What Are Business Cycles?
A nation’s overall economic activity is subject to fluctuations known as business cycles.
These cycles are characterized by periods of growth experienced by many sectors of the economy around the same time, followed by periods of contraction known as recessions. These shifts occur frequently but not in a regular pattern.
A common type of economic cycle is the business cycle.
KEY POINTS
- The broad indicators of economic activity (output, employment, income, and sales) experience synchronized cyclical upswings and downswings that make up business cycles.
- The business cycle consists of periods of growth followed by periods of decline, known as recessions.
- It is common for recessions to begin as an expansion ends (the “peak”) and end (the “trough”) of the business cycle.
- The three D’s—depth, spread, and length—are used to assess the severity of a recession, while the same metrics are used to evaluate the robustness of an expansion.
Knowing How the Economy Works
The expansion and contraction of aggregate economic activity, as well as the correlation between economic variables, are the defining characteristics of business cycles.
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Key coincident economic indicators used for the official determination of U.S. business cycle peak and trough dates include real (i.e., inflation-adjusted) GDP (a measure of aggregate output), as well as aggregate measures of industrial production, employment, income, and sales.
The common belief that a recession occurs after two consecutive quarters of declining real GDP is incorrect. Two consecutive quarterly declines in real GDP did not characterize the recessions of 1960–1961 and 2001.
Recessions are particularly pernicious cycles, with a downward spiral of falling output, employment, income, and sales that quickly spreads from industry to industry and region to region.
Comovement among these coincident economic indicators and the persistence of the recession are driven by the domino effect, which spreads recessionary weakness across the economy.
What Is Recession?
When the vicious cycle of a recession turns into a virtuous cycle, with higher output leading to higher employment, income, and sales, the business cycle is said to be recovering.
Only if the recovery becomes self-feeding, with this domino effect propelling its spread across the economy, can it last and lead to sustained economic expansion.
What Is Recovery?
No one would ever mistake the stock market for the economy. Because of this, broad stock price indices are not a good proxy for the business cycle.
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Measuring and Dating Business Cycles
The three Ds (depth, diffusion, and duration) are used to quantify the severity of a recession. The steepness of the decline from peak to trough in broad measures of output, employment, income, and sales indicates the severity of a recession.
The rate at which it has spread to new areas of the economy, new fields, and new countries is an indicator of its degree of diffusion.
The distance between its high and low points is a measure of how long it will last.
In a similar vein, the magnitude of an expansion is established by the degree to which it is noticeable, widespread, and long-lasting. The three Ds of a downturn are paralleled by these three Ps.
Business cycles have two distinct phases: an expansion, which begins at the bottom and continues until the next peak, and a recession, which begins at the peak and continues until the next trough.
Stay tuned for more on business cycle in our next article.
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