Different Economic Stages of Business Cycle

Different Economic Stages of Business Cycle

Stages of Business Cycle

It is generally recognized today that the dynamics of economic life in the capitalist social order does not have a simple, linear but rather complex character and cyclic trend. When we talk about stages of business cycle in the economy we generally refer to the cycles of the duration of the activity for a period of time, it is clear that these are not the last movement type of business cycles. In fact the dynamics of economic life is complicated and can last for many years more. The economic cycles or cyclical fluctuations in economic activity, they can be defined as the oscillations of expansion to contraction of the economy, which occur between successive crisis.

Introducing the concept of stages of business cycle

The level of income and output of a country is measured by the Gross Domestic Product (GDP). When evolution is observed in terms of the GDP of a country there are two types of movement to take into account:

– Long-term growth, or trend. This trend has in modern economic history a positive sign, which is indeed the main source of improving the welfare of citizens.

– Short-term fluctuations around this trend. GDP data shows every year some alternating periods when production is above what would correspond to the trend, and periods where it is below.

The term stages of business cycle refers precisely to these recurring income fluctuations around its long-term trend. To illustrate with an example, the graph shows these fluctuations in the case of Spain between 1980 and 2008. You can see for example how between 1980 and 1987 the GDP was below the trend (which may be referred to as stages of business cycle low), while between 1988 and 1992 was above. This period forms a complete business cycle (ie, a period of contraction and other expansion).

Over an economic cycle can be distinguished the following phases or also called stages of business cycles: Expansive, recovery, peak and recession.

It is often said that the economy is on the bottom or low point of the economic cycle when you have reached the highest negative distance from the trend. At this point, unemployment is high and there is spare capacity, which makes investment also reach very low levels. On the economic cycle of the graph, this point was reached in 1982, when GDP was nearly 5% lower than the trend.

stages of business cycle

The recovery phase occurs when the economy begins to experience higher growth rates, allowing you to place oneself in its tendency and normally overcome. Recovery is characterized by the reuse of production capacity that was previously empty, an investment process that allows companies to replace the old equipment, high consumption and employment growth.

Recovery ends when it reaches the roof or top, in the full cycle in the graph this occurred in 1990. In that year, the Spanish GDP was 4% above the trend. At this point there is a very high utilization of production capacity and labor shortages and bottlenecks start to occur. This hampers the continuity of economic growth and cost increases and inflationary pressures occur.

These problems give way to the growth slowdown and probably a recession or contraction, which is the fall in economic activity. More specifically, it is said that an economy is in recession when GDP is reduced for at least two consecutive quarters. At this stage a fall in demand occurs and employment is destroyed, leading to further falls in consumption. This change in the direction of demand makes investment that seemed profitable during the boom cease to be by the fall in sales, and this also contributes to a further drop in activity, since purchases of equipment will stop capital coming in. This process will take the economy to a new fund, which will lead to the start of new stages of business cycle.

To measure the cyclical phase in which the economy is, we use the concept of output gap. Defined as the percentage difference between production recorded in the economy in a given period and production that it would have been recorded if it had kept its long-term trend.

In addition to income, other variables such as employment also experience cyclical swings around its trend. This allows classifying variables in procyclical (move in the same direction as stages of business cycle of income), countercyclical (move in the opposite direction to income in each phase) or acyclic (not affected by the cycle.)

Facts of business cycle stages stylized

Some economic phenomena is characterized by the presence of certain empirical regularities so called “stylized facts”. The business cycle does not always occur in the same way (duration and amplitude it is variable are not periodic fluctuations) and therefore is completely predictable. For example, in the US the average cycle length is five years, but may be longer or shorter. However, if they can establish some common characteristics (qualitative rather than quantitative) all periods of boom or recession. These stylized facts relate primarily to how the different variables move together and have been systematized by authors such as N. G. Mankiw. The most important are:

1. Changes in the level of production have the same meaning in all economic sectors, ie expansionary or contractionary phases are general and occur approximately simultaneously throughout the economy.

2. Employment is procyclical. When you increase the level of production companies need to hire more workers, but when income falls dismissals of workers are also produced.

stages of business

3. Prices tend to be procyclical: upturns in inflation, which, however, is usually lower in the phases of growth below the long term trend increases. However, this will largely depend on the origin of the disturbance. For example, if the drop in production is a result of a supply shock (such as rising oil prices) it is likely to occur a drop in income and a faster rise in prices simultaneously, it is known by the name of “stagflation”.

4. When considering the different components of expenditure, both consumption and investment are procyclical. However, those with greater stability are the non-durable consumer goods, compared to the greater amplitude of the fluctuations recorded investment or consumer durables. The greater relative stability of consumption could be explained by the theories of the life cycle and permanent income. According to these theories, individuals try to ensure a stable pattern throughout life depending on the level of income they expect consumption. When increases or decreases in income above or below that level they consider normal occur, they do not change to the same extent spending on consumption (saving more expansions and contractions borrow in).

5. The money supply is also procyclical. This has led to a controversy over whether variations in the money supply are ahead of the changes in income (which could be interpreted as fluctuations in income have a monetary origin) or occur after (in this case, monetary authorities would rather accommodative). There is no consensus on the empirical evidence on this issue.

6. The interest rate of short term is clearly procyclical, while interest rates in the long term only show a slight pro-cyclicality.

7. Real wages are procyclical.

8. The synchronization of stages of business cycle at international level has increased as a result also of the increasing interdependence of economies, which derives from the increase in international financial flows and movements of factors, goods and services.