Trade Cycles Research Paper

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Trade cycles are fluctuations in patterns of prosperity and depression that have occurred throughout history as the result of shocks such as wars, oil crises, new technologies—or as the result of waves of investor optimism and pessimism. Economic growth has not been, and is unlikely to be in the future, smooth and steady, but will consist of fluctuations around a trend.

Since the time of the Old Testament, when Joseph prophesied to Pharaoh that Egypt would experience seven fat years followed by seven lean years, economic activity has been characterized by wavelike rhythms and by longer-term trends and irregular fluctuations. Boom periods of prosperity and expansion are succeeded by recessions and depressions, which in turn give way to recovery and renewed prosperity. In preindustrial societies, cycles and fluctuations in the weather, which affected harvests, had the largest effect on the level of prosperity, while all aspects of life were affected by the cycle of the seasons. The “little Ice Age” of the fourteenth century was a period of economic depression in Europe. In the 1870s the economist and philosopher William Stanley Jevons argued that an eleven-year cycle in sunspots caused cycles of the same average length in the weather, harvests, and economic activity, but this theory has since been rejected so completely such that in current macroeconomics the term sunspots is used to refer to any intrinsically irrelevant variable.

Beyond the weather and the seasons, preindustrial cycles and fluctuations in economic activity were set off by real shocks (wars, inventions, and plagues such as the Black Death of 1348–1351, or discovery of trade routes such as the sea route around the Cape of Good Hope to Asian spices) or by monetary shocks (such as the “price revolution of the sixteenth century,” as silver from the new Spanish colonies in Mexico and Upper Peru raised Europe’s money supply and quadrupled its prices). The Black Death, which raised the amount of arable land per person by killing a third of Europe’s population, was followed by more than half a century of high real wages. A financial shock, such as the failure of the Bardi and Peruzzi banking houses in Florence when Edward III of England defaulted, rippled through the commercial cities of northern Italy and Flanders and their trading partners around the Mediterranean and Baltic. Lord Overstone, a banker, introduced the phrase cycles of trade in the 1840s, and in 1862 the economist Clement Juglar published his pioneering history of commercial crises and their periodic recurrence in England, France, and the United States (including cycles in French marriage, birth, and death rates). The phenomenon itself was much older: the economist Thomas Ashton identified twenty-two economic fluctuations in eighteenth-century England, finding their origins in Britain’s wars, seventeen financial crises, and eleven bad harvests.

Long Waves

In 1925 the economist Nikolai D. Kondratieff observed recurring long waves of fifty to sixty years (twenty to thirty years of rapid economic growth, followed by an equally long period of slow growth) in British, French, and U.S. data on output, prices, wages, and interest rates from the Industrial Revolution onwards. This analysis led to his arrest and death in Stalin’s purges and the suppression of the Moscow Business Conditions Institute because of the implication that the Great Depression following the Wall Street crash of 1929 was not the final crisis of capitalism, but merely a severe downturn that would be succeeded by an upswing in the capitalist economies.

The political economist Joseph Schumpeter attributed the economic expansion at the start of each Kondratieff wave to a clustering of technological innovations that both improved productivity and induced a surge of investment: water power, cotton textiles (spinning jenny, power loom, cotton gin), and iron (coked coal replacing wood as fuel) in the first Kondratieff wave from the 1780s (the Industrial Revolution); steam, railways, and steel in the second Kondratieff wave in the middle of the nineteenth century; chemicals, electricity, and automobiles in the third wave that began in the 1890s. Later writers emphasize electronics, petrochemicals, and aviation in the fourth wave and computers and the Internet in a fifth Kondratieff wave. Such breakthroughs in technology and organization are instances of “creative destruction” rendering obsolete the physical and human capital of the previous techniques of production.

Schumpeter interpreted economic fluctuations as the aggregation and interaction of three superimposed cycles: a short Kitchin cycle (inventory cycle) averaging forty months duration, a Juglar cycle of nine or ten years, and a Kondratieff cycle of forty-eight to sixty years, generated by clusters of innovations of different importance and gestation. By contrast, the economist Solomos Solomou concludes that the evidence is against the existence of a Kondratieff long wave in output or prices, that the leading industrial economies have not shared the same phases of boom and bust over long cycles, and that innovations have not been clustered in the way suggested by Schumpeter. But Solomou found more evidence to support the existence of a Kuznets cycle averaging twenty years in length (varying from fourteen to twenty-two years), while other authors had argued that the apparent Kuznets cycle was an artifact of the filtering techniques used to decompose time series into trend, cycles, and irregular fluctuations. Increasingly, economists and economic historians have become skeptical of the existence of true economics cycles—persistent rhythms whose average length and size remains unchanged—but recognize that responses to real and monetary shocks can be oscillatory, moving through successive phases of expansion and contraction but with the response to each shock gradually fading away.


The depression of 1873 to 1896 was a long period of generally declining commodity prices and rising purchasing power of money, as the demand for real money balances grew faster than the world’s supply of gold. Such falling price levels were perceived at the time as depressing industry and commerce, but the period 1873–1896 is viewed in retrospect as one of depression in prices and nominal interest rates rather than in real output. The deflation was reversed by gold discoveries in South Africa and the Klondike and by the invention of the cyanide process for extracting gold from low-grade ores. The Great Depression of the 1930s, following the Wall Street crash of October 1929 that ended the U.S. stock market bubble of the late 1920s, was a depression in real output and employment as well as in prices. A quarter of the U.S. labor force and more than two-fifths of German industrial workers were unemployed by 1932, more than one-fifth of British workers by 1931. Bank failures and the fear of additional possible bank failures, with no deposit insurance, caused depositors to withdraw cash from U.S. banks, and banks to hold more reserves against their deposits, causing the U.S. money supply and price level to fall by a third or more. The gold standard, requiring the convertibility of national currencies into gold and other currencies at fixed rates, was seen as spreading the depression from one country to another, as national central banks were obliged to contract their money supplies to defend the exchange rates in the face of gold outflows. A country could maintain a fixed exchange rate only if the prices of its goods fell by the same proportion as the price level declined in its major trading partners and competitors. These pressures led to the breakdown of the gold standard, with Britain leaving in September 1931 and the United States in 1933. Another consequence was declining international trade and movement away from global economic integration, as countries responded to high unemployment and declining production by imposing tariffs and quotas on imports and subsidizing exports. Such moves increased friction between nations, and together with high unemployment, especially in Germany, helped to undermine democracy and international peace in the years leading to World War II. Similarly, the “golden age” of largely sustained western European, North American, and Japanese prosperity from 1950 (after the Marshall Plan and comparable American aid to Japan assisted postwar reconstruction) until the first oil shock of 1973 contributed to the growth of democratic institutions and international stability.

Trade Cycles in the Present and the Future

Do business cycles still exist? Are periods of economic boom still followed by slumps? The Great Depression of the 1930s and the associated rise of Keynesian macroeconomics (following the economic and monetary theories of British economist John Maynard Keynes) led national governments in the leading industrialized countries to accept responsibility for stabilizing the economy; they used monetary and fiscal policies to manage aggregate demand to try to smooth out fluctuations in output and employment. The larger share of government spending in the economy also acted as an automatic stabilizer, since government spending would be maintained when private consumption and investment fell in a recession, while such structural reforms as deposit insurance made the financial system less vulnerable to runs on banks by anxious depositors. Swift reaction by the U.S. Federal Reserve System prevented the abrupt stock market slump of October 1987 from having the wider consequences of the stock market crash of October 1929. Even with the OPEC oil price shocks of 1973 and 1979–1980, the world economy has clearly been more stable since World War II than it was between the two world wars. However, the economist Christina Romer has argued, controversially but influentially, that the apparent greater stability of the U.S. economy after World War II than before World War I is nothing more than a statistical artifact, resulting from the ways in which retrospective national accounts data were created for the pre-1914 United States. The global financial crisis of 2007–2010, referred to by many as the worst financial crisis since the Great Depression, and triggered to a large extent by the bursting of the U.S. housing bubble, is offered by some as evidence of this.

Prior to the global financial crisis, from the 1980s, governments were less influenced by Keynesian arguments for government stabilization of output and employment to smooth out the business cycle. Instead, the emphasis was on limiting inflation and on public policies to promote long-run growth of productive capacity. Booms and recessions continue to succeed each other, transmitted internationally through trade and investment flows in an increasingly integrated global economy, but with different countries not always in the same phase of the cycle at the same time. Since the breakdown in 1973 of the Bretton Woods system of fixed exchange rates, these fluctuations in prosperity and international payments have been accompanied by fluctuations in exchange rates (with the adoption of the Euro, initially by eleven European countries in 1999, reducing the number of exchange rates and currencies, and thus reducing the possibilities for variation). Economists now use the terms trade cycles or business cycles to mean economic fluctuations, without any implication that the fluctuations are cycles of fixed duration.

The fluctuating pattern of economic prosperity and depression has had deep social effects throughout history, and fluctuations continue to recur, as the result of shocks such as the creation of the OPEC oil cartel, the invention of a new technology, wars, or weather, or as the result of waves of optimism and pessimism among investors. The process of economic growth has not been, and likely will not be in the future, smooth and steady, but will consist of fluctuations around a trend.


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  11. O’Brien, D. P. (Ed.). (1997). The foundations of business cycle theory. Cheltenham, U.K.: Edward Elgar.
  12. Sherman, H. J. (1991). The business cycle: Growth and crisis under capitalism. Princeton, NJ: Princeton University Press.
  13. Solomou, S. (1987). Phases of economic growth, 1850–1973: Kondratieff waves and Kuznets swings. Cambridge, U.K.: Cambridge University Press.
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