Economics

Business Cycles

Business Cycles

Business Cycles
Real GDP Cyclical behavior of GDP growth,
inflation, and employment

Average
Peak

Contraction
Expansion
(recession)
(recovery)
Trough
Time
As short as a year, as long as a decade
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 Business Cycles

Business Cycles
 The classical cycle is based upon real GDP relative to a
beginning value (the curve on the previous slide).
 The growth cycle refers to changes in the percentage
difference between real GDP and its longer trend
(the average line).
 The growth rate cycle refers to changes in the annualized
percentage growth rate from one month to the next relative to a
trend rate (the preferred measure of economists).

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Business Cycles

Business Cycle Characteristics

Trough
 GDP growth rate changes from negative to positive
 High unemployment rate
 Increasing use of overtime and temporary workers
 Spending on consumer durable goods and housing
may rise
 A moderate or decreasing inflation rate

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 Business Cycles

Business Cycle Characteristics

Expansion
 GDP growth rate increases
 Unemployment rate decreases as hiring accelerates
 Investment increases in equipment and construction
 Inflation rate may increase
 Imports increase as domestic growth accelerates

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Business Cycles

Business Cycle Characteristics

Peak
 GDP growth rate decreases
 Unemployment rate decreases, but hiring slows
 Consumer spending and business investments grow at
slower rates
 Inflation rate increases

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 Business Cycles

Business Cycle Characteristics

Contraction/recession
 GDP growth rate is negative for two consecutive quarters
 Hours worked decrease; unemployment rate increases
 Consumer spending, home construction, and business
investments decrease
 Inflation rate decreases with a lag
 Imports decrease as domestic income growth slows

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Business Cycles

Credit Cycles
 Credit cycles refer to the cyclical fluctuations in interest rates
and the availability of loans (credit).
 Lenders are typically more willing to lend and offer lower interest
rates during expansions, and less willing to lend and require
higher interest rates during contractions.
 Credit cycles tend to be longer in duration than business cycles.
 They may contribute to stronger expansions, deeper
contractions, and asset price bubbles.

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 Business Cycles

Inventory/Sales Ratios
 Inventories are an important business cycle indicator. Firms try to
keep enough inventory to meet sales demand.
 Early in a contraction, sales slow unexpectedly, causing an
unplanned increase in inventories; inventory/sales ratios increase
to above-normal levels.
 Early in an expansion, sales increase unexpectedly, causing an
unplanned decrease in inventories; inventory/sales ratios decrease
to below-normal levels.

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Business Cycles

Labor and Capital Utilization

 Firms are slow to hire/lay off employees and slow to
increase/decrease physical capital; frequent adjustments are costly.

 At the beginning of a contraction, sales fall and both labor

and capital are used less intensively.
 At the beginning of an expansion, sales increase and both labor
and capital are used more intensively.

 When sales trends persist, firms adjust labor and physical capital
over time.
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 Business Cycles

Consumer Sector Activity

 Consumer spending is the largest component of GDP and
depends on the level of consumers’ current and expected
future incomes.
 Consumer spending increases in expansions and decreases
during contractions.
 Durable goods: highly cyclical
 Services: somewhat cyclical (more so for discretionary services)
 Nondurable goods: largely noncyclical
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Business Cycles

Housing Sector
 Housing is a highly cyclical sector of the economy.
 Activity is determined by the following:
1. Mortgage rates: rates ↑, housing ↓
2. Income/housing costs: income ↑, housing ↑
3. Speculation: home purchases based on expected price
increases (e.g., 2007–2008)
4. Demographics: household formations (25–40 age segment),
geographic shifts in population density

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 Business Cycles

External Trade Sector

 Imports determined by domestic incomes—depend on domestic
business cycle
 Exports determined by foreign incomes—independent of
domestic business cycle

Both imports and exports influenced by currency exchange rates

 Domestic currency appreciates: imports ↑, exports ↓
 Domestic currency depreciates: imports ↓, exports ↑

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Business Cycles

Economic Indicators
Economic indicators can be classified into three categories:
leading, coincident, and lagging indicators.
1. Leading indicators change direction before peaks or troughs in
the business cycle.
2. Coincident indicators change direction at roughly the same time
as peaks and troughs in the business cycle
3. Lagging indicators change direction after expansions or
contractions are already underway.

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 Business Cycles

Leading Indicators
Turning points in these tend to precede business cycle peaks
and troughs.

Weekly hours, manufacturing New unemployment claims

Manufacturers’ new orders, Manufacturers’ new orders, nondefense
consumer goods capital goods excluding aircraft
ISM® New Orders Index Building permits
Stock prices Leading Credit Index™
Yield curve Consumer expectations

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Business Cycles

Coincident Indicators
Turning points in these tend to coincide with business cycle peaks
and troughs.

Employees on nonfarm payrolls Personal income less transfer

payments
Industrial production Manufacturing and trade sales

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 Business Cycles

Lagging Indicators
Turning points in these tend to follow business cycle peaks and
troughs. The unemployment rate is a lagging indicator.

Duration of unemployment Prime rate

Inventory/sales ratio,
manufacturing, and trade
Commercial and industrial loans
Consumer Price Index
Manufacturing labor cost per unit
of input
Consumer credit/personal income
ratio

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