What is a Business Cycle?

Abstract

Well before the concept of a business (or trade) cycle originated, serious episodes of commercial and financial instability were observed repeatedly by contemporaries. The preceding quotations, from Adam Smith (1776) to Alfred Marshall (1881), illustrate the reactions of some of the classical economists and politicians in England. Smith’s brief mention of “over-trading” is the only one in The Wealth of Nations.¹ Attwood, a banker and politician, blamed reductions in the money supply under the gold standard for the resulting deflation and interacting declines in spending and incomes (see Link, 1958, pp. 6-35; Backhouse, 1988, pp. 134-34). The “famous words” of Lord Overstone, who may have been the first to write about a multistage “cycle of trade,” were cited with approval by Marshall a quarter-century later. Marshall’s stress of the confidence factor recalls not only Pigou of 1929 but also Keynes of 1936 (Marshall and Marshall, 1881). There is much in these and other early theories of crises and cycles that deserves to be rediscovered and reconsidered today.²

Sober men, whose projects have been disproportioned to their capitals, are as likely to have neither wherewithal to buy money, nor credit to borrow it, as prodigals whose expence has been disproportioned to their revenue. Before their projects can be brought to bear, their stock is gone, and their credit with it…. When the profits of trade happen to be greater than ordinary, overtrading becomes a general error both among great and small dealers. Adam Smith (1776, p. 406)

When prices fall, production is arrested until the expences of production fall in equal degree, and whilst production is thus arrested, consumption is also diminished…. the inducements to employ labour…. are diminished…. and the prices of labour fall. The consumption of labour is thus diminished, and the prices of property again fall, and again act in depressing labour, and in crippling production…. It is the deficiency of money which has occasioned the depression of prices…. Thomas Attwood (1817, pp. 99, 101)

We find [the state of trade] subject to various conditions which are periodically returning: it revolves apparently in an established cycle. First we find it in a state of quiescence, —nect improvement, —growing confidence, prosperity, —excitement, —overtrading, —convulsion, pressuere, stagnation, —distress, —ending again in quiescence. Lord Overstone (1857, p. 44)

But though men have the power to purchase they may not choose to use it. For when confidence has been shaken by failures, capital cannot be got to start new companies or extend old ones…. In short there is little occupation in any of the trades which make Fixed capital…. Other trades, finding a poor market for their goods, produce less, they earn less, and therefore they buy less…. Thus commercial disorganization spreads…. The chief cause of the evil is a want of confidence. Alfred and Mary Marshall (1881, pp. 154-155)