Virtuous circle and vicious circle

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For other uses, see Vicious circle.

A virtuous circle or a vicious circle is a complex of events that reinforces itself through a feedback loop toward greater instability. A virtuous circle (or virtuous cycle) has favorable results, and a vicious circle (or vicious cycle) has deleterious results. A virtuous circle can transform into a vicious circle if eventual negative feedback is ignored.

Both circles are complexes of events with no tendency towards equilibrium (at least in the short run). Both systems of events have feedback loops in which each iteration of the cycle reinforces the first (positive feedback). These cycles will continue in the direction of their momentum until an exogenous factor intervenes and stops the cycle. The prefix “hyper” is sometimes used to describe these cycles. The most well known vicious circle is hyperinflation.

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[edit] Example in macroeconomics

[edit] Vicious circle

Hyperinflation is a spiral of inflation which causes even higher inflation. The initial exogenous event might be a sudden large increase in international interest rates or a massive increase in government debt due to excessive spendings. Whatever the cause, the government could pay down some of its debt by printing more money (called monetizing the debt). This increase in the money supply could increase the level of inflation. In an inflationary environment, people tend to spend their money quickly because they expect its value to decrease further in the future. They convert their financial assets into physical assets while their money still has some purchasing power. Often they will purchase on credit. Because of this, the level of savings in the country is very low and the government could have problems refinancing its debt. Its solution could be to print still more money starting another iteration of the vicious cycle.

Vicious circle

[edit] Virtuous circle

Economic growth can be seen as a virtuous circle. It might start with an exogenous factor like technological innovation. As people get familiar with the new technology, there could be learning curve effects and economies of scale. This could lead to reduced costs and improved production efficiencies. In a competitive market structure, this will likely result in lower average prices. As prices decrease, consumption could increase and aggregate output also. Increased levels of output leads to more learning and scale effects and a new cycle starts. However, pollution, natural resource depletion and other externalities associated with uncontrolled economic growth can turn the virtuous cycle into a vicious cycle as many would argue is currently happening.

Virtuous circle

[edit] Example in management

[edit] Virtuous circle

An investment in your employees’ ability to provide superior service to customers can be seen as a virtuous circle. Effort spent in selecting and training employees and creating a corporate culture in which they are empowered can lead to increased employee satisfaction and employee competence. This will likely result in superior service delivery and customer satisfaction. This in turn will create customer loyalty, improved sales levels, and higher profit margins. Some of these profits can be reinvested in employee development thereby initiating another iteration of a virtuous cycle.

Virtuous circle

[edit] Vicious circle

A harvesting strategy can be an example of a vicious circle. Rather than reinvesting in employee development, new product development, and market research, management could decide to harvest their investment by reducing costs then increasing dividends or increasing executive compensation. The consequence of this could be reduced employee wages, minimal training, an outdated product line, and a failure to understand the needs of the customer. This will likely result in employee dissatisfaction, employee incompetence, and high employee turnover. This could cause poor service delivery, customer dissatisfaction, high customer turnover, and loss of market share. Reduced sales and lower profit margins may require a further reduction in investment thereby initiating another iteration of the vicious cycle.

[edit] Vicious Cycles in the Subprime Mortgage Crisis

Vicious Cycles in the Subprime Mortgage Crisis

The contemporary subprime mortgage crisis is a complex of vicious circles, both in its genesis and in its manifold outcomes, most notably the late 2000s recession. A specific example is the circle related to housing. As housing prices decline, more homeowners go "underwater" meaning they have homes worth less than their mortgages. This is called "negative equity." This provides an incentive to walk away from the home, increasing defaults and foreclosures. These in turn lower housing values further, reinforcing the cycle.[1]

The foreclosures reduce the cash flowing into banks and the value of mortgage-backed securities (MBS) widely held by banks. Banks incur losses and require additional funds, also called “recapitalization.” If banks are not capitalized sufficiently to lend, economic activity slows and unemployment increases, which further increases foreclosures.

Economist Nouriel Roubini described the vicious cycles within and across the housing market and financial markets during interviews with Charlie Rose in September and October 2008.[2][3][4]

[edit] Other examples

Other examples include the poverty cycle and sharecropping.

[edit] External sources

[edit] References

  1. ^ NYT-Vicious Cycle in Subprime Crisis
  2. ^ Charlie Rose - Roubini & Panel
  3. ^ Rose & Roubini Discussion
  4. ^ Rose & Roubini

[edit] See also

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