Business Cycles

The idea of a business cycle in the economy functions as a straightforward narrative to explain why things occasionally go wrong in capitalist countries.

It works something like this: the business cycle begins when banks start expanding the amount of available credit in the economy by pushing down interest rates. This, so the argument goes, has the effect of turning ventures that would have otherwise been unprofitable under a higher interest rate into profitable ones. As a result of the new investment in the economy, the price of labor and capital rise. In the cycle, this is the boom phase. But credit expansion can’t keep going on forever. At some point, the general public will come to the conclusion that endless credit is leading to inflation, which then further leads to desperate attempts to dump the increasingly valueless money in exchange for other assets. This is the hyperinflation. As soon as banks cut off the credit spigot, the natural rate of interest kicks back into gear, making some number of profitable projects unprofitable. We’ve now reached the bust part of the cycle.

But there are at least several problems with this:

  1. Lowered interest rates don’t always mean more credit is introduced into the economy
  2. The economy is not necessarily in equilibrium
  3. Continuous inflation often occurs for decades without general panic and currency dumping