Business Cycle / Economic Cycle

Cyclical Economic Fluctuations and the Management of Macroeconomic Variables to Regain Economic Equilibrium

An Article in the Compendium of Market-Based Social-Ecological Economics

Key issues in view of the neoliberal crisis:
How can we guarantee employment and fair income?
How can we protect the environment effectively?
How should we shape the economic globalization?
What should the economic sciences contribute?
What must be the vital tasks of economic policy?
How can we legitimize economic policy democratically?

Click here for the list of all articles: Compendium
Click here for the German-language version: Konjunktur

Table of Contents

  1. Abstract
  2. Classification and Clarification of Terms
  3. Definition of Economic Equilibrium
  4. Schumpeter’s Economic Cycles
  5. Economic Stabilization Policy
  6. Failing Neoliberal Countercyclical Policy
  7. Promising Countercyclical/Stabilization Policy

1. Abstract

Historically, counter-cyclical economic policy measures are still one-sidedly limited to increasing production volume and reducing production costs. Under the prevailing conditions of neoliberal Economic Globalization, a country can thus improve its position in the cut-throat competition, but – due to mounting cost pressure – only at the price of relocating production to lower-cost countries and cutting jobs. The consequence is a permanent global depression, that has been going on since the 1990s, with unemployment, underemployment, precarious jobs, poverty and environmental pollution. In order to return to normal economic cycles, it is therefore mandatory to establish an economic order geared towards social and ecological returns, i. e. towards full employment and environmental protection.

2. Classification and Clarification of Terms

KonjunkturJPG02

Gemälde “Konjunktur” von Andreas Bogdain

The term »business cycle« refers to the cyclical fluctuations of macroeconomic variables occurring in market economies, variables such as production, investment, total demand, consumption, employment, wages, prices and interest rates. The terms »business cycle« and »economic cycle« are used synonymously, but the term »business cycle« usually focusses more on the entrepreneurial aspects of the general macroeconomic state. Throughout this article, however, I will use the more general term »economic cycle«.

The fluctuations of macroeconomic variables are an indication of the natural dynamics that characterize the market economy. However, a socially and ecologically sound economic policy regulation and control is necessary to ensure a sustainable dynamic equilibrium of the market economy.

Sustainable dynamic equilibrium in practice means that any economic downturn is decelerated in due time by the automatic pricing mechanism as well as supportive counter-cyclical economic policy measures, thus diverting it into an upswing before it turns into a crisis and reaches harmful dimensions. Conversely, any upswing that threatens to accelerate a current economic boom is decelerated in the same way and diverted into a new downturn before an »overheating« (more details below) of the economy can occur. The macroeconomic variables mentioned above are thus moved towards a new equilibrium before the imbalance becomes extreme due to an impending crisis or overheating.

In the light of the crises of the »neo-liberalized« world economy, it needs to be underlined that a socially and ecologically sound economic policy regulation and control presupposes a uniform and autonomous economic and monetary area.

Economic fluctuations can be caused by a variety of endogenous and exogenous effects:

Examples of possible causes of an upswing:

  1. Inventions and technological breakthroughs,
  2. discovery of new sources of raw materials,
  3. development of new domestic or export markets,
  4. more constructive competition through improved antitrust laws,
  5. improved competitive position on export markets,
  6. improved credit terms by the central bank,
  7. optimistic consumer expectations.

Examples of possible causes of a downturn:

  1. Scarcity of raw materials due to exploitation or lack of substitution,
  2. saturation on domestic or export markets,
  3. entrepreneurial misinvestments on a broad front,
  4. deteriorating competitive position in export markets,
  5. declining competition due to cartels and mergers,
  6. bursting speculative bubbles in the financial or real economy,
  7. rising environmental costs due to a lack of precautionary measures,
  8. protracted wage negotiations,
  9. weather extremes and other natural disasters,
  10. warlike conflicts,
  11. pessimistic consumer expectations.

In the current mainstream of economics, economic fluctuations are usually only measured based on the utilization rate of production capacity and gross domestic product (GDP), because it is wrongly assumed that high capacity utilization or a growing GDP would automatically lead to full employment and investments in environmental protection. Historical experience shows, however, that underemployment can also occur under allegedly ideal production conditions and, given today’s circumstances, environmental protection can also decline. The English economist John Maynard Keynes had already pointed out this phenomenon regarding underemployment in the first half of the twentieth century, which had been considered impossible until then. Under the current neoliberal conditions, underemployment together with high capacity utilization or GDP growth is even the norm, and investments in environmental protection are mainly restricted by the high costs of global predatory competition.

It should be noted that economic cycles, which are defined as temporary phenomena lasting at least one year, must be distinguished from the annually recurring seasonal fluctuations. However, distinguishing the two types of fluctuations is not always possible. The West German GDP, for example, rose uninterruptedly during the upswing of the post-war era over a period of 15 years, from 1949 to 1964. The entire 15 years can either be understood as one single upswing, or the alternating periods of different levels of positive GDP growth can be interpreted as cycles of upswings and downturns.

3. Definition of Economic Equilibrium

A general economic equilibrium is achieved in the market economy when the savings and investment plans and the planned supply and demand of all economic players coincide. In other words: when all market participants – private households, employees and companies – are able to maximally achieve their individual profit targets, and when they, regulated and controlled by economic governance, sustainably utilize the natural resources and sustainably contribute to social welfare at the same time (see also the article Sustainable Social Welfare).

In the 1967 German Stability and Growth Act (Stabilitäts- und Wachstumsgesetz), which is still in force today, the four criteria listed below are cited as being decisive for a macroeconomic equilibrium (the so-called magic square). Please note that the criterion growth is primarily understood as quantitative growth:

  1. stability in the general price level,
  2. high level of employment,
  3. foreign trade equilibrium, and
  4. adequate economic growth.

However, to achieve a sustainable macroeconomic equilibrium, the six criteria listed below must be taken into account. And growth must primarily be qualitative, that is, the added value generated by production has to manifest itself in products that are increasingly being produced and disposed of in a more environmentally friendly manner and that offer increasingly greater benefits to users:

  1. stability in the general price level,
  2. high level of employment,
  3. foreign trade equilibrium,
  4. adequate, primarily qualitative economic growth,
  5. high level of production capacity utilization,
  6. sustainable use of natural resources.

Item 1: In all experience, an acceptable stability in the general price level prevails if prices do not rise by more than two percent per year.

Item 2: In this context, a high level of employment equates to an inevitable job search unemployment rate of about one percent, thus meaning full employment.

Item 3: Foreign trade equilibrium refers to the medium-term balancing of payments (trade and services account) which is indispensable to avoid permanent disparities and dependencies on foreign trade as well as disturbances through external events.

Item 4: Adequate economic growth is dependent on incentives that stimulate investments in technological development and progress. Under a sustainable paradigm of globalization, these incentives have to aim at primarily qualitative progress, i. e. economic growth has to be socially beneficial and ecologically compatible – which does not exclude periodic quantitative growth.

Item 5: A lasting high level of production capacity utilization is achieved when the investment incentives mentioned above meet qualitative criteria on the one hand and are realistically oriented towards a environmentally compatible quantitative growth potential on the other.

Item 6: A sustainable use of natural resources is achieved when the preservation of both renewable and non-renewable resources is guaranteed in the long term.

The collective maximization of benefits and profits, which market participants enjoy in an ideal state of equilibrium, is accompanied by an optimal utilization of production capacities on the supply side, by an optimal satisfaction of needs on the demand side, by full employment on the labour market and, including foreign trade, by an allocation of all production factors (labour, natural resources and capital) that is both micro- and macroeconomically (on the business and national level) optimal and sustainable.

Whether a market economy aims to categorically regain equilibrium after both endogenous and exogenous influences depends on whether it is based on an equilibrium-oriented economic order. Such an economic order is characterized by the fact that it

  1. gears its technological development and productivity growth towards society and environment (that it adapts wages and working hours in step with productivity growth and focuses technological progress on environmental quality),
  2. ensures supplier and consumer polypoles, thus preventing monopolies,
  3. makes market activities transparent for all market participants, and
  4. maintains a functioning pricing and competition mechanism.

Since these requirements are not met under the present regime of the neoliberal globalization, the national economies cannot even come close to achieving the ideal state of equilibrium – and the above mentioned German Stability and Growth Act must also remain ineffective under these conditions.

4. Schumpeter’s Economic Cycles

KonjunkturJPG01The Austrian economist Joseph A. Schumpeter (1883 to 1950) has described the economic cycle in four phases, as it typically occurs in economies with autonomous economic policy:

  1. The upswing or recovery is characterized by increasing capacity utilization and production as well as a rise in investment and total demand (investments plus consumption) and finally a rise in employment accompanied by low price increases and low interest rates.
  2. The boom or prosperity is characterized by full capacity utilization, maximum production and full employment as well as rising wages, prices and interest rates. The economic boom tends to »overheat«, that is, dispite rising interest rates companies become too optimistic and tend to invest debt-financed, thus risking overindebtedness and removal from the market.
  3. The downturn or recession is characterized by a decline in capacity utilization, production, investment, total demand and employment, and the creation of surplus stocks, while wages, prices and interest rates are falling at the same time.
  4. The crisis or depression is characterized by the lowest point of capacity utilization, production, investment and overall demand, with many companies going out of business and high unemployment emerging, while at the same time wages, prices and interest rates are falling with the risk of a deflationary tendency that resembles a vicious circle: consumers are postponing their consumption because they speculate on falling prices and fear unemployment, thus further weakening the circulation of products and money and causing further unemployment.

Hint: Schumpeter considered the downturn or recession to be an inescapable phase of economic dynamism that can and must be used to restore economic equilibrium in an economy. By contrast however, he considered the crisis or depression as a rather infrequently occurring emergency. In other words, he expected the downturn normally to directly give way to a new upswing (recovery) without the detour via a depressive exaggeration. As specified further down, the current economic crisis has however mutated into a permanent depression under the prevailing neoliberal conditions – especially with regard to unemployment, underemployment, precarious jobs, poverty and environmental pollution!

According to Schumpeter, the economic cycle is (ideally typical!) complete when the downturn (the recession) enters the phase of upswing (recovery), either directly or with a detour via a crisis (a depression).

5. Economic Stabilization Policy

The counter-cyclical economic policy is also synonymously referred to as economic stabilization policy. Its task is to counteract economic fluctuations by steering the economy into a new state of equilibrium in the shortest possible time. As mentioned above, the basic prerequisite for the success of economic policy measures is an equilibrium-based economic order. The measures of an economic stabilization policy can involve monetary policy, fiscal policy, structural policy and social and environmental policy.

As already said, the traditional counter-cyclical economic policy or economic stabilization policy is very one-sidedly focused on controlling production, especially the utilization of production capacity. This results from the false assumption that a controlled dynamic equilibrium with moderate fluctuations in production, investment (including the demand for raw materials, monetary and physical capital) as well as consumption would automatically guarantee stable prices and full employment.

6. Failing Neoliberal Countercyclical Policy

Under the conditions of the neoiberal globalization, the endogenous (domestic) causes of economic fluctuations are increasingly being superimposed by exogenous (external) economic influences. The greater a country’s dependence on international trade and the more its industry is internationally networked, the greater the impact on its domestic economy. The mechanism of action on open global markets takes its course through cut-throat competition based on (absolute) dollar prices, thereby negating the worldwide extremely different productivity and price levels which can no longer be neutralized by calculated exchange rates due to speculative trading on the exchange market. This competition creates high cost pressure that misguides companies and nation states to distort their original price levels (to dump prices) by externalizing social and environmental costs (to be passed on to the general public), that is, they consciously accept unemployment, underemployment, precarious jobs, poverty and environmental degradation for a better competitive position in global markets. It seems obvious that national as well as supranational economic stabilization policies – including those of the European Union, and in particular those of the euro zone – must more and more lose their impact in an environment of open global markets until they ultimately become totally ineffective.

Since the 1990s, the reciprocal exogenous influences within the neoliberal system have brought the majority of economies a permanent depression with the consequences already mentioned above – a phenomenon unique in economic history, which eludes any kind of classification and opposes all methods of counter-cyclical economic control.

Neither the anti-cyclic, demand-oriented method of Keynes nor the supply-side economics based on the neoclassical school of thought and monetarism, which later went down in history as Reagonomics and Thatcherism, show any effect. The Keynesian method is based on increasing debt-financed public investments in a recession and additionally lowering public revenues in order to stimulate the total demand emenating from investments and subsequently from consumption – this method has become known under the term »deficit spending«. Supply-side economics, on the other hand, rely on the »unleashing of market forces« by reducing corporate taxes and deregulating entrepreneurial activities as well as money creation and interest rate cuts on the part of the central bank and commercial banks.

Both methods were originally developed with intent to generate growth during a depression and subsequently create jobs, thus initiating a new upswing. However, both methods have emerged at a time when the autonomous regulation and control of domestic and foreign trade were still a matter of course. It should therefore come as no surprise that both methods must fail in a »liberalized« environment. As a compliment see the article Classical and Neoclassical Economics.

7. Promising Countercyclical/Stabilization Policy

An equilibrium-oriented economic order as a condition for promising countercyclical economic policy measures therefore means, above all, that a wide range of decentralized structures (polypoles) are created and maintained dynamically within an economic area and that exchange rates, trade quotas and in addition tariffs are agreed upon for foreign trade competition, in order to neutralize the respective bilateral price gaps between trading partners – and thus indirectly productivity gaps – so that cross-border competition stimulates domestic competition rather than distorting it, and that mutual trading profits are realized and nonsensical crowding-out effects including depressive developments are avoided.

Under these conditions, and only under these, does the significance of the above-mentioned »deficit spending« diminish because the other means of countercyclical control are sufficient:

Monetary Policy: The central bank can help to prevent a boom from overheating by reducing the money supply and raising key interest rates. In a downturn (recession), the central bank can help to prevent a crisis (depression) and initiate an upswing (recovery) by increasing the money supply and lowering key interest rates.

Fiscal Policy: Tax increases for companies are another way of preventing a boom from overheating. Tax cuts for companies can help to avoid a crisis and trigger an upswing. A progressive income taxation can improve performance-based equal distribution, effect higher consumer spending and stimulate economic cycles (the velocity of circulation of money and goods).

Structual Policy: Stricter antitrust laws and progressive taxation of entrepreneurial economies of scope can be used to decentralize economic structures, create higher employment and prevent a crisis.

Social Policy: Revenues from progressive taxation can be used for investment in education, training and family policy to ensure a diverse range of jobs for both the male and female working population and to prevent crises.

Environmental Policy: Tax incentives for the re-use (recycling) or substitution of non-renewable resources and the preservation of renewable resources as well as tax burdens for environmentally harmful behaviour can help to avoid crises.

As illustrated above, attempts are generally made to dampen economic fluctuations through anticyclic economic policy measures. Since economic correlations are complex, especially if economies do not protect themselves from exogenous events, there is always the risk that the impact intended by anticyclic measures will be missed and the trend will instead be amplified procyclically.

Click here for the German-language version: Konjunktur

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