The boom and bust cycle is an economic expansion and contraction process that occurs from time to time. It is the key characteristic of capitalist economies. When the boom occurs, the economies grow, offering employment opportunities and high returns from the market. Likewise, when the bust occurs, the economies shrink and unemployment increases. The investors lose their money on the trades in stocks and forex. Both boom and bust cycles last for different lengths of time, and they also vary in severity.
One of the benefits during the boom is the easy availability of loans at low-interest rates. Individuals and businesses can take bigger credits with ease and invest it in projects. Meanwhile, the people earn high returns on their investments and the economy of the country grows. People should be careful while taking credit and should not overinvest because of low-interest rates. Due to overinvestments, the demands will soon go down. This phase is called malinvestment phase. The things that people overinvest in will decline in value, and the bust will set in. During the bust, the investors will lose money, the companies will cut down the jobs, and the consumers cut down their spendings. The bust is also called the recession period, and if the recession is severe, it is called depression.
Why do boom and bust cycles occur?
Loose monetary policy
When the real interest rates become too low, the monetary policy gets too loose, and the economy of the state faces a downfall. Loose monetary policy affects the cost of credit and mortgage payments. This causes a rise in investment and consumer spending. This rise then makes the state to increase the money supply and cause economic growth which will be the boom. When a state has a long economic growth rate, it will soon experience rising inflation, wage inflation, labour shortages. Due to increasing inflation, the banks will put up higher interest rates which will turn the cycle once again back to the bust.
Loose fiscal policy
The loosening of fiscal policy can also cause excessive economic growth. With an already improving economic growth, if the income tax is reduced, the state will experience an economic boom. This loosening of fiscal policy will cause a rise in government borrowing. The could be inflationary if it gets financed by monetary policy. Also, when the government increases borrowing during the boom, it will have fewer resources to pursue fiscal policy when the bust occurs.
Also known as the accelerator effect is another cause for the bust and boom of an economy. There are factors that magnify growth, as well as losses. According to the multiplier effect, investment depends on the rate of change in economic growth. As the state experiences a slight improvement, the percentage of the investment will also increase. The rise in the investments will have better effects on the GDP of the state and will minimize initial injection. If the spending falls down, the state will experience a bust which will result in a lack of job opportunities.