The business cycle is a precarious phenomenon that is not fully understood. The business cycle is the concept used to describe the fluctuation of economic output. When economic expansion is robust, we refer to it as a “boom” time. When the economy shrinks, resulting in negative economic growth, we refer to this as a recession, or the “bust.” Why economic activity goes through boom and bust cycles is subject to great debate.
While it would be ideal to have predictable and steady economic growth, it simply isn’t feasible. This would require strong government intervention in the market place and would result in a command economy. This economic control is effectively communist macroeconomic policy, which fails to effectively deliver goods and services in response to demand. This means the boom and bust cycle is a byproduct to the capitalist system, where firms freely compete against each other. Why does free competition lead to boom and bust cycles?
One theory suggests the problem is the “bubble.” A bubble occurs when production expands rapidly in one industry to try and satisfy a strong level of demand. Increasingly more and more firms jump into the marketplace to try and capitalize on the demand, and eventually, overproduction results, with more goods or services provided than what is demanded. At this point, many of the firms stop production, meaning economic output suddenly slows or stops. This is effectively how the bubble “bursts,” and often ancillary industries feel the effect by also slowing or stopping production, causing economic recession.
In the spirit of remediating the effects of recession, some economists believe that government spending can replace the hole left by receding industrial output. The first problem with this idea is that government spending is a much smaller part of the economy than business and consumer spending. This would require enormous increases in government spending. This is often widely unpopular, because it must be achieved by higher taxation or borrowing money. A second issue is when funds are borrowed to prop up economic output, then borrowings should be repaid in boom times, but rarely does this occur.
The focus then shifts to avoiding bubbles, or overproduction, if they are indeed the reasons for the boom and bust cycle. The challenge with avoiding bubbles is often we aren’t quite sure what a bubble looks like. The rise of personal computers in the 1980’s and 1990’s could have been construed as a bubble, but it was clearly a justified increase in societal demand. The rapid expansion of internet firms in the late 1990’s and early 2000’s also seemed like a bubble at the time, and in fact it was. Too much capital and production had been allocated to the industry too soon. This resulted in a recession when the bubble burst when supply exceeded demand.
If there was a way to identify bubbles, that would only lead to another big debate. Is it the government’s responsibility to prevent, stop, slow, or manage the bubble? And if so, what tools should they use? How much government intervention are we willing to tolerate, if any? These debates may not be far off, but as for now, we still aren’t sure when we have a bubble on our hands.
It should also be noted that there is plenty of evidence that bubbles alone don’t cause every recession. Recessions can arise for several different reasons, including government policy or a rapid increase in production cost. With bubbles and other recession drivers being hard to predict, the business cycle of boom and bust is likely to continue.