Business Cycle Definition
The business cycle refers to recurring patterns of expansion and contraction in an economy. It is also called the economic cycle. During the expansion phase of the cycle of business, the economy is prospering and growing. During the contraction phase of the business cycle, economic activity is in decline. Economists and other interested parties watch certain macroeconomic indicators to gauge the condition of the economy and to try to forecast changes in the business cycle.
According to this cycle, economic activity expands until it reaches a peak, then it contracts until it reaches a trough, and then it begins to expand again. Measure business cycles from peak to peak. Furthermore, the duration of an average business cycle is around five years. However, they do not run like clockwork – the durations of the individual phases as well as the entire business cycles vary widely. In the U.S., these cycles are measured and peaks and troughs are declared by the National Bureau of Economic Research (NBER).
Phases of the Business Cycle
The business cycle consists of the four following phases: expansion, peak, contraction, and trough. During the expansion phase, also called the recovery phase, gross domestic product is growing, business activity is flourishing, and the economy is prospering. Expansion phases typically last around three to four years, but may be longer or shorter. The expansion phase ends at the peak, which is the high point of economic activity and the transition to contraction.
Economic contraction, also called recession, is often defined as two consecutive quarters of declining gross domestic product. During a contraction, business activity is slowing, unemployment is increasing, and the economy is struggling. A recession typically lasts about one year, but may be longer or shorter. The contraction phase of the business cycle follows the peak and continues till the trough. The trough is the bottom of the downturn, and represents the end of the contraction and the transition back to expansion.
4 Business Cycle Stages
Business Cycle Indicators
Economists watch certain macroeconomic indicators to gauge the condition of the economy. In the U.S., the Conference Board issues an index of several key economic indicators. There are three main types of economic indicators, including: leading indicators, lagging indicators, and coincident indicators.
Leading indicators considered predictors of economic trends. Analysts use these data to try to forecast changes in the business cycle. Examples of leading indicators include stock prices, building permits, average weekly initial claims for unemployment insurance and an index of consumer expectations.
Coincident indicators fluctuate simultaneously with the business cycle and reflect the current condition of the economy. Examples of coincident indicators include industrial production data, nonagricultural payroll data, and manufacturing and trade sales data.
Lagging indicators appear after the completion of economic trends and changes in the business cycle. Furthermore, they can be used to analyze the economy in retrospect or to confirm other economic data. Examples of lagging indicators include the following: average duration of unemployment, average prime rate charged by banks, and change in labor cost per unit of output.
Conference Board Index
To see economic indicators issued by the Conference Board, go to: conference-board.org
To learn more financial leadership skills, download the free 7 Habits of Highly Effective CFOs.