Phases of the Business Cycle

Business Cycle
Definition: alternating increases and decreases in the level of business activity of varying amplitude and length How do we measure increases and decreases in business activity?
Percent change in real GDP!

Business Cycle
Why do we say varying amplitude and length?
Some downturns are mild and some are severe Some are short (a few months) and some are long (over a year)

Do not confuse with seasonal fluctuations!

Real GDP 1958-2007, in 2000 dollars

Note: Years is on horizontal axis and real GDP is on vertical axis. General trend of economic growth Recession years are shaded blue: note downward slope on graph indicating that GDP is decreasing.

Note: Shaded areas indicate recessions.

The Phases of the Business Cycle

Expansion Peak
Total Output

Recession

Expansion

Trough

Secular growth trend

Jan.- Apr.- July- Oct.- Jan.- Apr.- July- Oct.- Jan.- Apr.Mar June Sept. Dec. Mar June Sept. Dec. Mar June
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Long-Run Economic Growth

Secular long-run growth, or long-run growth, is the sustained upward trend in aggregate output per person over several decades. A country can achieve a permanent increase in the standard of living of its citizens only through long-run growth. So a central concern of macroeconomics is what determines long-run growth.

A typical cycle is generally divided into four phases: 1.Expansion or prosperity or the upswing 2.Recession or upper turning point 3.Retrenchment or depression or down swing 4.Revival or recovery or lower turning point

These stages are recurring and consistent in the case of diverse cycles. But no phase has definite periodicity or time interval.

Commencement at the channel or below point, a cycle bypasses through a recovery and wealthy stage increases to a peak declines through a recession and depression stage and reaches a trough.

Recovery
Consequently, the levels of employment, earnings and productivity augment steadily in the fiscal system. In the prior phases of the revival stage there is considerable excess or idle capacity in the fiscal economy so that productivity hikes devoid of a proportionate hike in aggregate costs. .

However, as phase goes on productivity becomes less elastic, restricted access, appear with rising costs deliveries are trickier and plants may have to be extended. Under these stipulations, prices rise

Prosperity
In the wealthy stage, demand, productivity and earnings are at a high level. They are likely to raise prices. But remuneration such as salaries, wages, interest rates rentals and taxes do not rise in proportion to the rise in prices.

The lag among prices and costs hikes the margin of profit. The hike of profit and the prospect of its persistence usually cause a quick rise in stock market values. The fiscal system is overwhelmed in waves of positivism

Recession
Recession marks the turning point during which the forces that make for retrenchment finally win over the forces of extension. Its outward signs are liquidation signs are winding up in the stock market, strain in the banking system and some winding up in bank loans and the beginning of the diminish of prices.

Consequently profit margins decline further for the reason that costs begins overtaking prices. Some firms wind up. Others diminish production and try to sell out accumulated stocks.

Recession
What is a recession?
Generally, 2 or more quarters of declining real GDP Implication: its not officially called a recession until the economy has already been declining for 6 months!

 Who decides when were in a recession?

National Bureau of Economic Research traditionally declares recessions Private research organization, not a federal agency

Recession dates from peak of business

Depression
Recession then merges into depression when there is a general refuse in fiscal performance. There is considerable deduction in the production of goods and services, employment, earnings, demand and prices. The common refuse in fiscal performance tends to a drop in bank deposits. Credit extension ends for the reason that the business society is not willing to borrow.

Post-World War II Recessions*

*The February 1945October 1945 recession began before the war ended in August 1945.

Note: These recessions were of varying duration and severity.

Another Look at Expansions and Recessions

Can you find a pattern? Neither can economists! Thats why recessions are hard to predict.

FACTORS THAT SHAPE BUSINESS CYCLES For centuries, economists in both the United States and Europe regarded economic downturns as "diseases" that had to be treated; it followed, then, that economies characterized by growth and affluence were regarded as "healthy" economies. By the end of the 19th century, however, many economists had begun to recognize that economies were cyclical by their very nature, and studies increasingly turned to determining which factors were primarily responsible for shaping the direction and disposition of national, regional, and industry-specific economies. Today, economists, corporate executives, and business owners cite several factors as particularly important in shaping the complexion of business environments.

VOLATILITY OF INVESTMENT SPENDING

Variations in investment spending is one of the important factors in business cycles. Investment spending is considered the most volatile component of the aggregate or total demand (it varies much more from year to year than the largest component of the aggregate demand, the consumption spending), The Great Depression, for instance, was caused by a collapse in investment spending in the aftermath of the stock market crash of 1929. Similarly, prosperity of the late 1950s was attributed to a capital goods boom.

MOMENTUM
Many economists cite a certain "follow-theleader" mentality in consumer spending. In situations where consumer confidence is high and people adopt more free-spending habits, other customers are deemed to be more likely to increase their spending as well. Conversely, downturns in spending tend to be imitated as well.

TECHNOLOGICAL INNOVATIONS
Technological innovations can have an acute impact on business cycles. Indeed, technological breakthroughs in communication, transportation, manufacturing, and other operational areas can have a ripple effect throughout an industry or an economy. However, technological innovationsand consequent increases in investment take place at irregular intervals. Fluctuating investments, due to variations in the pace of technological innovations, lead to business fluctuations in the economy.

FLUCTUATIONS IN GOVERNMENT SPENDING

Variations in government spending are yet another source of business fluctuations. This may appear to be an unlikely source, as the government is widely considered to be a stabilizing force in the economy rather than a source of economic fluctuations or instability. Nevertheless, government spending has been a major destabilizing force on several occasions, especially during and after wars. More recently, the end of the Cold War resulted in a reduction in defense spending by the United States that had a pronounced impact on certain defense-dependent industries and geographic regions.

POLITICALLY GENERATED BUSINESS CYCLES

Many economists have hypothesized that business cycles are the result of the politically motivated use of macroeconomic policies (monetary and fiscal policies) that are designed to serve the interest of politicians running for reelection. The theory of political business cycles is predicated on the belief that elected officials (the president, members of congress, governors, etc.) have a tendency to engineer expansionary macroeconomic policies in order to aid their reelection efforts.

MONETARY POLICIES
Variations in the nation's monetary policies, independent of changes induced by political pressures, are an important influence in business cycles as well. Use of fiscal policy increased government spending and/or tax cutsis the most common way of boosting aggregate demand, causing an economic expansion. Moreover, the decisions of the Federal Reserve, which controls interest rates, can have a dramatic impact on consumer and investor confidence as well.

FLUCTUATIONS IN EXPORTS AND IMPORTS

Because net exports are a component of the aggregate demand in the economy, variations in exports and imports can lead to business fluctuations as well. There are many reasons for variations in exports and imports over time. Growth in the gross domestic product of an economy is the most important determinant of its demand for imported goodsas people's incomes grow, their appetite for additional goods and services, including goods produced abroad, increases. The opposite holds when foreign economies are growinggrowth in incomes in foreign countries also leads to an increased demand for imported goods by the residents of these countries. This, in turn, causes U.S. exports to grow. Currency exchange rates can also have a dramatic impact on international tradeand hence, domestic business cyclesas well.