Economic Cycle: Definition, Causes, Phases, Duration & Policies

Economic cycle

An economic cycle, also known as business cycle, is the succession of phases of expansion and depression in economic activity and has four phrases. The passage from expansion to depression is called a recession, and the passage from depression to expansion is called a recovery.

Cycle, in a general sense, means a phenomenon that occurs repeatedly every so often. To move in, follow, or put something through a regularly repeated series of events or actions. (1)

Prosperity are times of economic well-being and depression are times of economic hardship due to inability or difficulty in meeting the needs of society with scarce goods, due to lack of such goods or mismanagement, among many causes.

The theory of economic cycles makes it possible to predict changes or situations in the economy and to be able to fight against them. The goal is to prolong periods of economic well-being and avoid or reduce the impact of depressions as much as possible.

Causes of economic cycles

It usually happens that after times of economic prosperity there are economic crises that occur periodically and recurrently, which is a characteristic of economic cycles.

Industrialized countries have a very dynamic economy to the point where achieving a stable equilibrium is difficult for them because they have to deal with fluctuations up and down in their economy. In times of economic expansion, there is a high level of production and sales, so there are large incomes for entrepreneurs, better amounts of employment and greater consumption.

However, as a consequence of this great prosperity, there may be an excess in production and, therefore, in the next production cycle, companies decide to produce less. This in turn implies lower input consumption and lower income or sales for input vendors, fewer jobs, and decreased national production.

And this is how a recession or economic crisis can start, the globalization of world trade and trade relations between all countries makes the effects of these fluctuations know no borders, not excluding non-industrialized countries that benefit from these relations.

Phases of economic cycles

The four phases of economic cycles are expansion, recovery, recession, and depression. The moments of transition, which are recession and recovery, are shorter than depression and expansion.

Economic cycles are not the same, despite the fact that they all usually begin with the same phases. The difference is due to the fact that they don’t all have the same causes nor do they have the same intensity and duration, each has its own peculiarities.

Duration of economic cycles

The duration of economic cycles is usually measured from the highest point and further to the other highest point. Or from the lowest point that is the bottom to the other lowest point.

They can have a different duration depending on the branches of production that are being studied, however, economic cycles, generally speaking, typically last between 6 and 10 years, or an average of 8 years.

If we look at a graph that shows the different economic crises that the United States of America has gone through from 1900 to 2000, we can see the peaks of prosperity and crisis. You see the crisis of the great depression in the 1930s and then a time of prosperity during World War II.

Economic cycle theories

Economic cycle theories attempt to explain what causes the ups and downs the cycles, and there are two main categories, internal and external.

External or endogenous theories. External theories establish that fluctuations in economic cycles are caused by factors that are external to the economic system, such as social problems such as revolutions, war conflicts, or scientific and technological advances.
It has to do with Schumpeter’s innovation theory, according to which innovations and the increase in the production process contribute to the cumulative process, that is, to excess production that leads to a new economic crisis.
External or exogenous theories. External theories consider that the causes of fluctuations in economic cycles result from internal factors, as in the case of the derived demand theory.
Derivative demand theory. The phases of prosperity generate the accumulation and excessive production that originates a new crisis. When there is more demand, there is higher income, and there is more manufacturing and accumulation and there is no so much need to produce again and this is negative.

Economic policies on economic cycles – How to approach them

Economic policies are measures taken by the organs of public power in order to establish a balance in economic cycles and thus perpetuate phases of prosperity and slow down or reduce crises. Fiscal, public works, monetary and credit policies are applied to moderate these phases.

The function of these policies is summed up in stimulating economic activity in times of crisis and curbing excessive investments in times of prosperity, so that this phase of recovery and expansion can last longer, and minimize or avoid phases of recession and depression.

Monetary and credit policies

Loans. This consists of making loan of money more expensive to stop investment in times of expansion. In times of depression, the opposite is done, interest is reduced to encourage investment in the productive sector.
Modification of the legal reserve of commercial banking. This consists of government institutions deciding that, at some point, for the welfare of the economy, banks can lend a lower percentage for investment to stop the cumulative process that leads to recession. In times of recession, the opposite is done.

See more: Monetary Policy

Fiscal and Public Works Policies

In times of expansion, public spending and public works are reduced and taxes are raised. In times of recession, the economy must be stimulated, so public works are carried out and taxes are lowered to stimulate consumption and production.