Virtuous circle and vicious circle

The terms virtuous circle and vicious circle (also referred to as virtuous cycle and vicious cycle) refer to complex chains of events which reinforce themselves through a feedback loop.[1] A virtuous circle has favorable results, while a vicious circle has detrimental results.

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 previous one (positive feedback). These cycles will continue in the direction of their momentum until an external factor intervenes and breaks the cycle. The prefix "hyper-" is sometimes used to describe these cycles if they are extreme. The best-known example of a vicious circle is hyperinflation.

Example in macroeconomics

Virtuous circle

Economic growth can be seen as a virtuous circle. It might start with an exogenous factor such as 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 probably result in lower average prices or a decrease in employment as it takes fewer workers to produce the same output. As prices decrease, consumption could increase and aggregate output also. Increased levels of output lead to more learning and scale effects and a new cycle starts.

Virtuous circle

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. Eventually, the currency loses all of its value. 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

Example in management

Virtuous circle

An employer's investment in his 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 can 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

Vicious circle

A harvesting strategy, which 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 its 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 probably 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 circle.

Vicious circles 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", when the market value of a home drops below the mortgage on it. This provides an incentive to walk away from the home, increasing defaults and foreclosures. This, in turn, lowers housing values further, reinforcing the cycle.[2]

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 increase the number of foreclosures.

Economist Nouriel Roubini described the vicious circles within and across the housing market and financial markets during interviews with Charlie Rose in September and October 2008.[3][4][5]

Other examples

Other examples include the poverty cycle, sharecropping, and the intensification of drought. In climate change science, feedback loops involve positive feedbacks and negative feedbacks that respectively serve to intensify or dampen the effects of global warming.

See also

Analogous concepts

Vicious Circle by Jacek Malczewski, National Museum, Poznań

References

  1. ↑ Charles Webel, Johan Galtung (19 March 2012). Handbook of Peace and Conflict Studies. Routledge. Retrieved 19 March 2012.
  2. ↑ Post (2008-11-18). "WSJ-Vicious Cycle in Subprime Crisis". Online.wsj.com. Retrieved 2013-09-05.
  3. ↑ "Roubini & Panel". Charlie Rose. Retrieved 2013-09-05.
  4. ↑ "Rose & Roubini Discussion". Charlierose.com. Retrieved 2013-09-05.
  5. ↑ "Rose & Roubini". Charlierose.com. Retrieved 2013-09-05.

External sources

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