It is common knowledge today that recessions occur every decade in a cycle. The growth of an expanding economy in a certain period is often met with a grim recession filled with the increasing unemployment rates and failing businesses.
What if we can avoid these bad periods of time and have a constantly growing economy that is beneficial for everyone? Or are they a necessary evil?
A Look Back in Time
Before the 1800s, cyclic recessions like the ones we experience in the world today are not commonly found. The earliest periods of recession in the US economy were not recorded until the 1920s. There are many factors explaining why cyclical recessions did not exist in the past but put simply: the economy is much more complex and sophisticated today.
Countries and kingdoms of the past experience what we call today supply-side recessions, but they did not recognize these events as “recessions”.
Supply-side recessions occur when the producers of the economy are not able to supply the demands of the consumer for reasons such as droughts, floods, war, etc. These occurrences are technically considered recessions because it is a decline in economic activity for a prolonged period of time.
Though these occurrences are what we now call “recessions”, people historically did not classify these turbulent times as recessions because they did not understand why these turbulent times occur. With modern economic theories, we try to find the reasons that help us understand why these cyclical recessions occur.
Present Day Economies
When hearing about recessions nowadays, our brain immediately thinks about the loss of jobs and failing businesses around the country. But specifically, recessions occur when there are two consecutive quarters of negative economic growth. However, this does not explain whether or not recessions are necessary for our economy to grow.
Some believe that psychological factors are the driving force of these recessions. People tend to be either optimistic and confident or fearful and negative about the markets. This way of thought tends to lead people to create and collapse a market bubble.
An example of this can be seen through the dot-com bubble when people were extremely optimistic about the newly created internet and investors were blindly investing in Internet-related companies. The result of this was a crash in the US stock market and many of these Internet-related companies collapsed causing the evaporation of trillions of dollars.
Recessions can also be triggered by economic shocks. Economic shocks are random events that occur, such as wars and pandemics, that can negatively impact the economy.
With the COVID-19 pandemic, we are currently experiencing an economic downturn due to an economic shock. Though we can directly correlate these shocks with recessions, it does not necessarily explain the pattern of cyclical recessions.
An alternative theory that tackles the causation of cyclical recessions is the Austrian Business Cycle Theory (ABCT). The ABCT takes a closer look at how central banking and its monetary policies relate to the economy and psychological factors in play. But in layman terms, the key cause of recessions, according to the ABCT, is the creation of new money.
You’re probably wondering now: “How is it possible to create money out of thin air?”
In modern banking systems, banks are allowed to issue loans and corresponding deposits to its customers. This is an essential part of business models to a modern bank.
Creating a chain reaction, sets in motion an idea for people to continue to spend and incur debt even though they might not have the capital power to pay it off. But from a perspective of numbers, all is well and the world economy is rapidly growing due to the increase in consumption/demand of goods.
However, there are a number of people with a variety of thoughts on the consumption and use of capital. This causes conflict in their beliefs and shatters the illusion of a growing economy.
A once optimistic investment project becomes a cluster of miscalculations. These errors continue to instill fear into the hearts of investors causing people to start to save and hold cash. The decrease in consumption means the slowdown of economic growth until it presents itself with negative growth. A recession has occurred.
The economy machine will try to claw its way out of recession and central banks will soon use its arsenal of monetary policies to spark economic growth once again. By the use of decreasing interest rates, the consumers are tempted once again to spend and incur debt.
Only for the cycle to begin again.
With all factors considered, a cycle of recessions is inevitable and even essential to our current economy. As long as the central banks base their models on fractional reserve lending, the creation of new money will always be the root of cyclical recessions.
We have to accept that this is the economy we live in and in order for us to grow economically, we must have this necessary evil.