Economic Fundae - Business Cycles

Macroeconomics as a discipline is about the study of national economy, total output level, the general trend in employment. All this not only nation wide but also with respect to the global economy. I write this article as the stock market tanked 4000 points roughly about 20% in two days in reaction to the global recession- economic downturn. In the past century we have seen years of boom and bust between years, which is called the business cycle. What is happening today in the stock markets can be only a fraction of the impact which was there during the Great Depression- stock market crash of October 1929, but we can immediately strike a relationship in these events. But why is there business cycle, and what are reasons for the recession? This is a subject we are currently dealing with.

In fact we all would agree to the fact that the salary we get today is at least twice as much as our parents. This even after adjusting for inflation- which is the rise in the price level of goods and services have grown phenomenally. This is attributed to the long run growth of an economy. We are trying to address the issue of growth in the long run and the intermediate recession and expansion.

For an engineer turned management graduate like me trying to understand this phenomenon of recession would immediately associate with the unemployment, the effects of aggregate output and the government policy on these issues.

Looking at the issue of unemployment- the percentage of total number of people in the labour force who are unemployed. In general we have higher unemployment rate during recession and lower during expansion. The policy measures which are undertaken to stabilize the severity of the recession or to rein in the expansion are the Monetary Policy - which involves changes in the money, interest rates etc. & the Fiscal Policy- which involves changes in the tax policy or government spending etc.

Before going further to the discussion of recession, we will define what an open economy means. Until 1991, India had the policy of restricted trade regime, which essentially is the closed economy - the economy which does not trade goods or services with other countries, self sustained. This principle goes against what Adam Smith in his book mention of division of labour. A country should try and maximize its production in which it is generally good at. It is more of a focused approach rather than channelizing to all what an economy needs.

After 1991, India opened its economy to the world because of the crunch and the request by IMF to do so. Hence an open economy is one which trades with other countries. This is different from the closed economy dynamics with the exchange rates - which is discussed in the previous article.

There are numerous reasons for recession and it is measured by looking into the amount of business activity which is happening- Unemployment, industrial production etc. One should remember the effect of the "Paradox of thrift" - which is the reduction in spending forecasting a economic hard time actually leads to a slump in the economy and the business begins to layoff.

There were enough cues this time for the U.S economy slowdown and one article in our blog addressed the issue of "Merrill Lynch faces huge loss due to bad mortgage write-downs".

Long run growth is about the general increase in the standard of living. But remember we are all dead in the long run!!!