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Investment -Business Cycle
The business or economic cycle refers to the swings of the economy between periods of growth and recession.
The Business (or Economic) Cycle
As indicated earlier, analysts and economists spend a considerable deal of energy trying to anticipate real GDP, which is affected by business cycles. Economy-wide swings in economic activity are called business cycles.
A business cycle is a cycle of fluctuations in the GDP around its long-term, natural growth rate. It is typified by the expansion and contraction in economic activity that an economy experiences over time.
Phases of an economic cycle may include the following:
Expansion
Peak Contraction
Trough
Recovery
The business or economic cycle refers to the swings of the economy between periods of growth and recession.
The Business (or Economic) Cycle
As indicated earlier, analysts and economists spend a considerable deal of energy trying to anticipate real GDP, which is affected by business cycles. Economy-wide swings in economic activity are called business cycles.
A business cycle is a cycle of fluctuations in the GDP around its long-term, natural growth rate. It is typified by the expansion and contraction in economic activity that an economy experiences over time.
Phases of an economic cycle may include the following:
Expansion
Peak Contraction
Trough
Recovery
There is no universal agreement on what the phases of business cycles are or when they begin and terminate. Some economists consider recovery as the start of an expansion phase, whilst others view recovery as the end of a trough phase.
Representation of a Business Cycle
The exhibit on the left illustrates a stylised picture of a business cycle. The degree of national economic activity is assessed by the GDP growth rate.
Exploring characteristics of expansions, peaks, contractions, troughs, and recovery stages will help us think creatively about business cycles.
During an economic growth, production increases, and both interest rates and inflation (a general rise in prices for items and services) tend to rise. A high rate of employment, which is the same as a low rate of unemployment, means that employees can demand greater wages, placing upward pressure on costs and prices.
Interest rates grow as more people and companies need loans to support their spending or investments. When an economy is developing faster than its resources could allow, inflation often arises, and unemployment tends to diminish; the increasing demand for products, services, and labor can create inflationary pressures.
At a peak, economic growth reaches a maximum level and begins to decelerate, or contract. Each country has a central bank that serves as the banker for the government and other banks. Central banks may employ policies to slow the economy and manage inflation.
Other reasons leading to the end of an expansion include a loss in consumer confidence or corporate confidence triggered by such events as rising oil prices, dropping real estate values, or declining equities markets. Shocks, such as natural disasters, or geopolitical events, such as war, can also lead to the end of an expansion.
During a contraction, the rate of economic growth declines. If economic activity, as measured by real GDP or any other measure, drops, this is negative growth, and a recession may develop. In a contraction, inflation and interest rates tend to reduce because of market forces and central bank policies, whereas unemployment tends to increase. In this scenario, central banks often employ policies to try to encourage economic growth. Federal governments may strive to stimulate the economy through direct spending measures.
What is a Recession?
There are numerous definitions linked with the term ‘recession’. In Europe, a recession is commonly defined as two consecutive quarters of negative growth. In the United States, the National Bureau of Economic Research (NBER) defines a recession as a significant decline in economic activity spread across the economy, lasting more than a few months, normally visible in real GDP, real income, employment, industrial production, and wholesale–retail sales.
Trough signals the conclusion of the contraction phase and the beginning of recovery. In a trough, the rate of economic growth stabilises, and there is no further reduction. Eventually, firms need to replace antiquated equipment, and people need to acquire new home products, prompting more expenditure. Lower interest rates may promote more borrowing to finance consumption. Finally, the economic growth rate begins to improve, and the economy enters a recovery phase.
Why does GDP go through cycles rather than rising in a straight line? To answer that, recall the four main components of GDP:
Consumer spending
Business expenditure
Government spending
Net exports (exports minus imports)
A contraction in any of these components can induce a fall in the economic growth rate. Furthermore, the effect of a change in one component is generally exacerbated since the components are linked. The example below demonstrates how some of these components may be affected by changes in the housing sector.
Example: The Housing Sector and the Business Cycle
When consumer confidence is high, consumer expenditure improves, especially spending on homes. Because of rising demand, house costs increase. This increases wealth, and further consumer (household) spending and investing takes place.
As consumer spending increases, company spending increases too because of the increased demand for products and services and the increased availability of cash emerging from increasing consumer investing. The economy expands and pushes towards a peak. If the demand for housing stabilises or drops, and customers begin to consider that home prices are too high, the price of homes may decline. A period of contraction begins. Consumer confidence and wealth both drop along with the decline in property values. This fall results in less consumer spending and investing, and corporations observe a decline in the demand for goods and services and a reduction in the availability of capital. Meanwhile, governments see a drop in tax revenues and an increasing demand for social services as unemployment rises.
Governments and central banks will then normally take steps to try to stimulate the economy. When that happens, consumer confidence improves again along with consumer spending, and the economy begins a phase of recovery (growth).
As described in the example, during periods of economic downturn, governments may engage in fiscal stimulus measures to stimulate demand. Central banks may improve access to credit and cut borrowing costs to help the economy stabilise and recover. By adopting these acts, central banks infuse money into the economy, which encourages consumers and companies to increase spending. Those who gain from this greater spending, in turn, boost their own expenditure. This is known as the multiplier effect.
As the economy shifts from trough to boom, companies begin to hire. Other consumers who observe job growth may become more confidence in their own employment prospects, even if they are already employed. With unemployment dropping and confidence soaring, consumers boost their spending. Psychology and consumer confidence can play a considerable influence on spending decisions.
Representation of a Business Cycle
The exhibit on the left illustrates a stylised picture of a business cycle. The degree of national economic activity is assessed by the GDP growth rate.
Exploring characteristics of expansions, peaks, contractions, troughs, and recovery stages will help us think creatively about business cycles.
During an economic growth, production increases, and both interest rates and inflation (a general rise in prices for items and services) tend to rise. A high rate of employment, which is the same as a low rate of unemployment, means that employees can demand greater wages, placing upward pressure on costs and prices.
Interest rates grow as more people and companies need loans to support their spending or investments. When an economy is developing faster than its resources could allow, inflation often arises, and unemployment tends to diminish; the increasing demand for products, services, and labor can create inflationary pressures.
At a peak, economic growth reaches a maximum level and begins to decelerate, or contract. Each country has a central bank that serves as the banker for the government and other banks. Central banks may employ policies to slow the economy and manage inflation.
Other reasons leading to the end of an expansion include a loss in consumer confidence or corporate confidence triggered by such events as rising oil prices, dropping real estate values, or declining equities markets. Shocks, such as natural disasters, or geopolitical events, such as war, can also lead to the end of an expansion.
During a contraction, the rate of economic growth declines. If economic activity, as measured by real GDP or any other measure, drops, this is negative growth, and a recession may develop. In a contraction, inflation and interest rates tend to reduce because of market forces and central bank policies, whereas unemployment tends to increase. In this scenario, central banks often employ policies to try to encourage economic growth. Federal governments may strive to stimulate the economy through direct spending measures.
What is a Recession?
There are numerous definitions linked with the term ‘recession’. In Europe, a recession is commonly defined as two consecutive quarters of negative growth. In the United States, the National Bureau of Economic Research (NBER) defines a recession as a significant decline in economic activity spread across the economy, lasting more than a few months, normally visible in real GDP, real income, employment, industrial production, and wholesale–retail sales.
Trough signals the conclusion of the contraction phase and the beginning of recovery. In a trough, the rate of economic growth stabilises, and there is no further reduction. Eventually, firms need to replace antiquated equipment, and people need to acquire new home products, prompting more expenditure. Lower interest rates may promote more borrowing to finance consumption. Finally, the economic growth rate begins to improve, and the economy enters a recovery phase.
Why does GDP go through cycles rather than rising in a straight line? To answer that, recall the four main components of GDP:
Consumer spending
Business expenditure
Government spending
Net exports (exports minus imports)
A contraction in any of these components can induce a fall in the economic growth rate. Furthermore, the effect of a change in one component is generally exacerbated since the components are linked. The example below demonstrates how some of these components may be affected by changes in the housing sector.
Example: The Housing Sector and the Business Cycle
When consumer confidence is high, consumer expenditure improves, especially spending on homes. Because of rising demand, house costs increase. This increases wealth, and further consumer (household) spending and investing takes place.
As consumer spending increases, company spending increases too because of the increased demand for products and services and the increased availability of cash emerging from increasing consumer investing. The economy expands and pushes towards a peak. If the demand for housing stabilises or drops, and customers begin to consider that home prices are too high, the price of homes may decline. A period of contraction begins. Consumer confidence and wealth both drop along with the decline in property values. This fall results in less consumer spending and investing, and corporations observe a decline in the demand for goods and services and a reduction in the availability of capital. Meanwhile, governments see a drop in tax revenues and an increasing demand for social services as unemployment rises.
Governments and central banks will then normally take steps to try to stimulate the economy. When that happens, consumer confidence improves again along with consumer spending, and the economy begins a phase of recovery (growth).
As described in the example, during periods of economic downturn, governments may engage in fiscal stimulus measures to stimulate demand. Central banks may improve access to credit and cut borrowing costs to help the economy stabilise and recover. By adopting these acts, central banks infuse money into the economy, which encourages consumers and companies to increase spending. Those who gain from this greater spending, in turn, boost their own expenditure. This is known as the multiplier effect.
As the economy shifts from trough to boom, companies begin to hire. Other consumers who observe job growth may become more confidence in their own employment prospects, even if they are already employed. With unemployment dropping and confidence soaring, consumers boost their spending. Psychology and consumer confidence can play a considerable influence on spending decisions.
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