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What Is the Economic Cycle?
Let me explain the economic cycle to you—it's also called the business cycle, and it refers to the ups and downs in economic activity, swinging between times of expansion and contraction.
These stages are predictable in pattern, but you can't always pinpoint their timing. We look at things like gross domestic product (GDP), interest rates, total employment, and consumer spending to figure out where the economy stands and when the next shift might happen.
If you're an investor or run a business, grasping this cycle is key because it affects when you should invest or pull back—each phase impacts stock and bond prices, plus corporate earnings and profits.
Stages of the Economic Cycle
An economic cycle tracks how the economy shifts from expansion to contraction and loops back. Expansion means growth, while contraction includes recessions where activity drops for months. There are four main stages: expansion, peak, contraction, and trough.
Expansion
In the expansion stage, the economy grows quickly, interest rates stay low, and production ramps up. You'll see positive trends in employment, wages, profits, output, demand, and supply. Money flows well, and borrowing is cheap, but watch out—this can lead to inflation as the money supply grows.
Peak
The peak hits when growth reaches its max. Prices and indicators might hold steady briefly before dropping. This point often brings imbalances that need fixing, so businesses start rethinking budgets and spending, sensing the cycle's top.
Contraction
Contraction kicks in as growth slows, jobs decrease, and prices stall. Demand falls, and if businesses don't cut production fast, markets get oversupplied, pushing prices down. If it drags on, this can turn into a full depression.
Trough
The trough is the bottom, where supply and demand hit rock bottom before bouncing back. It's tough—spending and income stagnate, hurting everyone. But it's also a chance for you and businesses to reorganize finances for the coming recovery.
Measuring Economic Cycles
To measure cycles, we use key metrics that show the economy's position and direction. The National Bureau of Economic Research (NBER) officially dates U.S. cycles, focusing on GDP changes, measuring from trough to trough or peak to peak.
Since the 1950s, U.S. cycles have averaged about five and a half years, but lengths vary widely—from 18 months in 1981-1982 to the long expansion starting in 2009. NBER noted peaks in 2019 and 2020, with quarterly and monthly highs differing.
This variation shows cycles aren't like regular waves or pendulums. Economists debate what drives their length and existence.
Managing Economic Cycles
Businesses and investors must handle strategies across cycles to survive and maybe profit, not control them. Governments might use expansionary fiscal policy with deficit spending in recessions, or contractionary policy with taxes and surpluses to cool expansions.
Central banks adjust with monetary policy—lowering rates or expanding money in downturns to encourage spending, or raising rates to slow credit in expansions.
In expansions, look to sectors like technology, capital goods, and energy for opportunities. During contractions, focus on utilities, consumer staples, and healthcare that hold up better.
If your business tracks the economy, signs of a recession mean hold off on expanding and build cash reserves instead.
Economic Theory
Monetarism says governments can stabilize by controlling money supply growth, linking cycles to credit where interest rates affect borrowing and activity.
The Keynesian view points to unstable investment demand causing demand changes that drive cycles. Gloomy sentiment slows investment, leading to less spending, layoffs, and a sour economy—needing government stimulus to fix.
What Are the Stages of an Economic Cycle?
The cycle has four stages: expansion, peak, contraction, and trough. U.S. cycles average five and a half years since 1950, varying in length. Indicators like GDP, spending, rates, and inflation mark stages, with NBER determining lengths.
What Happens in Each Phase of the Economic Cycle?
Expansion brings growth over quarters, with low rates, rising jobs, and strong confidence. Peak is max output, ending expansion before declines in jobs and housing. Contraction features higher unemployment, tight credit, and falling prices at the trough.
What Causes an Economic Cycle?
Causes are debated. Monetarists tie it to credit cycles where rates influence spending. Keynesians blame volatile investment demand affecting overall spending and jobs.
The Bottom Line
The economic cycle is the economy's expansion-contraction pattern, peaking then contracting to a trough before expanding again. Metrics like GDP, rates, jobs, and spending define it. Theories explain drivers, and cycle stages impact your business and investment choices.
Key Takeaways
- Every economic cycle has four stages: expansion, peak, contraction, and trough.
- Once the trough is reached, the cycle repeats.
- The causes of a cycle are hotly debated by economists.
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