Business Cycles

Business cycles are fluctuations in economic activity that happen irregularly in developed countries. The measurement of these fluctuations is done through real gross domestic product (GDP), which is the sum total of all goods and services produced in an economy, weighted by market prices. A business cycle contraction or recession is understood as a period of at least two subsequent quarters (three-month periods) where the real GDP falls, followed by a time frame of at least six months where it continues to decline. Real GDP then experiences growth, which marks the beginning of a new business cycle. The duration of business cycles varies, with most contractions lasting for less than a year, and real GDP declining by 1 to 6 percent. Expansions are more variable, but they usually last from two to six years.

Business cycles have been around since colonial times. However, the data for that period is limited, making it difficult to accurately date cycles. Although business cycles are defined in terms of GDP, other economic variables tend to move together with it. Aggregate consumption expenditures rise and fall in tandem with GDP. Investment also moves similarly, but during expansions, it tends to increase at a higher pace than GDP, and during recessions, it falls more rapidly. The trade balance increases as GDP declines and vice versa. During expansions, imports tend to rise, while during contractions, they fall. Interest rates, especially short-term interest rates, tend to increase during expansions and decrease during contractions. The aggregate price level moves up and down along with GDP, as do profits.

Aggregate employment tends to rise during expansions and fall in contractions, usually fluctuating less than GDP. The unemployment rate rarely goes up by more than 4 percent during a recession. This is partly because the average hours worked per worker rise and fall with the cycle, and partly because firms tend to retain some workers during recessions to avoid the need to rehire when the expansion begins. As a result, output per worker falls during recessions.

Some other economic variables also move in tandem with GDP. The so-called "leading indicators" tend to precede changes in GDP. They include capacity utilization by industry, construction starts or plans, orders received for capital equipment, new business formation, new bond and equity issues, and business expectations. Analysts study these indicators along with the aggregate variables to predict business cycles, which is particularly challenging when forecasting the timing of turning points between expansion and contraction. While severe contractions affect every sector of the economy, milder contractions are observed only in some sectors, and employment continues to rise in about a quarter of industries.

References

Szostak, R. (2003). Business Cycles. In S. I. Kutler (Ed.), Dictionary of American History (3rd ed., Vol. 1, pp. 582-586). Charles Scribner's Sons. https://link.gale.com/apps/doc/CX3401800612/CSIC?u=miam11506&sid=bookmark-CSIC&xid=b4112e3f