We consider business cycles to be a continuous process, with recessions, troughs, recoveries, expansions, peaks, and downturns repeating themselves. Any business cycle may be divided into four phases:
Peak: the economy is at or near full employment; production, employment, and income have reached a transitory peak.
Recession (R): a drop in output, employment, and income. Many areas of the economy are seeing a downturn in commercial activity. Unemployment is on the rise. Recessions can last anywhere from six to twelve months. Monthly variations in output are higher during recessions than during expansions. In other words, during a recession, output decreases are far more pronounced.
Trough: At its lowest point, output, revenue, and employment "bottom out." The trough period might endure for a short time or for a long time.
Expansion (E): A phase of recuperation. Once again, output, income, and employment are on the rise. As the economy approaches full employment, we may expect price increases (inflation). Expansions, on average, last three to four times longer than contractions.
There have been ten recessions since 1950. In terms of time, the least severe was in 1980. (6 months). 2007-09 was the most severe (18 months).
During a business cycle, what happens? To begin with, many economic variables are linked.
The economy and unemployment are moving in different directions (the labor market is a lagging indicator, responding slowly to a change in GDP, as we saw in chapter 7 of the assigned textbook). Consumption growth tracks GDP, although it isn't very variable. The amount of money spent on investments is highly erratic. During business cycles, wages do not fluctuate considerably. Inflation follows the rise of output.
Sectors of the economy and the businesses that make up those sectors tend to move in lockstep. When one area does well, it is probable that others will as well. The same may be said for businesses in these fields. Construction and manufacturing, on the other hand, are more volatile during a business cycle. We can see that if one area of the economy is performing well, others will as well. As a result, if manufacturing is doing well, demand for construction and services will rise.
States, too, are subjected to the same business cycle. Nations, too, tend to go through business cycles at the same time. Every business cycle is unique. The lengths and extents of expansions and contractions alter throughout time. Towards the end of a project:
- Interest rates are rising
- Wages are rising faster than prices
- This results in falling profits
- Debts of households and firms have risen
- Lots of borrowing has occurred to finance spending during the expansion time period
Recessions typically come from declines in investment spending by firms.
- Firms cut back on capital stock expansion
- Households cut back on spending for consumer durables
- Sales fall
- Production declines
- Unemployment rises, workers are let go, and this reduces income, which reduce s spending still further.
Firms that produce capital goods and consumer durable products suffer the most during a recession. Firms can postpone capital goods acquisitions when the economy deteriorates. Increases in capital goods stock are not warranted by the company forecast. Businesses repair obsolete equipment that has outlived its usefulness. Consumer durable goods purchases are being postponed by consumers (autos, major appliances, personal computers, etc.). Budgets are being slashed, and consumer durable goods purchases are being postponed. Service businesses and non-durable products producers are frequently spared the brunt of the damage. It is tough for people to cut back on necessary medical and legal services. Purchases of food and clothing are more difficult to postpone.
Spending by families and businesses begins to grow as the recession persists and appears to be ending. Debt is decreasing. New borrowing takes place, resulting in a rise in spending. And thus a new chapter of growth starts.