TRE TIPTON The Business Cycle

Define Business Cycle: The periodic but irregular up and down movements in economic activity, measured by fluctuations in real GDP and other macroeconomic variables (Parkin and Bade: Economics)

History Jean Charles Leonard de Sismondi: 1819 wrote Nouveaux Principes d’economie politique in opposition to the prior theory of economic equilibrium Despite being called a cycle, the fluctuations in economic activity do not follow a mechanical or predictable pattern

Theories Keynesian: fluctuations in aggregate demand cause the economy to come to short run equillibrium at levels that are different from the full employment rate of output Keynesian models do not necessarily imply peiodic business cycles. However they involve the interaction of Keynesian multiplier and accelerator or responses to initial shocks

Keynesian Model Richard Goodwin a proponent of Keynesian theory believes the business cycle is dependent on employment cycles. As the economy is at high employment workers demand rises in wages, and when the economy is at low employment workers wages tend to fall When unemployment and business profits rise, the output rises

Credit/ Debt Cycle Credit cycle: the net expansion of credit (increase in private credit, equivalently debt, as a percent of GDP) yields economic expansions, while the net contraction causes recessions and maybe even depressions In an expansion period, interest rates are low and companies easily borrow money from banks to invest. Banks easily grant loans because expanding economic activity makes business increase cash flow and therefore will be able to pay back loans

Credit/ Debt cont’d This process leads to firms becoming excessively indebted, so that they stop investing, or giving out loans, and the economy goes into recession Similar to America’s recent recession where banks handed out mortgages like candy, and when people were not able to pay back their loans banks went bankrupt

Politically-based Business Cycle The partisan business cycle suggests: cycles are caused from succeeding elections of Parties who differ in policy. Party A for example, inputs expansionary policies, causing growth and inflation until voted out of office when inflation is too much Party B then changes policy and adopts more conservative or contractionary methods reducing inflation and growth but then unemployment gets to high and then is again replaced by Party A

Marxist Economics Marx believes the economy is based on production of commodities to be sold in the market is intrinsically prone to crisis Profit is the major engine of the market economy but as capital has a tendency to fall it repeatedly creates crises where mass unemployment occurs and businesses fail

My Theory In America specifically, looking at our current state of recession, I believe the Credit/Debt theory is the most correct in terms of our Business Cycle If you consider the recession, which is a result of much of the excessive investing of banks, you’ll see the relation between the Credit/Debt theory

My Theory Many banks were handing out loans to people who in actuality may have not been qualified, and when these people had to foreclose their homes, the banks would not get paid back on their investment, and after a widespread trend of this banks began to go broke I also believe the Political theory has some significance because as presidents change as do the policies we practice. This could create confusion and distortion amongst our economy as previous motives are now replaced by new and opposite motives Overall, I believe the Credit/Debt and Political theories best explain the reasons for business cycles