Businesses and economies are forever in flux, experiencing periods of ups and downs. These fluctuations, known as the business cycle, demonstrate expansions that occur across multiple economic activities, followed by general contractions. This cycle, although recurrent, isn’t periodic.
Key Highlights
- Concerted Cyclical Upturns and Downturns: Business cycles are composed of synchronized cyclical upswings and downturns in broad economic measures such as output, employment, income, and sales.
- Phases of the Business Cycle: Alternating phases include expansions and contractions.
- Recession Triggers: Contractions can lead to recessions, but not all contractions are labeled as recessions.
- Recession Dynamics: Recessions typically begin at a business cycle’s peak and conclude at its trough.
- Intensity Measurement: The severity of a recession is quantified using indicators like depth, diffusion, and duration.
Mastering the Business Cycle
Business cycles prominently feature alternating expansion and contraction phases in aggregate economic activities. Key factors include real GDP, industrial production, employment, income, and sales—all crucial indicators of the U.S. business cycle. While the informal rule gauges recessions by two consecutive quarters of GDP decline, it’s not the sole determinant, as emphasized by the NBER. Declines in real GDP are among various recession indicators.
In contrast, economic recoveries occur when the recessionary downward spiral reverses, leading to increased output, job growth, rising incomes, and boosted sales, promoting a self-sustaining expansion if consistent.
Measuring and Dating Business Cycles
A recession’s intensity is gauged by the three D’s: depth, diffusion, and duration. Depth is defined by the peak-to-trough decline magnitude in indicators like output, employment, income, and sales. Diffusion measures its spread across economic activities and regions, while duration marks the peak-to-trough time interval.
Expansions commence at the cycle’s trough and persist until the next peak, whereas recessions start at the peak, continuing until the subsequent trough. The National Bureau of Economic Research (NBER) provides the U.S. business cycle chronology, assessing recessions based on widespread, significant economic activity declines lasting several months. The NBER typically confirms recession start and endpoints long post-occurrence, refining its decisions after comprehensive account revisions, like it did after the 2007-09 recession.
Typical Recession Duration
On average, U.S. recessions last about 11 months post-World War II. The Great Recession topped this, lingering for 18 months. Historically, expansions tend to outlast contractions in the U.S. Pre-1945 contractions averaged around 18 months, decreasing to about 11 months post-1945, while expansions progressively stretched longer—from 29 months in the late 19th century to 70 months ending in 2009.
Stock Prices and the Business Cycle
Stock price downturns often coincide with business cycle downturns, like contractions and recessions. During the Great Recession, the Dow Jones fell by 51.1%, and the S&P 500 plummeted by 56.8% between October 2007 and March 2009. This downturn results from businesses adopting defensive measures and diminishing investor confidence amidst economic uncertainties, sparking panic and reduced investments until economic recovery aligns with market confidence.
The Stages of the Business Cycle
The business cycle includes four phases:
- Expansion: Increased production, employment, and incomes.
- Peak: The zenith of economic activity.
- Contraction: Decreased production and employment.
- Trough: The cycle’s lowest point, preceding recovery.
Economic Duration Insights
According to U.S. government studies, the average business cycle in America spans about 6.33 years. The 2009-2020 period marked the longest economic expansion on record, extending 128 months.
Conclusion
The business cycle encapsulates the economy’s path through expansion, peak, contraction, and trough phases. Expansions denote periods of rising profits and output, while contractions suggest dwindling profits and economic declines. Notably, expansions are the longer-lasting phase in the U.S. economy, whereas contractions, though impactful, consume less time in economic history.
Related Terms: economic expansion, economic contraction, peak, trough, GDP, NBER.
References
- St. Louis Federal Reserve. “All About the Business Cycle: Where Do Recessions Come From?”
- The National Bureau of Economic Research. “Business Cycle Dating”.
- National Bureau of Economic Research. “Business Cycle Dating Procedure: Frequently Asked Questions. What is a Recession? What is an Expansion?”
- National Bureau of Economic Research. “The NBER’s Recession Dating Procedure”.
- National Bureau of Economic Research. “Business Cycle Dating Committee, National Bureau of Economic Research”.
- National Bureau of Economic Research. “US Business Cycle Expansions and Contractions”.
- Federal Reserve Bank of Atlanta. “Stock Prices in the Financial Crisis”.
- Congressional Research Service. “Introduction to U.S. Economy: The Business Cycle and Growth”, Page 2.
