The Business Cycle

About this topic

Economies fluctuate in a business cycle with four phases: expansion (growing output and jobs), peak, contraction or recession (falling output; commonly defined as two consecutive quarters of negative growth) and trough, followed by recovery. A severe, prolonged downturn is a depression.

The cycle matters because it affects jobs, wages, profits and government budgets. During expansion, demand rises, unemployment falls and inflation may build. In a recession, firms cut spending and workers, unemployment rises and inflation eases. The cycles are irregular in length, and economists cannot perfectly predict turning points.

Examples: the Great Depression of the 1930s saw output fall by about a quarter in the US and unemployment reach about 25 percent. The 2008 financial crisis and the 2020 pandemic both caused sharp recessions followed by recoveries. Indicators such as GDP, unemployment, retail sales and consumer confidence help track the stage. Leading indicators like new building permits tend to turn before the economy does.

Misconceptions: cycles are not regular like a clock, and a recession does not mean the economy stops, just that it shrinks. Governments and central banks use fiscal and monetary policy to smooth the cycle. Tip: remember that growth rate, not the level, determines the phase.