Boom And Bust Cycle

Definition of 'Boom And Bust Cycle'


A process of economic expansion and contraction that occurs repeatedly. The boom and bust cycle is a key characteristic of today’s capitalist economies. During the boom the economy grows, jobs are plentiful and the market brings high returns to investors. In the subsequent bust the economy shrinks, people lose their jobs and investors lose money. Boom-bust cycles last for varying lengths of time; they also vary in severity.

Investopedia explains 'Boom And Bust Cycle'


Since the mid-1940s, the United States has experienced 12 boom-bust cycles. Why do we have a boom and bust cycle instead of a long, steady economic growth period? The answer can be found in the way central banks handle the money supply.
 
During a boom, the central bank makes it easier to obtain credit by lending money at low interest rates. Individuals and businesses can then borrow money easily and cheaply and invest it in, say, technology stocks or houses. Many people earn high returns on their investments, and the economy grows.
 
The problem is that when credit is too easy to obtain and interest rates are too low, people will overinvest. This excess investment is called “malinvestment”. There won’t be enough demand for, say, all the homes that have been built, and the bust cycle will set in. Things that have been overinvested in will decline in value. Investors lose money, consumers cut spending and companies cut jobs. Credit becomes more difficult to obtain as boom-time borrowers become unable to make their loan payments. The bust periods are referred to as recessions; if the recession is particularly severe, it is called a depression.
 
Government subsidies that make it less expensive to invest also contribute to the boom-bust cycle by encouraging companies and individuals to overinvest in the subsidized item. For example, the mortgage interest tax deduction subsidizes a home purchase by making the mortgage interest less expensive. The subsidy encourages more people to buy homes.


Filed Under:

comments powered by Disqus
Hot Definitions
  1. Debit Spread

    Two options with different market prices that an investor trades on the same underlying security. The higher priced option is purchased and the lower premium option is sold - both at the same time. The higher the debit spread, the greater the initial cash outflow the investor will incur on the transaction.
  2. Odious Debt

    Money borrowed by one country from another country and then misappropriated by national rulers. A nation's debt becomes odious debt when government leaders use borrowed funds in ways that don't benefit or even oppress citizens. Some legal scholars argue that successor governments should not be held accountable for odious debt incurred by earlier regimes, but there is no consensus on how odious debt should actually be treated.
  3. Takeover

    A corporate action where an acquiring company makes a bid for an acquiree. If the target company is publicly traded, the acquiring company will make an offer for the outstanding shares.
  4. Harvest Strategy

    A strategy in which investment in a particular line of business is reduced or eliminated because the revenue brought in by additional investment would not warrant the expense. A harvest strategy is employed when a line of business is considered to be a cash cow, meaning that the brand is mature and is unlikely to grow if more investment is added.
  5. Stop-Limit Order

    An order placed with a broker that combines the features of stop order with those of a limit order. A stop-limit order will be executed at a specified price (or better) after a given stop price has been reached. Once the stop price is reached, the stop-limit order becomes a limit order to buy (or sell) at the limit price or better.
  6. Pareto Principle

    A principle, named after economist Vilfredo Pareto, that specifies an unequal relationship between inputs and outputs. The principle states that, for many phenomena, 20% of invested input is responsible for 80% of the results obtained. Put another way, 80% of consequences stem from 20% of the causes.
Trading Center