The theory that business cycles are caused by fluctuations in credit. Booms occur because banks and other lenders become over-optimistic in granting credit. At some stage their mistakes lead to defaults and a loss of confidence, resulting in a depression. During the depression lenders are over-cautious, and bad debts are gradually written off. After a while bankers recover from the shock and start lending again, which leads to a recovery, in the course of which they once again become over-optimistic, leading to the next cycle.
|Reference: Oxford Press Dictonary of Economics, 5th edt.|