BUSINESS CIRCLE THEORY
INTRODUCTION.
The term business cycle (or economic cycle or boom-bust cycle) refers to economy-wide fluctuations in production, trade and economic activity in general over several months or years in an economy organized on free-enterprise principles. The business cycle is the upward and downward movements of levels of GDP (gross domestic product) and refers to the period of expansions and contractions in the level of economic activities (business fluctuations) around its long-term growth trend. These fluctuations occur around a long-term growth trend, and typically involve shifts over time between periods of relatively rapid economic growth (an expansion or boom), and periods of relative stagnation or decline (a contraction or recession).Business cycles are usually measured by considering the growth rate of real gross domestic product. Despite being termed cycles, these fluctuations in economic activity can prove unpredictable.
History

A BASIC ILLUSTRATION OF ECONOMY/BUSINESS CIRCLE.
Theory
The first systematic exposition of periodic economic crises, in opposition to the existing theory of economic equilibrium, was the 1819 Nouveaux Principes d'économie politique by Jean Charles Léonard de Sismondi. Prior to that point classical economics had either denied the existence of business cycles, blamed them on external factors, notably war, or only studied the long term. Sismondi found vindication in the Panic of 1825, which was the first unarguably international economic crisis, occurring in peacetime. Sismondi and his contemporary Robert Owen, who expressed similar but less systematic thoughts in 1817 Report to the Committee of the Association for the Relief of the Manufacturing Poor, both identified the cause of economic cycles as overproduction and underconsumption, caused in particular by wealth inequality. They advocated government intervention and socialism, respectively, as the solution. This work did not generate interest among classical economists, though underconsumption theory developed as a heterodox branch in economics until being systematized in Keynesian economics in the 1930s.Sismondi's theory of periodic crises was developed into a theory of alternating cycles by Charles Dunoyer, and similar theories, showing signs of influence by Sismondi, were developed by Johann Karl Rodbertus. Periodic crises in capitalism formed the basis of the theory of Karl Marx, who further claimed that these crises were increasing in severity and, on the basis of which, he predicted a communist revolution. He devoted hundreds of pages of Das Kapital (1867) to crises. In Progress and Poverty (1879), Henry George focused on land's role in crises – particularly land speculation – and proposed a single tax on land as a solution.

CLASSIFICATION BY PERIOD Proposed Economic waves | Cycle/wave name | Period | Kitchen inventory | 3-5 | Juglar fixed investment | 7-11 | Kuznets infrastructural investment | 15-25 | Kondratiev wave | 45-60 | Pork cycle |
In 1860 French economist Clement Juglar first identified economic cycles 7 to 11 years long, although he cautiously did not claim any rigid regularity. Later[when?], economist Joseph Schumpeter (1883-1950) argued that a Juglar Cycle has four stages:
1. expansion (increase in production and prices, low interest-rates)
2. crisis (stock exchanges crash and multiple bankruptcies of firms occur)
3. recession (drops in prices and in output, high interest- rates)
4. recovery (stocks recover because of the fall in prices and incomes) Schumpeter's Juglar model associates recovery and prosperity 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 their periodicity, so that a number of particular cycles were named after their discoverers or proposers: the Kitchin inventory cycle of 3 to 5 years (after Joseph Kitchin); the Juglar fixed-investment cycle of 7 to 11 years (often identified[by whom?] as "the" business cycle) the Kuznets infrastructural investment cycle of 15 to 25 years (after Simon Kuznets - also called "building cycle") the Kondratiev wave or long technological cycle of 45 to 60 years (after the Soviet economist Nikolai Kondratiev). Interest in the different typologies of cycles has wanedsince the development of modern macroeconomics, whichgives little support to the idea of regular periodic cycles.
OCCURRENCE.

A Simplified kondratiev wave,with the theory that productivity enhancjng innovatios drive waves of economic growth.
There were frequent crises in Europe and America in the 19th and first half of the 20th century, specifically the period 1815–1939. This period started from the end of the Napoleonic wars in 1815, which was immediately followed by the Post-Napoleonic depression in the United Kingdom (1815–30), and culminated in the Great Depression of 1929–39, which led into World War II.
See Financial crisis: 19th century for listing and details. The first of these crises not associated with a war was the Panic of 1825. Business cycles in OECD countries after World War II were generally more restrained than the earlier business cycles. This was particularly true during the Golden Age of Capitalism (1945/50–1970s), and the period 1945–2008 did not experience a global downturn until the Late-2000s recession. Economic stabilization policy using fiscal policy and monetary policy appeared to have dampened the worst excesses of business cycles, and automatic stabilization due to the aspects of the government's budget also helped mitigate the cycle even without conscious action by policy-makers.
In this period, the economic cycle – at least the problem of depressions – was twice declared dead. The first declaration was in the late 1960s, when the Phillips curve was seen as being able to steer the economy. However, this was followed by stagflation in the 1970s, which discredited the theory. The second declaration was in the early 2000s, following the stability and growth in the 1980s and 1990s in what came to be known as The Great Moderation. Notably, in 2003, Robert Lucas, in his presidential address to the American Economic
Association, declared that the "central problem of depression-prevention [has] been solved, for all practical purposes." Unfortunately, this was followed by the 2008–2012 global recession. Various regions have experienced prolonged depressions, most dramatically the economic crisis in former Eastern Bloc countries following the end of the Soviet Union in 1991. For several of these countries the period 1989–2010 has been an ongoing depression, with real income still lower than in 1989.[citation needed] This has been attributed not to a cyclical pattern, but to a mismanaged transition from command economies to market economies.

IDENTIFYING Economic activity in the us,1954-2005 Deviation from the long term us growth trend,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: “business cycles are a type of flunctuaton found in the aggregate economic activity of nations that organize their work mainly in business enterprises:a cycle consists of expansions occurring at about the same time in many economic activities,followed by similarly general recessions, contractions, and revivals which merge into the expansion phase of the next cycle;in duration,business cycles vary from more than one year to ten or twelve years;they are not divisible into shorter cycles of similar characteristics with amplitudes approximating their own.”
According to A. F. Burns:
“Business cycles are not merely fluctuations in aggregate that economic activity. the critical feature that distinguishes them from the commercial convulsions of earlier centuries or from the seasonal and other short term variations of our own age in that the fluctuation are widely diffused over the economy-its industry, its commercial dealings, and its tangles of finance. The economy of the western world is a system of closely interrelated parts. He who would understand business cycles must master the workings of an economic system organized largely in a network of free enterprises searching for profit.the problem of how business cycles come about is therefore inseparable from the problem of how a capitalist economy functions.”
In the United States, 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".

Upper turning points of business cycle, commodity prices and freight rates
There is often a close timing relationship between the upper turning points of the business cycle, commodity prices and freight rates, which is shown to be particularly tight in the grand peak years of 1873, 1889, 1900 and 1912.
Spectral analysis of business cycles Recent research employing spectral analysis has confirmed the presence of Kondratiev waves in the world GDP dynamics at an acceptable level of statistical significance.[non-primary source needed] Korotayev & Tsirel also detected shorter business cycles, dating the Kuznets to about 17 years and calling it the third sub-harmonic of the Kondratiev, meaning that there are three
Kuznets cycles per Kondratiev
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.
Explanations
The explanation of fluctuations in aggregate economic activity is one of the primary concerns of macroeconomics. The main 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) being the causes of the economic cycles, with the classical school (now neo-classical) arguing for exogenous causes and the under consumptionist (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 neoclassical 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 classical (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 real business cycle (RBC) theory. The debate between Keynesians and neo- classical advocates was reawakened following the recession of 2007. Mainstream economists working in the neoclassical tradition, 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.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.
Keynesian
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 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
Main articles: Credit cycle and Debt deflation 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 an 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 ( Eckstein & Sinai 1986), cited approvingly by (Summers 1986).
Real business cycle theory
Main article: 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. There were great increases in productivity, industrial production and real per capita product throughout period from 1870 to 1890 that included the Long Depression and two other recessions.[23][24] See:Long depression#Myth of the Long Depression There were also significant increases in productivity in the years leading up to the Great Depression. Both the Long and Great Depressions were characterized by overcapacity and Market saturation. Over the period since the Industrial Revolution, Technological progress has had a much larger effect on the economy than any fluctuations in credit or debt, the primary exception being the Great Depression, which caused a multi-year steep economic decline. The effect of technological progress can be seen by the purchasing power of an average hour's work, which has grown from $3 in 1900 to $22 in 1990, measured in 2010 dollars. There were similar increases in real wages during the 19th century. See: Productivity improving technologies (historical) A table of innovations and long cycles can be seen at: Kondratiev wave#Modern modifications of Kondratiev theory Carlota Perez blames "financial capital" for excess speculation, which she claims is likely to occur in the "frenzy" stage of a new technology, such as the 1998–2000 computer, internet, dot.com mania and bust. Perez also says excess speculation is likely to occur in the mature phase of a technological age. RBC theory has been categorically rejected by a number of mainstream economists in the Keynesian tradition, such as ( Summers 1986) 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 discussed "the reluctance of the 'captains of industry' to accept
Government intervention in the matter of employment."[30] 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 heterodox 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. Henryk Grossman reviewed the debates and the counteracting tendencies and Paul Mattick subsequently emphasized the 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. The American mathematician and economist, Richard M.
Goodwin formalized a Marxist model of business cycles, known as the Goodwin Model in which recession was caused by increased bargaining power of workers (a result of high employment in boom periods) pushing up the wage share of national income, suppressing profits and leading to a breakdown in capital accumulation.
Later theorists applying variants of the Goodwin model have identified both short and long period profit-led growth and distribution cycles in the United States, and
Elsewhere. David Gordon provided a Marxist model of long period institutional growth cycles, in an attempt to explain the Kondratiev wave. This cycle is due to the periodic breakdown of the 'social structure of Accumulation' – a set of institutions which secure and stabilise capital accumulation.
Austrian School
Main article: Austrian business cycle theory Economists of the heterodox Austrian School argue that business cycles are primarily caused by excessive creation of bank credit – or fiduciary media – which is encouraged by central banks when they set interest rates too low, especially when combined with the practice of fractional reserve banking. The expansion of the money supply causes a "boom" in which resources are misallocated due to falsified interest rate signals, which then leads to the "bust" as the market self-corrects, the malinvestments are liquidated, and the money supply contracts. One of the primary criticisms of Austrian business cycle theory is the observation that the United States suffered recurrent economic crises in the 19th century, most notably the Panic of 1873, prior to the establishment of a U.S. central bank in 1913. Adherents, such as the historian Thomas Woods argue that these earlier financial crises were prompted by government and bankers' efforts to expand credit despite restraints imposed by the prevailing gold standard, and are thus consistent with Austrian Business Cycle Theory.

Georgism
Henry George identifies land price fluctuations as theprimary cause of most business cycles. The theory is generally ignored in most of today's discussions of the subject despite the fact that the two great economic contractions of the last 100 years (1929–1933 and 2008–2009) both involved speculative real estate bubbles.
George observed that one of the factors that is absolutely necessary for all production – land – has an inherent tendency to rise in price on an exponential basis as the economy grows. The reason for this is that the quantity of land (the stock of locations and natural resources) is fixed, while its quality is improved due to improvements such as transportation infrastructures and economic development of the surroundings. Investors see this tendency as the economy grows and they buy land ahead of the boom areas, withholding it from use in order to take advantage of its increased value in the future. Because housing and commercial real estate provide collateral for a large portion of lending, there is a tendency for real estate prices to rise faster than the rate of inflation in business cycle upswings.
Speculation in land concentrates profits in landholders and diverts economic resources to speculation in land, squeezing profits away from production that has to occur on this land. In effect, land speculation creates a built-in supply shock, that squeezes the economy just as economic output increases. This is a systemic retardation of the economy, placing a sharp brake on further economic expansion.
This shock to the economy occurs as long as there is land speculation, creating an underlying tendency toward inflation and recession late in the growth phase of the business cycle. Land speculation, according to George, is always the cause of economic downturns. There are any number of contributing causes; things like oil price shocks, consumer confidence crises, international trade fluctuations, natural disasters – but none of these things creates the underlying weakness.
Land speculation slows the economy in two ways. It increases production costs by making land in general more expensive (shifting the Aggregate supply (AS) curve upward) as well as decreasing productivity by denying access to the best locations, shifting the AS curve to the left and lowering "potential output".
The Wisconsin Business School publishes an on line database with building cost and land values for 46 U.S. metro areas.
Mitigating an economic downturn
Many social indicators, such as mental health, crimes, and suicides, worsen during economic recessions (though general mortality tends to fall, and it is in expansions when it tends to increase). 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, following the Keynesian revolution, most governments of developed nations have seen the mitigation of the business cycle as part of the responsibility of government, under the rubric of stabilization policy.
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). By contrast, some economists, notably New classical economist Robert Lucas, argue that the welfare cost of business cycles are very small to negligible, and that governments should focus on long-term growth instead of stabilization. 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.