What is a boom and bust cycle?

In order to answer the question you should first familiarise yourself with economic cycles. An economic cycle or business cycle refers to the period when an economy’s business activities repeatedly grow, peak, contract and bottom out. As such, boom and bust economic cycles are periods of economic expansion and contraction.

Where have you heard of boom and bust cycles?

The causes of boom and bust cycles are a variety of macroeconomic factors such as gross domestic product (GDP), unemployment rate, industrial production and retail sales. Considering these factors tend to trickle-down, you will experience the implications of boom and bust economic cycles in your day-to-day lives through the pricing of commodities, interest rates on loans and more.

Boom and bust cycle – explained

The history of boom and bust cycles dates back to the 19th Century, when revolutionary economist Karl Marx first put forward the theory. According to him, these alternating phases of economic expansion and contraction are as much guided by consumer psychology as the fundamentals of the market and economy at large.

In a boom, or during the expanding business cycle, economic growth is positive. It’s often indicated by a predominantly bullish or rallying stock market, a low unemployment rate and higher wages. During this time, the liquidity of money is high as central banks lower interest rates and it becomes easier to take out loans. 

If the money supply becomes excessive, people may overinvest and money starts to lose its value. This can lead to a decline in the value of assets. Investors lose money, unemployment rises and the economy enters the bust part of the cycle.

A bust is often referred to as a recession. According to the Business Cycle Dating Committee of the National Bureau of Economic Research, a recession features a significant decline in economic activity spread across an economy, lasts more than a few months, and is normally visible in GDP, income, employment, industrial production and wholesale retail sales.

A bust cycle can be triggered by a stock market crash. This typically happens when investors do not feel confident about the future. They begin selling, withdrawing their money from the markets. While there’s no specific quantitative benchmark to define a stock market crash, The Motley Fool suggests it usually applies to a major stock market index losing more than 10% of its value in a relatively short time period.

In recent times

The Covid-19 pandemic caused havoc across the globe. It provides us with a recent example of boom and bust cycles. The pandemic threw the world economies into a bust cycle. According to UK data, GDP declined by 9.7% in 2020, the steepest drop since consistent economic records began in 1948 and equal to the decline in 1921, on unofficial estimates. However, almost two years since the start of the coronavirus pandemic, with vaccination roll-outs and a pick up in business activities, global economies are recovering.