Economic Activity and therefore the levels of production, income and expenditure with a national and in fact, the world economy are in constant flux. In other words they oscillate around the general trend, which for most key indicators (such as GDP) are on a gradually upward trend. This is however also a tendency for these metrics to move in some unison. This produces movement in which some analysts have discerned patterns ranging from 2-5 years to seventy years.
The causes of these patterns have been ascribed to phenomena such as varied as sun-spot activity, natural climatic cycles, to government intervention. We will look at these in a bit more detail below.
These oscillations are referred to as business or economic cycles.
Traditionally these cycles are divided into four phases, each with distinctive characteristics. Let us start with the upswing - there is growing economic activity, interest rates are relatively low in relation to the returns that can be achieved by investing in projects. Employment levels increase and there is pressure on prices as produces vie for productive resources. As the cycle reaches the peak consumers vie for products and services which cause prices to rise (increase in CPI) to high levels - Governments in their attempt to "cool down" the economy increase interest rates (private banks too would as prudent lenders also reduce loans to more speculative ventures) these kinds of actions would the cause the economy to contract from peak levels, production capacity will start being idle employment would not grow and some may even lose their jobs. The economy would now be in a downswing (or recession) with entrepreneurs being more pessimistic in future outlooks and therefore not commit capital to expansionary endeavours. as it moves down further it could also deepen to what is called a depression. At some point prices would however stabilise as some people on the the consumer side "snap up bargains" and businesses start to invest in longer term assets. the bottom end or trough had been reached which is the bottom turning point and things start looking up - the beginnings of the the next upswing. The length of these cycles are measured from peak to peak or from trough to trough.
Read further below.
The causes of business cycles
Academics have argued about the causes of this apparent phenomenon for decades. In mainsteam economics the following broad categories of causes are often identified:
Natural causes.
These causes relate to production levels, employment levels and expenditure levels that are affected by extraneous and internal factors in an economy. For example if there is an upswing in the economy of China or any of out trading partners it would cause our production levels, and employment to improve. This would lead to more money being availabe by consumers for consumer goods and that would further simulate the economy.
Monetary causes
If one looks at what happens for example at the bottom end of the trough - interest rates will be low (few firms need money for expansion) so the demand for credit is low. Interest rates are lowered, to the point that businesses are now willing to borrow. If there is any reason for rates not to respond in the relation to the increase in the demand (government being in control of money supply and interest rate) borrowings will overshoot the normal clearing quantities. Loans will be made that are less than prudent and though high production and employment levels will be reached it will all come to a rather abrupt and sudden peak as governments hike interest rates - often more than they should with the resultant job losses and spare capacities that have been created.
Also refer to the Austrian analysis below.
Psychological causes
It is often said that people behave like herd animals - that market pessimism and market optimism are the key factors that drive economic decisions and that these decisions are affected by this "herd" mentality. This is however not clearly substantiated by economic theory and one would normally find these explanations in school textbooks on economics and popular magazines and should not be awarded too much space in the academic theoretical treatment of the phenomena.
Also refer to: https://sites.google.com/site/wealthcreationclub/austrian-economics/austrian-business-cycle-theory