Boom and Bust Cycle - Explained

What is the Boom and Bust Cycle?

Updated at June 27th, 2021

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What is the Boom And Bust Cycle?Why the Boom And Bust Cycle in Important Additional Factors in Boom and Bust Cycles Academic Research on the Boom And Bust Cycle

What is the Boom And Bust Cycle?

A boom and bust cycle refers to a series of fluctuations in an economy in which there are persistent expansion and contraction of the economy. Boom and bust cycles affect different sectors and industries in an economy, for instance, when it occurs in the business cycle, businesses undergo fluctuations. In a boom cycle, industries and businesses enjoy surplus, high sales, and profit margin and significant business performance which in turn affects the overall economy. The reverse is the case in a bust cycle, this is the period business encounter losses, individuals are also subject to a decline in income and there is an overall shrink on the economy.

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Why the Boom And Bust Cycle in Important

Boom and bust cycles occur in different economies at different times, both cycles also last for different periods of time. According to a business report, 28 boom and bust cycles have occurred in the business cycle since 1929. Generally, boom cycles are times when there is a surplus of jobs, economic growth, growth of business and industries and enough money in circulation. Bust, on the other hand, is a period of economic struggle coupled with the scarcity of jobs, losses in investments and economic decline. In boom cycles, obtaining credits is easier and cheaper, the investor also records high returns on their investments. The bust cycle sets in when investors begin to make too much investment which creates a decline in the value of investments.

Additional Factors in Boom and Bust Cycles

While boom cycles are related to periods of economic growth, employment and presence of wealth in an economy, bust cycles are associated with periods of recession or depression in an economy. There are certain factors that lead to boom and bust cycles in an economy, for instance, malinvestment is a major cause of bust periods, this happens when investments are very cheap and there is too much supply of capital in an economy, thereby creating an excess investment. There are certain monetary policies that the government uses to restore confidence in an economy and lift the economy out of depression. Such monetary policies are created by the Federal Reserves or Central Banks.

Academic Research on the Boom And Bust Cycle

Local labormarketimpacts of energyboom-bust-boomin Western Canada, Marchand, J. (2012). Local labor market impacts of energy boom-bust-boom in Western Canada. Journal of Urban Economics,71(1), 165-174. The impacts of energy price boom and bust are analyzed through the differential growth in employment and earnings between local labor markets with and without energy resources in Western Canada. The estimated differentials attributed to the boom-induced labor demand shocks show significant direct and indirect impacts on the earnings and employment within the energy extraction and other non-energy local sectors respectively. The local job multipliers indicate that job creation within the energy extraction sector leads to modest job creation within the non-energy local sectors during boom periods. For every ten energy extraction jobs created during a boom period, approximately three construction jobs, two retail jobs, and four and a half service jobs are created.
Monetary policy and stock market boom-bust cycles, Christiano, L. J., Ilut, C. L., Motto, R., & Rostagno, M. (2008). Monetary policy and stock market boom-bust cycles. We explore the dynamic effects of news about a future technology improvement which turns out ex post to be overoptimistic. We find that it is difficult to generate a boom-bust cycle (a period in which stock prices, consumption, investment and employment all rise and then crash) in response to such a news shock, in a standard real business cycle model. However, a monetized version of the model which stresses sticky wages and a Taylor-rule based monetary policy naturally generates a welfare-reducing boom-bust cycle in response to a news shock. We explore the possibility that integrating credit growth into monetary policy may result in improved performance. We discuss the robustness of our analysis to alternative specifications of the labor market, in which wage-setting frictions do not distort ongoing firm/worker relations.
Booms andbusts in housingmarkets: Determinants and implications, Agnello, L., & Schuknecht, L. (2011). Booms and busts in housing markets: Determinants and implications. Journal of Housing Economics,20(3), 171-190. This study looks at the characteristics and determinants of booms and busts in housing prices for a sample of eighteen industrialised countries over the period 19802007. From an historical perspective, we find that recent housing booms have been amongst the longest in the past four decades. Estimates of a Multinomial Probit model suggest that domestic credit and interest rates have a significant influence on the probability of booms and busts occurring. Moreover, international liquidity plays a significant role for the occurrence of housing booms andin conjunction with banking crisesfor busts. We also find that the deregulation of financial markets has strongly magnified the impact of the domestic financial sector on the occurrence of booms.
Credit booms gone bust: Monetary policy, leveragecycles, and financial crises, 1870-2008, Schularick, M., & Taylor, A. M. (2012). Credit booms gone bust: Monetary policy, leverage cycles, and financial crises, 1870-2008. American Economic Review,102(2), 1029-61. The financial crisis has refocused attention on money and credit fluctuations, financial crises, and policy responses. We study the behavior of money, credit, and macroeconomic indicators over the long run based on a new historical dataset for 14 countries over the years 1870-2008. Total credit has increased strongly relative to output and money in the second half of the twentieth century. Monetary policy responses to financial crises have also been more aggressive, but the output costs of crises have remained large. Credit growth is a powerful predictor of financial crises, suggesting that policymakers ignore credit at their peril. (JEL E32, E44, E52, G01, N10, N20)
Booms and busts in the UK housingmarket , Muellbauer, J., & Murphy, A. (1997). Booms and busts in the UK housing market. The Economic Journal,107(445), 1701-1727. The often volatile behaviour of UK house prices between 1957 and 1994 is analysed in an annual econometric model. Theory suggests that financial liberalisation of mortgage markets in the 1980s should have led to notable shifts in house price behaviour. The evidence supports the predictions of theory, suggesting shifts took place in wealth effects, as in the consumption function, and that real interest rates and income expectations became more important. The presence of transactions costs suggests important nonlinearities in house price dynamics. The paper also contains an explicit econometric treatment of expectations, demography, supply spillovers from the rented sector and of composition biases in the official house price index.

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