Lecture Notes: Economic Cycles

Introduction

• Economic cycles are driven by credit and spending behaviors.
• Central banks play a crucial role in managing these cycles.

Short-Term Debt Cycle

Phases

• Expansion Phase
  • Economic activity increases due to credit.
  • Increased spending → Prices rise (Inflation).
  • Central banks raise interest rates to combat inflation.
• Recession Phase
  • High interest rates → Reduced borrowing.
  • Lower spending and incomes lead to deflation.
  • Central banks lower interest rates to stimulate economy.
• Cycle Duration
  • Typically lasts 5 to 8 years.

Mechanism of Short-Term Debt Cycle

• Economy operates like a machine with credit availability as a key factor.
• Economic expansion when credit is available; recession when it isn't.
• Central banks control interest rates to manage cycles.

Long-Term Debt Cycle

Characteristics

• Over time, debts grow faster than incomes.
• Credit is extended freely during periods of economic growth.
• Rising incomes and asset values (Stocks, real estate) create a bubble.
• Debt Burden
  • Ratio of debt to income remains manageable as long as incomes rise.
  • Asset value appreciation encourages borrowing.

Deleveraging

• Debt burdens eventually outgrow incomes.
• High debt repayments → Reduced spending/income.
• Decreased creditworthiness → Less borrowing.
• The cycle reverses, leading to economic downturns.
• Historical Examples:
  • 2008 Financial Crisis.
  • Japan's 1989 economic crisis.
  • Great Depression, 1929.

Conclusion

• Understanding these cycles helps manage economic expectations and policies.
• Both short-term and long-term cycles are influenced by credit and central bank policies.