Business Cycle

The growth projection

Do you have any idea what the size of the national economy is going to be in two years? Unless you have a crystal ball, or contact with the genie in the lamp, the answer is most likely “no”, since the economic process is not linear. However, a relatively regular sequence of fluctuations in economic output allows us to project a long-term path. We call this oscillation of growth and deceleration an economic cycle.

Cycles:

Economic cycles bring together a succession of upward and downward phases that are commonly composed of four elements:

Depression: this is the lowest point of the cycle. During this phase, demand is significantly low in relation to the country's productive capacity, causing unemployment and stock accumulation.

Recovery/expansion: this is the upward phase of the cycle, following a depression. It usually happens that after bottoming out, at some point capital must begin to be replaced so as not to become obsolete, which drives investment, with multiplier effects on all activity. When a company decides to increase investment, it triggers a cumulative process of demands, where the company from which it buys goods is also forced to produce more, and therefore hire more labor, which will in turn increase consumption and more companies can produce more and hire, and so on. This is what the multiplier effect is all about.

Boom: this is the peak of the cycle. Unfortunately, no recovery is infinite. We have already talked about the relevance of the concept of “scarcity” in the economy (see section). At a certain point in the expansionary phase, rigidities begin to appear: growing sectors can no longer find sufficiently qualified labor for the required jobs, or raw materials: resources are now close to full utilization! The only possibility for further growth is to increase productivity (i.e. the amount of goods produced with the same resources), but this takes longer to transform.

Recession: the downturn. Upon reaching the limit of potential production and due to the shortage of available labor, companies begin to see how their sales are not keeping up with the expected pace. As a result, they begin to slow down investment, since they realize that they will not be able to continue growing at the rate they had been doing. This phenomenon may even lead them to lay off some workers, who therefore consume less, and the effects may spread throughout the economy. Recession may be milder or more abrupt

The role of economic policies in the existence of cycles

While it is true that all economies tend to face fluctuations due to the development of the actors themselves, the economy grants a relevant role to fiscal and monetary policy: that of smoothing the cycles. Even with expansionary and recessionary phases, it is evident that it is much healthier for an economy not to face abrupt movements that from one month to the next leave a population unemployed or abruptly accelerate inflation. Moreover, we have seen how decisions are contagious: a company that decides to lay off workers may have more effects on the overall economy than imagined. This is why stabilizing fiscal policies (increasing the fiscal deficit or lowering the interest rate during recession, and increasing the surplus or raising the rate during expansion) can help keep economic growth stable.