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The Business Cycle

The Business Cycle



The most widely-used measure of the health of an economy is GDP. Real GDP, measured within an economy over time, indicates whether the economy is expanding or contracting, and by how much.

When real GDP is rising, the economy is growing. A healthy economy will grow over time; an increase in real GDP per capita is an indication of a rising standard of living.

Economies do not grow at a constant rate, however. Changes in real GDP follow a pattern, which is called the business cycle. The business cycle varies in length of time, but the pattern is always the same - a series of stages in this order: expansion, peak, contraction, and trough.

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Business Cycle



Recession Duration


Recession Frequency


Recession Severity



Since economic growth is desirable, special focus is on recessions and their side effects.


Definition of a recession:


Recession: A period of significant decline in total output, income, employment, and trade, usually lasting from six months to a year, and marked by widespread contractions in many sectors of the economy.



This is the official definition used in the United States, as defined by the National Bureau of Economic Research (NBER).

Many people consider a recession to be two consecutive quarters of declining real GDP, but that is not the official definition. The official definition of a recession is not based on GDP statistics at all, although as a practical matter the results would probably be the same if it were. NBER focuses on monthly data while real GDP is measured quarterly. NBER looks at these monthly numbers: employment; real personal income less transfer payments; the volume of sales of manufacturing and wholesale-retail sectors adjusted for price changes; and industrial production.


Indicators



Indicators are variables that tend to move along with the business cycle. They are classified as leading indicators, coincident indicators, and lagging indicators. Indicators are used to identify changes in the stage of the business cycle.


Leading indicators: Economic variables that tend to change before real GDP changes. Since these are changes which occur before changes in output occur, they are used to predict future output. However, leading indicators can be very unstable. Unless they move in the same direction for several consecutive months, their usefulness for predictions is limited.


Coincident indicators: Economic variables which tend to change at the same time that real GDP changes.


Lagging indicators: Economic variables which tend to change subsequent to changes in real GDP.


The following table summarizes these indicators:


Economic Indicators




More topics related to the business cycle:


Unemployment


Inflation