The natural rise and fall in economic growth that takes place throughout time is known as the business cycle. You can utilize the cycle to analyze the economy and improve your financial decisions.
A Business Cycle Definition and an Example
Economists use the phrase “business cycle” to refer to the cyclical ups and downs in economic activity. The economy includes all corporate, labor, and consumer activity that produces, trades, and consumes goods and services inside the United States. Thus, the business cycle is related to the measured level of productivity.
The business cycle is the economy’s productivity level’s upward and downward oscillations, together with its long-term natural growth rate.
Alternative names: commercial cycle, economic cycle
Businesses require more personnel as their output rises. As a result, more workers are employed, there is more money available for spending, firms make more money, and they can concentrate on expanding. Economic expansion is the process by which production and consumption move in a positive direction. It keeps going until something happens that slows down its output.
There is a reduction in labor force requirements as corporate production slows. As a result, consumers have less money to spend and firms invest less on expansion. “Economic contraction” refers to the rate at which consumption and production are changing negatively as a whole.
How Do Business Cycles Operate?
A business cycle’s duration is the time frame that includes one expansion and one downturn in quick succession. The four stages of a full business cycle are expansion, peak, contraction, and trough. They don’t happen at predictable times or intervals, but they do have telltale signs.
It’s crucial to realize that there can be little swings inside an economic phase that provide the impression that the economy is changing. Using quarterly GDP growth rates, the National Bureau of Economic Research (NBER) determines which cycle the economy is in. Additionally, it makes use of monthly economic statistics such as retail sales, industrial output, real personal income, and employment.
Although there will be media speculation on the state of the economy, the NBER will not officially announce what cycle the economy is in until it has had time to evaluate the data and make a determination.
Each stage of the business cycle is influenced by three variables: the forces of supply and demand; capital availability; and investor and consumer confidence.
The economy tends to grow when consumers and investors have faith in the future and policymakers, making future confidence the most important factor. When confidence levels decline, it has the opposite effect.
An economic expansion is a time when the entire economy is growing. Productivity is typically shown on a curve as an upward trend because it is rising. Due to the fact that it comes after a protracted period of economic contraction, the expansion phase is often referred to as the economic recovery phase.
The statistic most frequently used to represent economic output is gross domestic product (GDP). It rises throughout the growth stage. A GDP growth rate of between 2% and 3% is regarded as healthy by economists.
The Federal Reserve wants to maintain inflation, which is the measure of the change in prices, at a level of about 2%, which is also seen as healthy by economists and government authorities.
The stock market experienced growing prices during an expansion, and investors are optimistic. Consumers have more money to spend, businesses make more money, and both are growing. An economy may continue to grow for many years.
When the economy starts to grow too quickly, the expansion phase is about to come to an end. When the unemployment rate is far below the natural rate and inflation is rising, this is referred to as “overheating.” When investors in the stock market experience “irrational exuberance,” they get unduly optimistic about prices and think they will keep rising, which drives up stock prices to an extremely overpriced level.
The second stage of the cycle is the apex. It happens when all of the expansionary indications start to level off. It could take the economy weeks or even a year to enter the contraction stage. The GDP growth rate drops to about 2% and keeps going down. On a graph, the peak is shown as the highest point of the curve before it descends.
The contraction stage is the third stage. It starts when the economy reaches its peak and ends when the GDP and other indicators stop declining. The economy is not growing at this point; rather, it is contracting. The economy enters a recession when the GDP rate declines. Companies fire workers, the unemployment rate increases above average levels, and prices start to fall.
On a graph, the portion of the curve that is consistently decreasing represents a contraction.
The fourth stage of the business cycle is the trough. The falling GDP starts to slow down and finally starts to alter positively again. The shift of the economy from the recession phase to the expansion phase starts. The lowest point of a curve is shown as a trough on a graph. When the GDP starts to rise, the business cycle starts up again, and the curve steadily advances upward.
The four stages of the business cycle are known as the “boom-and-bust cycle” because they may be so harsh.
How Does the Business Cycle Affect Things?
The government keeps track of the business cycle, and lawmakers try to affect it by altering spending and taxes. Taxes can be raised and spending can be reduced when the economy is growing. The government can reduce taxes while increasing spending if it is contracting. We refer to this as “fiscal policy.”
The Fed, the country’s central bank, affects the business cycle by setting targeted rates for unemployment and inflation. It makes use of instruments intended to alter interest rates, bank lending, and consumer, corporate, and consumer borrowing. We refer to this as “monetary policy.”
In an effort to stop a contraction or trough, the Fed lowers its target interest rates to stimulate borrowing. Because they are seeking to return the business cycle to the expansionary stage, this is referred to as expansionary monetary policy.
The central bank boosts its target interest rates to discourage borrowing and expenditure in order to prevent the economy from expanding too quickly. Because the bank is attempting to reduce economic output to restrain expansion, this is known as “contractionary monetary policy.”
Fiscal and monetary policy’s objective is to maintain an economy that is expanding at a rate that is both moderate enough not to raise inflation and sustainable enough to provide jobs for everyone who wants one.
Prior to the 2008 recession, GDP growth reached its highest point in the third quarter of 2007, when it was 2.4 percent. Because the economy shrank by 1.6 percent in the first quarter of 2008, the recession in 2008 was particularly difficult. In the second quarter, it improved by 2.3 percent, which is encouraging. In the third quarter, there was a 2.1 percent decline, and the fourth saw an 8.5 percent decline. In the first quarter of 2009, it fell by 4.6 percent.
The unemployment rate increased in 2008, going from 4.9 percent in January to 7.2 percent in December.
According to the NBER, the trough was reached at the conclusion of the second quarter of 2009.
In 2014, GDP fell by only 0.7 percent.However, because unemployment is a lagging indicator, it had risen to 10.2 percent by October 2009.
When the GDP increased by 1.5% in the third quarter of 2009, the expansion period began. Because the recession phase pushed the economy so low that recovery took so long, the unemployment rate remained above 7% four years into the expansion phase.1611
- The four main stages of the business cycle are expansion, peak, contraction, and trough.
- While this cycle occurs in all economies, the length and intensity of each phase differ.
- While heads of state and governing bodies employ fiscal policy to regulate the cycle, the Federal Reserve uses monetary policy to do so.
- Investor and consumer confidence both have an impact on the economic cycle’s stages and performance.