Business cycles are defined by the alternating of expansion and contraction phases in aggregate economic activity, as well as the comovement of economic indicators during each phase of the cycle. Aggregate economic activity is represented by aggregate measures of industrial production, employment, income, and sales, which are the key coincident economic indicators used for the official determination of U.S. business cycle peak and trough dates, as well as real (i.e., inflation-adjusted) GDPa measure of aggregate output.
How is the business cycle determined using GDP?
The broadest measure of economic activity is real gross domestic product (GDP), which is total economic production adjusted for inflation. The business cycle is the movement of the economy through these alternating phases of expansion and decline.
Is the business cycle affected by GDP?
The term “economic cycle” refers to the economy’s swings between expansion (growth) and contraction (contraction) (recession). Gross domestic product (GDP), interest rates, total employment, and consumer spending can all be used to indicate where the economy is in its cycle. Because it has a direct impact on everything from stocks and bonds to profits and corporate earnings, understanding the economic cycle may assist investors and businesses understand when to make investments and when to pull their money out.
What do the terms business cycle and GDP mean?
The term “business cycle” (also known as “economic cycle” or “boom-bust cycle”) refers to oscillations in output, commerce, and general economic activity that affect the entire economy. The business cycle refers to the period of expansions and contractions in the level of economic activities (business fluctuations) around a long-term growth trend and is defined as the upward and downward movements of GDP (gross domestic product) levels.
What factors go into determining a business cycle?
The concept of the deviation or growth cycle is a typical technique to measure the business cycle. The business cycle is defined as cyclical changes in overall economic activity around its long-term trend in this method.
What is the purpose of GDP?
GDP quantifies the monetary worth of final goods and services produced in a country over a specific period of time, i.e. those that are purchased by the end user (say a quarter or a year). It is a metric that measures all of the output produced within a country’s borders.
What is the impact of the business cycle on the economy?
A rise in property prices has a positive wealth effect, resulting in increased consumer expenditure. Lower consumer spending and bank losses result from falling housing prices. (Consumer spending and housing prices) The increase in property prices in the late 1980s triggered an economic boom. House price declines in the early 1990s were a major contributor to the recession of 1991-92.
External events have a powerful influence on people. When consumers are discouraged from buying and investing as a result of a string of poor economic news, a small downturn can quickly evolve into a larger recession. However, if the economy improves, this can result in a positive bandwagon effect. Consumers and banks alike are encouraged to borrow as the economy grows. This leads to increased economic growth. The business cycle is triggered by a lack of confidence.
According to this idea, investment is very volatile, and even modest changes in the rate of growth have a significant impact on investment levels. As a result, the business cycle becomes more volatile.
Causes of recessions
- House prices are falling, resulting in a negative wealth effect and decreasing consumer expenditure.
- The credit crisis has resulted in a rise in borrowing costs and a paucity of capital.
- Stock and money market volatility are eroding company and investment confidence.
Examples of business cycles
The Phillips curve appeared to illustrate a simple trade-off between unemployment and inflation in the postwar economy. There have been multiple economic booms, each followed by a downturn.
There was a classic boom and bust in the late 1980s, with economic expansion exceeding the long-term trend rate and resulting in inflation. The government eventually tried to lower inflation, and the boom turned into a recession. See Lawson’s Boom and Bust for further information.
Because we enjoyed a long period of economic expansion without inflation during the Great Moderation (1992-2007), some economists believed we had reached the conclusion of the business cycle. The worldwide credit crunch, however, plunged the global economy into recession in 2008, indicating that the business cycle had not yet concluded. See Financial Instability Hypothesis – Why Economic Stability Can Cause Financial Instability for more information.
Impact of business cycle on economy
- A choppy business cycle is thought to be harmful to the economy. Inflation with diverse economic costs is generally associated with periods of economic boom (rapid expansion in GDP). This inflationary expansion is typically unsustainable, resulting in a bust (recession).
- The most serious issue with the business cycle is that a recession results in significant resource waste. Unemployment for an extended period of time can lead to a loss of labor productivity as people become disillusioned and exit the workforce completely.
- A tumultuous business cycle creates uncertainty, which leads to decreased investment and, in turn, lower long-term economic growth.
- Other economists, such as J.Schumpeter, contend that capitalism’s creative destruction can be beneficial. In a recession, inefficient businesses close their doors, providing an incentive to lower costs.
Moderation of business cycle
- Monetary authorities attempt to keep business cycle swings to a minimum. They want to avert a recession as well as an inflationary boom. Interest rates are the principal tool used in the UK to smooth the business cycle. Fiscal policy is another tool that the government can use. In a recession, the government may strive to boost spending while lowering taxes.
- The success of monetary and fiscal policy, on the other hand, is dependent on a number of conditions; central banks are not always capable of overcoming a recession. Cuts in interest rates, for example, were insufficient to halt the crisis and restore to normal growth in 2008 and 2009. This was due to the severity of the recession, which made banks wary of lending.
Is the business cycle inevitable?
The business cycle, according to some economists, is a necessary component of any economy. Even downturns have a role to play since they tend to’shake-up’ the economy, weeding out ‘inefficient’ businesses and increasing incentives to decrease expenses and be more efficient. However, other economists argue that even ‘good efficient’ firms can go out of business during a recession, resulting in a permanent loss of productive capacity.
What is a business cycle example?
A classic example is the business cycle since the year 2000. Between 2000 to 2007, there was a surge in activity, which was followed by the Great Recession from 2007 to 2009.
It all started with the ease with which bank loans and mortgages could be obtained. Because new homebuyers could easily obtain loans, they did so. The number of homebuyers continued to rise, resulting in an increase in housing demand. As a result, property prices began to rise.
The Federal Reserve proceeded to decrease interest rates, and the government issued particular mortgage guarantees, allowing banks to lend money at even lower rates. Because the government insured the banks’ funds, they were unable to lose money and began lending to anyone. Because house prices continued to rise, they began enabling people to take out two or three mortgages on a single property. People spent the money on boats and cars, boosting economic activity even more.
Because expansions and other stages of the economic cycle are evaluated in real GDP, this inflation created a misleading sense of expansion, leading to excessive speculation. The activity peaked in December 2007. People began to recognize what had happened at this time, and housing prices began to plummet. In addition, the federal funds rate was raised to prevent excessive borrowing, leading mortgage interest payments to rise. With rising interest rates and falling home prices, many homeowners were left with sub-prime loans that they would eventually fail on.
The economy shrank from late 2007 to 2009, when it bottomed out and began to recover, bringing the cycle to a close.
Quiz: What does GDP say about business cycles?
What can economists learn about business cycles from the gross domestic product (GDP)? When GDP records are compared to one another chronologically, a pattern emerges. Economists will recognize what stage of the business cycle the country is in based on whether the trend is increasing or decreasing.
What is extension of the business cycle?
In economics, expansion is an upward trend in the business cycle marked by a growth in production and employment, which leads to an increase in household and business incomes and spending. Although not all people and businesses receive income improvements as a result of expansion, their increased confidence in the future encourages them to make larger purchases and investments.