1 WHAT IS A BUSINESS CYCLE?

Victor Zarnowitz

Sober men, whose projects have been disproportioned to their capitals, are
as likely to have neither wherewithal to buy money, nor credit to borrow it,
as prodigals whose expence has been disproportioned to their revenue.
Before their projects can be brought to bear, their stock is gone, and their
credit with it. ... When the profits of trade happen to be greater than ordi-
nary, overtrading becomes a general error both among great and small
dealers.
-Adam Smith (1776, p. 406)

When prices fall, production is arrested until the expences of production fall
in equal degree; and whilst production is thus arrested, consumption is
also diminished . .. the inducements to employ labour . .. are diminished
... and the prices of labour fall. The consumption of labour is thus dimin-
ished., and the prices of property again fall, and again act in depressing
labour, and in crippling production. ... It is the deficiency of money
which has occasioned the depression ofprices. ...
-Thomas Attwood (1817, pp. 99, 101)

We find {the state of trade] subject to various conditions which are

periodically returning: it revolves apparently in an established cycle.
First we find it in a state of quiescence,-next improvement,-growing

M. T. Belongia et al. (eds.), The Business Cycle: Theories and Evidence

© Kluwer Academic Publishers 1992
4 THE BUSINESS CYCLE

confidence, -prosperity, -excitement, -overtrading, -convulsion, -pres-

sure,-stagnation,-distress,-ending again in quiescence.
-Lord Overstone (1857, p. 44)

But though men have the power to purchase they may not choose to use it.
For when confidence has been shaken by failures, capital cannot be got to
start new companies or extend old ones. ... In short there is little occu-
pation in any of the trades which make Fixed capital. ... Other trades,
finding a poor market for their goods, produce less; they earn less, and
therefore they buy less. ... Thus commercial disorganization spreads. ...
The chief cause of the evil is a want of confidence.
-Alfred and Mary Marshall (1881, pp. 154-155)

1 The Emergence of Business Cycles in History and

Economic Thought

1. 1 Early ObselVations and Interpretations

Well before the concept of a business (or trade) cycle originated, serious
episodes of commercial and financial instability were observed repeatedly
by contemporaries. The preceding quotations, from Adam Smith (1776) to
Alfred Marshall (1881), illustrate the reactions of some of the classical
economists and politicians in England. Smith's brief mention of "over-
trading" is the only one in The Wealth of Nations'! Attwood, a banker
and politician, blamed reductions in the money supply under the gold stan-
dard for the resulting deflation and interacting declines in spending and
incomes (see Link, 1958, pp. 6-35; Backhouse, 1988, pp. 134-34). The
"famous words" of Lord Overstone, who may have been the first to write
about a multistage "cycle of trade," were cited with approval by Marshall a
quarter-century later. Marshall's stress of the confidence factor recalls not
only Pigou of 1929 but also Keynes of 1936 (Marshall and Marshall, 1881).
There is much in these and other early theories of crises and cycles that
deserves to be rediscovered and reconsidered today.2
Because of the predominance of classical tradition, problems of long-
term equilibrium constituted the principal concern of the prominent
theorists in the nineteenth century, and short-term business cycle problems
were at best a secondary interest. Yet throughout that century, from
Sismondi and Malthus to Marx and Hobson, intense controversies
prevailed about the validity of Say's law, that supply creates its own
demand, and about the possibility of a "general glut" (Sowell, 1972). There