe recessions in modern history, affecting almost every economy in the world.

The US stock market crashed in 1929, leading to a massive drop in industrial production, employment, and aggregate demand.This event prompted the adoption of Keynesian policies to try to stabilize the global economy.

2. The Economic Boom of the 1990s 🌟

During the 1990s, many developed economies, especially the United States, experienced a long period of economic expansion.

This boom was driven by the adoption of new information technologies, such as the Internet, which created new industries and business opportunities.

3. The Great Recession (2008-2009) 💥

The global financial crisis of 2008 was caused by the bursting of the real estate bubble in the United States and the subsequent crisis in the financial markets.

This led to a global recession, and governments and central banks implemented expansionary fiscal and monetary policies to revive economic growth.The business cycle was particularly affected by the intervention of the Federal Reserve and fiscal stimuli around the world.

Conclusion 🎯

The business cycle is an intrinsic part of any capitalist economy, and understanding it is essential for policymakers, investors, and businesses. Throughout history, we have seen how different theories and approaches have attempted to explain and manage these cycles, from Keynesian state intervention to monetarist strategies of money supply control. Although business cycles cannot be completely avoided, appropriate policies can mitigate their effects and facilitate a faster recovery.