Joseph Schumpeter, who defined the length and phases of the business cycle in his classic 1939 book Business Cycles, stated that there are definite investment cycles that correspond to the four stages of a sinusoidal wave. These four stages constitute the typical nine-year business cycle, which has been shown to exist with “considerable regularity.” Joseph Schumpeter called these nine-year periods “Juglar cycles,” for Clement Juglar, who was the first to interpret the changes in interest rates, prices, and banking data as proof of the existence of an underlying wave or cycle.
Schumpeter stated that the business cycle starts with the entrepreneur having an idea and innovating a new way to build, implement, or solve something. “Motivation is supplied by the prospect of profit….” As the entrepreneur spends savings to create the new widget, this upsets the equilibrium of the system and causes the economy to expand. The prior state of the economy had no unemployed resources, thus wages and/or costs of production will rise, which will cause older firms to reinvest in the company or product. Then competition will create additional demand for material or labor. This eventually leads other firms to join in and plan for additional production, eventually resulting in overinvestment and unrealistic projections of sales and profit. When sales disappoint, production is cut and employment is reduced, thereby reducing GDP growth and slowing the economy.
Depending on how quickly the economy expands and how overheated the response is to that prior innovation, the recession could lead to a depression or a crisis of some proportion. The business cycle could now zip right past the equilibrium line and into negative territory, as crisis turns to disaster and conditions worsen. Unemployment will rise as the firms that overexpanded, expecting significant growth, find that their capital outlay will incur negative returns, and so they must cut labor resources to remain profitable and cost competitive. As unemployment worsens, economic activity across the board is reduced, as employees seek to minimize their spending to preserve their savings. As for the business enterprise, reorganization and adaptation remain the key tools to confront and respond to the crisis. Recovery will only occur once the elimination of excess capacity in plant, personnel, and equipment is realized. The curve of the business cycle will move back toward equilibrium and the neutral state, until the next big idea causes another wave of innovation.
Below is Schumpeter's graphic of the interaction of the Kondratieff, Juglar, and Kitchin cycles.