Q3. Clearly explain why business cycles occur.

1. Contents
Contents.....................................................................................................................................................1
Q3. Clearly explain why business cycles occur...........................................................................................2
Introduction to business cycle....................................................................................................................2
Reasons for Business Cycles ......................................................................................................................2
Conclusion .................................................................................................................................................4
References .................................................................................................................................................5

2. Q3. Clearly explain why business cycles occur.
Introduction to business cycle
In this modern era, many of the industrial economies are experiencing the significant
swings in the activity of an economy. In the recent years most of the industries were at
boom and the ratio of unemployment was also low. But nowadays the industries are
facing serious problems of unemployment and their production is well below the
capacity. The time period in which the prospect of an economy is at its best is known
as boom or an expansion. On the other hand if the economy is declining it is known as
the depression or recession. This combination of recession and expansion, the flow
and ebb of an economic activity is known as the business cycle. It is said that most of
the indicators of an economy move together. During the period of boom, there is an
increase in the output levels and employment as well which can lead to falling
unemployment (TVEDE, 2006). There is an increase in new construction and this might
also lead to inflation rising if this expanding period is brisk. On the other hand during
the periods of recession, the output of services and goods declines and the
employment level also falls which can lead to rising unemployment level. The new
construction can also decline during this stage. It is also seen that the prices of the
goods also fall during the period of recession. Recession is the time when many
economic indicators are found to be falling for the time period which is sustained for
roughly around 6 months. The business cycles are recorded accordingly when the
economic activities changes direction. There is a peak of this cycle which is often
referred to the previous month before the important economic indicators which include
the output, retail sales and employment which begins to fall. As these key indicators of
an economy often vary the direction at various times, the dating of troughs and peaks is
necessarily considered as subjective. There are many ways in which the term of
business cycle is often considered as misleading one. Cycle itself indicates there is
regularity in the duration and timing of the downswings and upswings in an economic
activity. Many of the economists don’t consider this concept as correct. For instance
there were around 3 recession’s period between the years 1973-1982. But then the
trough of 1982 was followed by the 8 years of expansion which was an uninterrupted
one. The recession of 1980 lasted for 6 months and the 1981 recession lasted for 16
months. Therefore in order to describe the swings in an economic activity, many of the
economists prefer this term as the short run fluctuations in an economy to business
cycle (MULLINEUX, 1984).
Reasons for Business Cycles
If there is no system of regulatory in the business cycles timings, there can be no
reason for these business cycles to be occurring at all. The economists give a
prevailing view about the economic level of activity which is often known as the full
employment where the economy has the capability of staying forever. Full employment

3. means that all the resources are being fully utilized in an economy while it is producing
and they are not so easily wearing out, breaking down or insisting on the higher wages.
Inflation remains constant at the level of full employment and only if there is movement
of the output below or above the normal, the inflation rate tends to systematically fall or
rise. If the economy is not disturbed, the output level at full employment level grows as
there is an increase in the population and there is discovery in the new technology
which can be maintained easily. There are no causes for full employment giving ways
to either inflationary recession or boom (OPPENLANDER, 1997)̈ .
Business cycle is found to be occurring due to the economy disturbances of one or
another sort pushing the economy below or above the full employment level.
Inflationary boom can be easily generated through surges in the public or private
spending. For instance if the government is spending more on fighting a war and is not
raising the taxes, the increase in demand cannot only cause the increasing output of
the material related to war but also increase the take home pay of workers in the field
of defense. The output of the services and goods which these workers are purchasing
with the wages will also tend to increase and the overall production will be surging
above the normal and comfortable level. Similarly the optimism wave will lead to
consumers spending more than normal and the firms will be building factories which
might lead to the expansion of the economy quite rapidly as compared to normal.
Depressions or recessions can also be caused through the similar forces which are
operating in the reverse. A substantial amount of cut in the spending of the government
or pessimism wave among the firms and consumers can lead to output of all the kinds
of goods to decline (PUU, 2006).
Another possibility of the booms and recessions cause is the se of monetary policy.
The Federal Reserve can influence the growth and size of the money stock and thus
the interest level rates in an economy. Interest rates are important determinant of how
much consumers and firms are willing to spend. A firm facing high interest rate can
decide in postponing the building of new factories as the borrowing costs are high.
Consumers will be lured into purchasing the new home if the interest rates are lower
and the payments of the mortgage becomes affordable. Thus if there is a raise or fall in
interest rates, the Federal Reserve will be able to generate booms or recessions.
The description of the reasons for the business cycles is found to be reflecting the
views of Keynesian that these cycles are the outcomes of the nominal rigidities. Only
when the inflationary expectations and prices are not flexible can fluctuate in the
aggregate demand causing the huge swing in the real output. The new classical
approach suggests that the modern economies are considered as quite flexible
(ZARNOWITZ, 1992). It is because of this reason that the variation in spending cannot
affect the real employment and output. For instance the new classical approach says
that the changes in the money stock will bring changes in prices only. It will have no
impact on the interest rates and the willingness of the people to invest. In this approach
the business cycles are heavily disturbed because of the tastes and productivity, not
because of changes in the overall demand.

4. Conclusion
There is strong evidence available which supports the fact that there are deviations
occurring because of the full employment which are often the outcomes of the spending
shocks. Monetary policy is the main reason behind the swings in the business cycles.
For instance, during the recession period in the early 1970s and 80s, the raising of
interest rates impacted greatly on the business cycles. In case of expansion, the
inflationary booms in the year 1960s-1970s, these were least partly because of the low
interest rates and monetary ease. The major impact on the business cycles is often
seen because of the variation in the flow of money. There are many prewar
depressions which include the recessions of 1921, 1908 and the 1930s great
depression which were all because of the monetary contraction and the real interest
rates which were high. In the earlier era, there were swing because of the financial
panics, monetary developments and the mistakes in policy. Recessions which were
seen in the early era of postwar were of similar severity as seen before the World War
1. The decreasing downturns frequency reflects the economic policymaking progress.
There are some of the great depressions which bring in large strides in the economic
understanding and the government’s capacity in moderating cycles. There is an
employment act which says that the government uses the tool in stabilizing the
employment and output (STOCK, 1993). It is because of these tools there are many of
the shocks which have been counteracted and prevented long periods of recessions. In
the earlier times the policymakers used the expansionary policy for too long and this
led to an increase in the inflation levels. It is because of this reason the Federal
Reserve required to adopt the contractionary fiscal and monetary policies in moderating
the recession to bring the inflation levels down.

5. References
ZARNOWITZ, (1992). Business cycles theory, history, indicators, and forecasting.
Chicago, University of Chicago Press.
STOCK, J. H. (1993). Business Cycles, Indicators, and Forecasting. Chicago,
University of Chicago Press.
PUU, T., (2006). Business cycle dynamics models and tools. Berlin [etc.], Springer.
BELONGIA, (1992). The business cycle: theory and evidence : proceedings of the
Sixteenth Annual Economic Policy Conference of the Federal Reserve Bank of St.
Louis. Boston u.a, Kluwer Acad. Publ.
MULLINEUX, (1984). The business cycle after Keynes: a contemporary analysis.
Totowa, N.J., Barnes & Noble Books.
TVEDE, L. (2006). Business cycles: history, theory and investment reality. Chichester,
West Sussex, England, John Wiley & Sons.
OPPENLANDER, (1997).̈ Business cycle indicators. Aldershot [u.a.], Avebury.
HÉNIN, P.-Y. (1995). Advances in business cycle research: with applications to the
French and US economies. Berlin, Springer.

6. References
ZARNOWITZ, (1992). Business cycles theory, history, indicators, and forecasting.
Chicago, University of Chicago Press.
STOCK, J. H. (1993). Business Cycles, Indicators, and Forecasting. Chicago,
University of Chicago Press.
PUU, T., (2006). Business cycle dynamics models and tools. Berlin [etc.], Springer.
BELONGIA, (1992). The business cycle: theory and evidence : proceedings of the
Sixteenth Annual Economic Policy Conference of the Federal Reserve Bank of St.
Louis. Boston u.a, Kluwer Acad. Publ.
MULLINEUX, (1984). The business cycle after Keynes: a contemporary analysis.
Totowa, N.J., Barnes & Noble Books.
TVEDE, L. (2006). Business cycles: history, theory and investment reality. Chichester,
West Sussex, England, John Wiley & Sons.
OPPENLANDER, (1997).̈ Business cycle indicators. Aldershot [u.a.], Avebury.
HÉNIN, P.-Y. (1995). Advances in business cycle research: with applications to the
French and US economies. Berlin, Springer.