The boom and bust cycle epitomizes economic expansion and contraction that repeats itself cyclically. It’s a central feature in capitalist economies and often synonymous with the business cycle.
During boom periods, the economy flourishes—jobs are abundant and investors enjoy high returns. Inevitably, the bust follows, marked by economic decline, job losses, and dwindling market values. These cycles vary significantly in duration and intensity.
Key Takeaways
- The boom and bust cycle encapsulates phases of growth and decline typical in modern capitalist economies.
- Initially predicted by Karl Marx in the 19th century, this cycle is influenced by both psychological factors and economic fundamentals.
- The cycle can span from a few months to several years, with an average period of approximately 5 years since the 1850s.
Comprehending the Boom and Bust Cycle
Since the mid-1940s, various boom-bust cycles have disrupted the U.S. economy. Why do economies experience these cyclical patterns instead of sustained growth? The answer lies in how central banks manage the money supply.
During a boom, central banks ease credit availability by lowering interest rates, making it less costly for individuals and businesses to borrow and invest, whether it’s in tech stocks or real estate. As a result, economy booms, driven by high investment returns.
However, overly accessible credit at very low interest rates leads to “malinvestment.” This excessive investment floods certain sectors (e.g., housing) beyond demand, triggering the bust cycle as asset values plummet. Investors suffer losses; consumer spending and jobs are cut, consequently tightening credit availability. These downturns, known as recessions, can escalate into depressions if particularly severe. According to the National Bureau of Economic Research, there were 34 business cycles between 1854 and 2020, each lasting roughly 56 months on average.
Additional Factors Contributing to Boom and Bust Cycles
A sharp drop in confidence amplifies bust cycles. Investors and consumers react nervously to market corrections, selling off positions in favor of stable investments like bonds, gold, and the U.S. dollar. As companies reduce workforce, consumer spending compresses to essentials, exacerbating economic decline.
Bust periods eventually cease as undervalued assets attract investors with cash. Yet, this recovery phase might extend over a long duration, potentially resulting in a depression. Confidence is often restored quicker through central bank monetary policy and government fiscal measures.
Government subsidies sometimes spur boom-bust cycles by promoting overinvestment in specific sectors. Take, for instance, the mortgage interest tax deduction that reduces the cost of home purchases, encouraging higher demand for housing.
Related Terms: economic growth, recession, monetary policy, central bank.
References
- National Bureau of Economic Research. “US Business Cycle Expansions and Contractions”.
