What is the business cycle?

The business cycle is the way the economy of a country goes up and down over time. It has four main parts: growth, downturn, recession, and recovery.

The economy is growing when companies are doing well and lots of people have jobs. People feel good and buy more things. This part is called an expansion or boom. It is the time between the lowest point, or trough, of the last cycle to the highest point, or peak, of the current cycle.

After things have been good for a while, the economy usually starts to slow down. Companies make less money and some people lose their jobs. This is called a downturn. It is the part of the cycle from the peak to the trough.

If the economy is bad for a long time, it is called a recession. This is when the economy has gone down for at least six months. Many people lose their jobs and companies go out of business during a recession.

Eventually things start to get better again. This is called a recovery. Companies slowly start making more money and hiring workers again. Recovery is the period from the trough of the cycle to the peak of the next cycle when the economy is expanding again.

How long does each business cycle last?

Business cycles do not always last the same amount of time. Since World War II, business cycles in the United States have usually been between 2 to 10 years long. The average is about 5 and a half years.

The longest expansion was from 1991 to 2001 and lasted almost 10 years. The shortest was in 1980 and only lasted 12 months.

The longest recession since World War II was from 2007 to 2009. It was so bad people called it the “Great Recession.” It lasted 18 months. Most of the time recessions are much shorter, averaging about 11 months.

What causes the business cycle?

Economists do not always agree about what makes the business cycle happen. They think it is caused by changes in things like:

How much money people and businesses have to spend
How many things companies are making
How many people have jobs
Prices of goods and services
Interest rates
Levels of government spending

When consumers have more money, they tend to buy more. This makes companies produce more and hire more workers. The opposite happens when people have less to spend.

Businesses also play a role. When they expect good times ahead, they make more products and build more factories and stores. This helps the economy grow. But if they get scared about the future, they make less and might lay off workers.

Governments can impact the business cycle too. If they spend more money or cut taxes, it can give the economy a boost. But if they cut spending or raise taxes, it can slow things down.

Interest rates also matter a lot. When rates are low, it is easier for people and companies to borrow money to spend. This usually helps the economy grow. When rates go up, borrowing gets more expensive and this can slow growth.

Phases of the Business Cycle

Let’s look more closely at each part of the cycle:

Expansion

This is when the economy is growing. Here are some key things that happen in an expansion:

GDP (the total value of goods and services) is increasing
Incomes are rising
Unemployment is low
Consumer spending is up
Business profits are growing
Stock prices are rising
Inflation can start to increase

If the expansion goes on for too long, the economy can start to “overheat.” This is when growth is happening so fast it is hard for companies to keep up. They raise prices and inflation can get high. The central bank usually raises interest rates to cool things off.

Peak

The peak is the highest point of the business cycle. This is when the expansion ends and the economy is doing the best it can. The peak comes right before things start slowing down.

It can be hard to know exactly when the peak happens until you are looking back later. At the time, people are usually feeling good. Unemployment is low, shops and restaurants are busy, and companies are making a lot of money.

Contraction

After the peak, the economy starts going down. Another word for this is contraction. It is the opposite of expansion. Here’s what happens:

Overall economic activity is slowing
Employment is falling, layoffs are happening
Incomes go down or grow more slowly
Consumers buy less
Company sales and profits decline
Stock market usually goes down

If the contraction is really bad, the economy can go into a recession. That is the next phase.

Recession

A recession happens when the economy has been contracting for at least 6 months. Some signs of a recession are:

People losing their jobs
Businesses closing
Less money being spent by consumers
Falling housing prices and sales
Government has less tax money coming in

Recessions are usually bad for most people. Many lose their jobs or have their pay cut. Businesses see sales fall and some go bankrupt. Overall, people are not as well off as they were before.

The good news is that recessions do not last forever. The economy will eventually hit bottom. This low point is called the trough.

Trough

The trough is the lowest point of the recession. Things might still seem bad but the economy is not getting any worse. It has stopped going down.

At the trough, unemployment is usually the highest it will get. Businesses are still struggling but the worst may be over for them. Consumers are spending the least they will spend.

After the trough, things slowly start to get better as the economy moves into recovery.

Recovery

In the recovery phase, the economy starts growing again. It is bouncing back from the recession. Recovery looks like this:

Businesses are hiring again, so unemployment slowly falls
People start spending a bit more
Company sales and profits turn positive
Housing market improves
Stock market goes up

Recovery can take a while. It is not a quick bounce back in most cases. It can take months or years to get back to the level the economy was at before the recession hit.

As the recovery gains steam, it turns into an expansion and the whole cycle starts over again from the beginning. The economy goes from the trough back up to a new peak, and on it goes.

Impact of the Business Cycle

The business cycle affects everyone. How much it impacts a person depends on many things, like if they have a job, own a business, or have money in the stock market.

Expansion and the time near the peak are usually the best parts of the cycle for most people. Jobs are easy to get, incomes are going up, and people can afford to buy more. Many businesses are thriving. The downside is that if the central bank thinks the economy is growing too fast, it will raise interest rates. This makes loans more costly for people and businesses.

Recessions and the time near the trough are the hardest parts for most people. Many workers lose their jobs or have their hours cut. Businesses often have to close stores or lay off staff. Investments like stocks and houses usually lose value. Borrowers may have a harder time paying back loans. This can all lead to more people struggling to make ends meet.

Governments have a big job during recessions. They often need to spend more money to help boost the economy. At the same time, they are getting less tax money because people and businesses are earning less. This can make government debt grow.

Tracking the Business Cycle

Economists have ways to figure out where the economy is in the business cycle. They study lots of data, like:

GDP numbers
Employment and unemployment rates
Incomes
Consumer spending
Business and factory activity
Housing data
Inflation rates

They look at which direction these things are going. Are they moving up, down, or staying the same? How fast are they changing? Using this data, experts can usually tell which phase of the cycle the economy is in.

Predicting the length and severity of each phase is not an exact science. Things can change fast in the economy and throw off forecasts. Events like natural disasters, wars, and disease outbreaks can impact the business cycle in ways that are hard to predict. So can big swings in things like oil prices or the stock market.