The business world is not stable. The situation in world economics is changing all the time. These changes are unpredictable for the general public. Yet, economists who study macroeconomics have learned to make predictions thanks to the theory of business cycles. There are four business cycles: expansion, peak, contraction, and recovery. Each cycle has its own peculiarities and influences world economics in a different way. The business essay below analyzes how exactly every cycle changes the economic situation.
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What Are the Main Business Cycles and How Do They Affect World Economics?
First explanations of what the business cycle is we can find in the book “Measuring Business Cycles” (Burnes and Mitchell), and it considered to be classical definition till nowadays:
“Business cycles are a type of fluctuation found in the aggregate economic activity of nations that organize their work mainly in business enterprises: a cycle consists of expansions occurring at about the same time in many economic activities, followed by similarly general recessions, contractions, and revivals which merge into the expanding phase of the next cycle; in duration, business cycles vary from more than one year to ten or twelve years; they are not divisible into shorter cycles of similar characteristics with amplitudes approximating their own.”
Different theories appeared in the Macroeconomics after the years of investigations and observations, and now it is common to identify four business cycles: expansion, peak, contraction and through (or recovery).
Understanding of business cycles is an opportunity to interpret the economic numbers and determine the situation in the economy, giving a chance to build the future forecasts, based on the theories of business cycles.
After The Great Depression, the macroeconomic studies changed dramatically. In the modern economics courses the clearest definition of business cycle is “the periodic but irregular up-and-down movements in economic activity, measured by fluctuations in real GDP and other macroeconomic variables” (“Business Cycles: Definition And Concept”).
Each business cycle consists of four stages:
- Expansion (or boom) – is a speedup in the of economic activity, marked from trough to peak. The period is characterized by increasing employment, economic growth, and upward pressure on prices.
- Peak – is the highest point of a business cycle and the point where expansion is transforming into contraction. Here the economy produces its maximum possible output, employment is equal or above full employment, and the pressure of inflationary on prices is obvious.
- Contraction (also known as recession or depression) means a slowdown in the development of economic activity defined by low or inert growth, high unemployment, and falling prices. It is the period from peak to trough, where growth slows, employment declines (unemployment increases), and pricing pressures drop.
- Trough – is the lowest critical point of a business cycle in which a contraction turns into an expansion. At this point, the economy has hit a critical mark from which the next cycle of expansion and contraction will arise (“Reading: The Business Cycle: Definition And Phases | Introduction To Business”).
As we can see from the characteristics of business cycles, each of them has its pattern of behavior, and a direct influence on the factors as unemployment, prices, productivity and investments, what means affection on the economics of the individual countries and all the world.
Talking about the duration of business cycles, a group of economists of the 20th century suggested classification based on periodicity of these cycles (Schumpeter, Joseph Alois et al.). They were named by the persons who made the discover or proposal:
– the Kitchin inventory cycle of 3 to 5 years;
– the Juglar fixed-investment cycle of 7 to 11 years;
– the Kuznets infrastructural investment cycle of 15 to 25 years;
– the Kondratiev wave or long technological cycle of 45 to 60 years.
Business cycles are always coming together with dramatic changes in a labor market. Total unemployment lags peaks in output because when the economy first slows down, some workers are still finding jobs (even as new layoffs may be increasing). When the economy begins to improve, the last inputs to be re-added by firms are more workers, so unemployment also lags troughs. Economists also closely follow two other variables related to unemployment. The first is the duration of unemployment, which is countercyclical and a lagging indicator of peaks and troughs. The second is initial unemployment claims, which are the number of new claims for unemployment insurance. Initial unemployment claims are more sensitive to changes in the business cycle than total unemployment. Unlike total unemployment, which lags peaks and troughs because of lags in the hiring process, initial unemployment claims are a leading indicator because firms anticipate changes in economic conditions and increase layoffs before production falls and decrease layoffs before conditions improve. The volatility of unemployment indicates that the labor market plays a critical role in business cycles.
Inflation. There are two commonly used measures of inflation. The GDP deflator measures changes in the price of all goods produced within U.S. borders and included in GDR Inflation as measured by the GDP deflator is weakly procyclical, falling during only five of the last ten recessions. It lags peaks and troughs primarily because it includes investment goods and government purchases, the prices of which are slow to respond to changes in economic conditions.
Interest rates. Both short-term and long-term interest rates are procyclical. In general, short-term and long-term interest rates are lagging indicators of business cycle turning points because inflation is a key determinant of the level of interest rates, which tends to lag business cycle fluctuations.
Capacity utilization. Capacity utilization is the employment rate of capital. For obvious reasons, capacity utilization is procyclical. Its downturns tend to lead peaks because firms typically purchase significant amounts of capital during expansions and this capital usually comes on line before a downturn, reducing capacity utilization. On the other hand, capacity utilization lags troughs because firms first reduce inventories and delay new investment projects for as long as possible during downturns.
Output per hour (productivity). Increasing productivity is the primary way that economies improve the standards of living of its citizens over the long run. However, in the short run, the relationship between GDP and productivity is much less clear. Productivity is procyclical, falling during nine of the last ten recessions, and it does lead peaks and troughs in the business cycle. However, the reasons for this remain unclear.
Consumer confidence. Expectations play a key role in many of the explanations of business cycles discussed later in the book because of their importance in influencing investment and consumption decisions. As a result, measures of consumer confidence are very carefully watched by economic forecasters.
Stock prices. One of the most visible and closely followed macroeconomic series, stock prices are procyclical and a leading economic indicator of peaks and troughs. The same holds true for two other variables that are fundamental determinants of stock prices: consumer expectations and corporate profits. The problem with using the stock market to predict business cycles is that stock prices are much more volatile than GDP. Stock prices cannot be relied on exclusively when forecasting because of the high probability of false signals.
The money supply. M2 is the most commonly used definition of the money supply and is the summation of currency, checkable deposits, savings deposits, money market mutual funds, small certificates of deposit, and traveler’s checks. M2 is strongly procyclical and a leading indicator of peaks and troughs in the business cycle. Federal Reserve policy largely, but not entirely, determines the level of M2.
The consumer price index (CPI) measures changes in the prices of consumer goods. Like the GDP deflator, it is only mildly procyclical, falling during six of the last ten recessions. Unlike the GDP deflator, changes in the CPI are roughly coincident with business cycle turning points because consumer prices are more sensitive to changes in prevalent market conditions.
Real wages. Real wages (true meaning adjusted for changes in inflation) do not behave consistently over business cycles, although changes in the real wage do always lag behind peaks and troughs in GDP. (Knoop, Todd A).
So what is, is the influence of business cycles to the world economy?
To summarize information mentioned above, I would like to refer to Adam Smith and his book “The Wealth of Nation,” who cited four main reasons for economic growth:
1) the labor force;
2) the level of labor specialization;
3) the size of capital stock;
4) the situation on the market of technologies.
Labor and capital stock are the first sources of economic growth. At the same time, specialization of labor and technologies make labor and capital stock move productive, what multiplies the economic output. Encouraging entrepreneurship also stimulates productivity, because it provokes efficiency in the ways of providing goods and services, or even cause the creation of the new goods and services. Increases in productivity allow to make more investments in development and research and take more risks in creating new enterprises. With economic growth the quality of products and services growth, what also, in general, let people enjoy their lives more.
In the fast-pacing environment of our nowadays world, the progress of technologies takes the first place among factors which push the economic growth. Primary, we are talking about computers, automation, and networking.
The size of the economy or business also influenced by their size: small business tends to grow faster, then a big one, because of having a smaller foundation to grow from, and in the opposite – the bigger economy is, the smaller will be the growth.
Eventually, economic growth can not increase infinitely; it will be changed by another business cycles. Peaks are usually synonyms of prosperity, but they are always coming with inflation when recessions bring unemployment growth. Business cycles can have a different duration from a couple of months to several years. However, the trend of economic growth in the world goes up.
When the economy goes down, the first who feel the influence are the producers of capital and durable consumer goods. The consumers feel insecure buying expensive things and most likely will cut expenditures and that is the reason why we can see the economy falling. However, after a while, people realize that they can not delay their purchasing any more. A good reason can be a medical therapy, which cannot wait anymore, or the fact that a car repair became more expensive than buying a new car.
One more thing that helps in economic recovery is that in the period of cutting down people’s spending helps debtors to accumulate and pay back their debts. For this reason, they start buying more when the opportunity of purchase starts again.
A special place I would leave for the politically based business cycles – the one which depends on a political decision. The party which heads the government brings the policy of growth and inflation, and the replacing regime comes with reducing of growth and inflation but creates unemployment in the country.
When a new party is elected, it usually comes with opposite policy to create a reputation for economic competence. There is an idea in recent years, that this “electoral business cycle” theory that demonstrates the promoting prosperity by elected politicians before elections to ensure re-election. However, afterward, the citizens pay for it with recessions (Kalecki, Michał).
There were many hypotheses in the history trying to explain the reasons of existence of business cycles. Economists argue if it is the influence of innovation or money supplies, some of the economists even accept that the exact reason is still not detected. In any case, it is common to conclude that the main impact of business cycles make the fluctuation of customer expenses.
The historical events in the next chronology The Great Depression, Industrial Revolution, World War II, Golden Age of Capitalism and Late 2000 recession let us observe and realize the actions and results of four business cycles – expansion, peak, recession, and trough. Knowledge and analysis of these facts give people the deep understanding of the business cycles on the world economics.
However, this these skills do not let society to build the stable forecasts in the economy; it only gives a chance to guess a forecast depending on the market fluctuations. In any case, the conclusions of this paper research are that business cycles make reasonable impact on the world economy, affecting the spheres of labor, technology, capital, and production.
1. A. F. Burns and W. C. Mitchell, Measuring business cycles, New York, National Bureau of Economic Research, 1946.
2. “Business Cycles: Definition And Concept.” Economics Discussion, 2017, http://www.economicsdiscussion.net/business-cycles/business-cycles-definition-and-concept/4115.
3. “Reading: The Business Cycle: Definition And Phases | Introduction To Business.” Courses.Lumenlearning.Com, 2017, https://courses.lumenlearning.com/introbusinesswmopen/chapter/reading-the-business-cycle-definition-and-phases/.
4. Schumpeter, Joseph Alois et al. History Of Economic Analysis. London, Routledge, 1997.
5. Knoop, Todd A. Recessions, And Depressions: Understanding Business Cycles. Praeger, 2004.
6. Smith, Adam. The Wealth Of Nations. Tustin, Xist Publishing, 2015.
7. Kalecki, Michał. “Political Aspects Of Full Employment | MR Online.” MR Online, 2017, https://mronline.org/2010/05/22/political-aspects-of-full-employment/.