Causes of the business cycle - important link!
The exchange rate will play an important role for firms who export goods and import raw materials. Essentially:
- A depreciation (devaluation) will make exports cheaper and exporting firms will benefit.
- However, firms importing raw materials will face higher costs of imports.
- An appreciation makes exports more expensive and reduces the competitiveness of exporting firms.
- However, at least raw materials (e.g. oil) will be cheaper following an appreciation
For a hundred years or more there has been an unresolved debate over what causes fluctuations in economic activity. These fluctuations have been given different names often associated with the length and amplitude of the cycle. Some of the more quoted are:
• Trade cycle
• Business cycle
• Stop-go cycle
• Kondratiev cycle
• Business cycle
• Stop-go cycle
• Kondratiev cycle
Because these cycles are often observed in capitalist economies there is a mistaken belief that capitalism is the cause, or at least that these cycles are inevitable in a capitalist economy. I will suggest that the step from capitalism to cycles is a non-sequitur as all the individual participants in a capitalist system are much too small and insignificant to have anything other than a minimal effect on the overall level of economic activity.
Early theories related cyclical momentum to agricultural surpluses and shortages and more recently to a wider range of commodities that impose a supply shock on the economy. Psychological theories looked at business optimism and pessimism as a driver, while excessive investment, malinvestment and the volatility of invention, innovation and economic growth have all been considered. The cumulative nature of expansionary and contractionary forces were given further voice with the multiplier and accelerator effects described by Keynes. Political or voting cycles in democratic societies tended to mean that monetary and fiscal policies were overdone in the run-up to an election and these explanations are probably closer to the real cause of fluctuations in economic activity.
As has already been hinted, the cause of these fluctuations has to be something that drives the whole economy rather than just being a small component of that economy. Over the last few centuries trade has taken place using money. In the first instance this money had value in use and value in exchange. It was something that was generally acceptable, held its value and was portable, durable, divisible and relatively stable over time. Monetary metals like gold and silver fulfilled these characteristics and became acceptable as money across nations and between countries.
If we remove exceptional years, the real economy tends to grow at a relatively slow and steady rate so if we are looking for a source for instability in trade we need look no further than changes in the supply of money and its effect on aggregate monetary demand and the level of economic activity. Ideally the money supply and monetary demand need to grow at the same rate as the growth in output. This keeps prices stable and gives prices the opportunity to act as signals in the market place as relative prices change in response to consumer demand and resources are reallocated to reflect what consumers want.
