One day, the papers are full of growth, new jobs and record highs. A few years later, the same papers are full of crisis, bankruptcies and unemployment. Why does the economy go up and down like this? Economists call it business cycles, and they've been arguing about the causes for more than a century.
In short: business cycles are the alternation between periods when economic activity grows (expansion) and periods when it shrinks (recession). Like the seasons, they always come back, but with no fixed date on the calendar.
The signpost that gets it wrong
Two Austrian economists, Ludwig von Mises in 1912 and then Friedrich Hayek in 1931, put forward an explanation built around one idea: the interest rate, the rent on money, is a signpost. When people save a lot, there's plenty of money to lend and that rent falls. Entrepreneurs read the sign: "People are willing to wait, so we can start long projects."
But if that rent is pushed artificially low, for instance when a lot of new credit is created, the signpost shows savings that don't actually exist.
The story of the bakery
Mangosteen runs a bakery. In his storeroom there are 6 sacks of flour, enough for 6 cakes. But the sign on the storeroom door is wrong: it says "10 sacks". Confident, Mangosteen starts 10 cakes. All goes well… until the flour runs out. Four cakes are left half-made: butter, eggs and time wasted.
That, in simple terms, is Hayek's idea: a boom built on imaginary savings ends in a correction, once people discover there aren't enough resources to finish everything.
The same trap, in francs
A developer borrows CHF 1,000,000 to build chalets. At 1% interest, he pays CHF 10,000 a year: the project looks profitable. If the rate goes back up to 4%, he has to pay CHF 40,000 a year, four times as much. Many projects launched in the easy years suddenly stop. Building sites freeze, jobs disappear: that's the recession.
Not everyone agrees
Not all economists share this explanation. Other schools, such as that of John Maynard Keynes, focus more on the moments when households and businesses suddenly spend too little. But on one point they all agree: the seasons come back, and nobody can predict exactly when.
What a forward-thinking family does
- It keeps a winter store: a few months of spending, available straight away.
- It's wary of years that feel too easy: when borrowing costs next to nothing, that's not the time to take on debt up to your neck.
- It doesn't panic in winter: like spring, recovery comes in the end.
Try this tonight with your child
Play squirrel for four weeks, with each week standing for a season. In "spring" and "summer", your child gets 4 counters and can put some aside. In "autumn", they get 2. In "winter", they get only 1, but have to spend 3 to "eat". At the end, take stock together: "What helped you get through the winter?"
Read also: The rent on money · Can you get your money back tomorrow?
Further reading
- Mises, L. von (1912). Theorie des Geldes und der Umlaufsmittel. Munich and Leipzig: Duncker & Humblot.
- Hayek, F. A. (1931). Prices and Production. London: George Routledge & Sons.
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