In a free market economy, business activity is characterized by cyclic expansions and contractions within very long periods of linear average annual growth. The contractions are known as recessions or, when more serious, as depressions. During a recession a decline of production is accompanied by a reduction in the number of jobs, resulting in a reduction of income and consumer spending. Distributors consequently reduce their orders to manufacturers who in turn reduce their demand for commodities which therefore suffer production or price decreases. At the same time wages are maintained or even increased, thus reducing business profits and increasing the number of bankruptcies. Investment in new ventures is reduced thus reinforcing the contraction, which may then spiral into a depression. The likelihood that a depression will develop depends on factors such as: scale of speculation, quality of credit, excess capacity, magnitude of national debts balance of payments, and saturation of markets.
Cyclic business effects often spread from one country to another and may engulf much of the world economy. Obstacles to foreign trade, extremes in commodity prices, depressed stock prices, high interest rates and artificially valued leading world currencies play a vital role in this process of transmission, both directly and through their influence on business psychology.
Recent recessions have forcefully demonstrated how much more interrelated national economies have become. It is evident that the restrictive policies of the powerful countries have onerous consequences for the weak; it is also striking that this weakening of the poorer countries has posed a threat both to the viability of financial institutions serving the strong, and to the recovery of world production and trade. All recessions bring about a worsening of living conditions for large groups of people in most societies, and an aggravation of social tensions and cleavages.