What Is the Economic Cycle?
An economic cycle, also known as a business cycle, refers to tát economic fluctuations between periods of expansion and contraction. Factors such as gross domestic product (GDP), interest rates, total employment, and consumer spending can help determine the current economic cycle stage.
Understanding the economic period can help investors and businesses determine when to tát make investments and when to tát pull their money out, as each cycle impacts stocks and bonds as well as profits and corporate earnings.
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- An economic cycle is the overall state of the economy as it goes through four stages in a cyclical pattern: expansion, peak, contraction, and trough.
- Factors such as GDP, interest rates, total employment, and consumer spending can help determine the current stage of the economic cycle.
- The causes of a cycle are highly debated among different schools of economics.
Stages of the Economic Cycle
An economic cycle is the circular movement of an economy as it moves from expansion to contraction and back again. Economic expansion is characterized by growth and contraction, including recession, a decline in economic activity that can last several months. Four stages characterize the economic cycle or business cycle.
During expansion, the economy experiences relatively rapid growth, interest rates tend to tát be low, and production increases. The economic indicators associated with growth, such as employment and wages, corporate profits and output, aggregate demand, and the supply of goods and services, tend to tát show sustained uptrends through the expansionary stage. The flow of money through the economy remains healthy and the cost of money is cheap. However, the increase in the money supply may spur inflation during the economic growth phase.
The peak of a cycle is when growth hits its maximum rate. Prices and economic indicators may stabilize for a short period before reversing to tát the downside. Peak growth typically creates some imbalances in the economy that need to tát be corrected. As a result, businesses may start to tát reevaluate their budgets and spending when they believe that the economic cycle has reached its peak.
A correction occurs when growth slows, employment falls, and prices stagnate. As demand decreases, businesses may not immediately adjust production levels, leading to tát oversaturated markets with surplus supply and a downward movement in prices. If the contraction continues, the recessionary environment may spiral into a depression.
The trough of the cycle is reached when the economy hits a low point, with supply and demand hitting bottom before recovery. The low point in the cycle represents a painful moment for the economy, with a widespread negative impact from stagnating spending and income. The low point provides an opportunity for individuals and businesses to tát reconfigure their finances in anticipation of a recovery.
Measuring Economic Cycles
Key metrics determine where the economy is and where it's headed. The National Bureau of Economic Research (NBER) is the definitive source for marking the official dates for U.S. economic cycles. Relying primarily on changes in GDP, NBER measures the length of economic cycles from trough to tát trough or peak to tát peak.
Since the 1950s, a U.S. economic cycle, on average, lasted about five and a half years. However, there is wide variation in the length of cycles, ranging from just 18 months during the peak-to-peak cycle in 1981 to tát 1982 up to tát the expansion that began in 2009. According to tát the NBER, two peaks occurred between 2019 and 2020. The first was in the fourth quarter of 2019, a peak in quarterly economic activity. The monthly peak happened in a different quarter, which was noted as taking place in February 2020.
This wide variation in cycle length dispels the myth that economic cycles are a regular natural activity akin to tát physical waves or swings of a pendulum. But there is debate as to tát what factors contribute to tát the length of an economic cycle and what causes them to tát exist in the first place.
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Businesses and investors need to tát manage their strategy over economic cycles—not ví much to tát control them but to tát survive them and perhaps profit from them.
Managing Economic Cycles
Governments, financial institutions, and investors manage the course and effects of economic cycles differently. During a recession, a government may use expansionary fiscal policy and rapid deficit spending. It can also try contractionary fiscal policy by taxing and running a budget surplus to reduce aggregate spending to tát prevent the economy from overheating during expansion.
Central banks may use monetary policy. When the cycle hits a downturn, a central ngân hàng can lower interest rates or implement expansionary monetary policy to tát boost spending and investment. During expansion, it can employ contractionary monetary policy by raising interest rates and slowing the flow of credit into the economy.
During expansion, investors often find opportunities in the technology, capital goods, and energy sectors. When the economy contracts, investors may purchase companies that thrive during recessions, such as utilities, consumer staples, and healthcare.
Businesses that track the relationship between their performance and business cycles can plan strategically to tát protect themselves from approaching downturns and position themselves to tát take maximum advantage of economic expansions. For example, if your business follows the rest of the economy, warning signs of an impending recession may suggest you shouldn't expand. You may be better off building up your cash reserves.
Monetarism suggests that government can achieve economic stability through their money supply's growth rate. It ties the economic cycle to tát the credit cycle, where changes in interest rates reduce or induce economic activity by making borrowing by households, businesses, and the government more or less expensive.
The Keynesian approach argues that changes in aggregate demand, spurred by inherent instability and volatility in investment demand, are responsible for generating cycles. When business sentiment turns gloomy and investment slows, a self-fulfilling loop of economic malaise can result. Less spending means less demand, which induces businesses to tát lắc off workers. According to tát Keynesians, unemployment means less consumer spending, and the whole economy sours, with no clear solution other phàn nàn government intervention and economic stimulus.
What Are the Stages of an Economic Cycle?
An economic cycle, or business cycle, has four stages: expansion, peak, contraction, and trough. The average economic cycle in the U.S. has lasted roughly five and a half years since 1950, although these cycles can vary in length. Factors to tát indicate the stages include gross domestic product, consumer spending, interest rates, and inflation. The National Bureau of Economic Research (NBER) is a leading source for indicating the length of a cycle.
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What Happens in Each Phase of the Economic Cycle?
In the expansionary phase, the economy experiences growth over two or more consecutive quarters. Interest rates are typically lower, employment rates rise, and consumer confidence strengthens. The peak phase occurs when the economy reaches its maximum productive output, signaling the over of the expansion. After that point, employment numbers and housing starts to tát decline, leading to tát a contractionary phase. The lowest point in the business cycle is a trough, which is characterized by higher unemployment, lower availability of credit, and falling prices.
What Causes an Economic Cycle?
The causes of an economic cycle are widely debated among different economic schools of thought. Monetarists, for example, liên kết the economic cycle to tát the credit cycle. Here, interest rates, which intimately affect the price of debt, influence consumer spending and economic activity. On the other hand, a Keynesian approach suggests that the economic cycle is caused by volatility or investment demand, which in turn affects spending and employment.
The Bottom Line
The economic or business cycle refers to tát the cyclical pattern experienced by the economy. The economy remains in an expansion phase until it reaches its peak, reversing to tát the downside and entering a contraction before a trough, and begins to tát expand once again. GDP, interest rates, employment levels, and consumer spending can help define the economic cycle. Although there are different economic theories to tát explain what drives the economic cycle, the conditions associated with each stage can impact business and investment decisions.