The Little Book of Economics: How the Economy Works in the Real World, Revised and Updated

Chapter Two

Economic Bungee Jumping

Business Cycles, Recessions, and Depressions . . . Oh My!

In early 1973 the New York Times asked four economists for their forecasts. Alan Greenspan predicted that the economy would grow 6 percent and declared, “It’s very rare that you can be as unqualifiedly bullish as you can now.” He was half right; the economy did grow 6 percent that year, but it was a lousy time to be bullish. A few days after the Times article appeared, stocks entered a deep, multiyear bear market and by the end of the year the economy had fallen into its worst recession in decades.

What happened? Economic growth and falling unemployment began to strain the economy’s productive capacity. Inflation was rising and soon, so were interest rates. That October came the coup de grâce: The Arab embargo sent oil prices skyrocketing. High interest rates and recession are a nasty combination for stocks and employment.

Over long stretches, the economy grows thanks to rising population and productivity. But in the short run, it goes through cycles of expansion and recession. Catching the bottom of the cycle can turbocharge your portfolio or business plan, while missing the peak can lay waste to both.

Medicine has made countless breakthroughs that enable us to live longer, healthier lives, but it hasn’t yet eradicated epidemics. For the same reason, both our wealth and our understanding of the economy have advanced tremendously but we haven’t yet abolished the business cycle. Business ...