Business Cycle

Introduction

• The business cycle is the rise and fall of economic activities that occur over time in an economy. It is also referred to as an ‘economic cycle’ or ‘trade cycle’.
• It is an alternate expansion and contraction in overall business activity, as evident by fluctuations in the gross domestic product (GDP).
• Generally, the business cycle is characterized by four phases which are Expansion (Boom), Contraction (recession), Depression and Recovery.    
• The duration of business cycles may be anywhere from about two to twelve years, with most cycles averaging six years in length.

Significance of Business Cycle

• Major macroeconomic variables such as the Index of Industrial Production (IIP), Income and employment are also sensitive to the business cycle. 
• Business cycle is a useful tool for analyzing the economy.
• Investors, corporations and the government make major financial decisions based on it.

Phases of Business Cycle

Expansion

• This phase of the business cycle is also known as the ‘Economic Boom’, an upturn or upswing of Real GDP.
• In this phase, the economy experiences expansion in all dimensions, leading to accelerated and prolonged demand and increased investment, production, employment, etc. 
• Due to prolonged response, demand exceeds economic output or production which results in demand and supply disequilibrium.  
• The economy may also face structural problems like shortage of investable capital, lower savings, falling standard of living, etc. 
• At this stage, the economy may suffer due to inflationary pressure.  
• To avoid such inflationary pressure, the market should have adequate supply of goods or on the other hand, the demand should be controlled from reaching peak. 

Contraction 

• This phase is most commonly  known as ‘recession’.  
• In this phase, the overall economic activities declines, leading to low economic output or the Real GDP.
• Macroeconomic variables such as consumption, corporate profits, investment, employment, retail sales, etc. also fall. 
• This phase also experiences low Inflation due to low demand and consumption expenditure.  
• It also hampers countries’ export growth and may severely affect  the balance of payment.
• However, recession is different from economic slowdown as recession signifies a drop in the gross domestic product (GDP), while a slowdown is merely a decline in the growth rate of the GDP. 

Growth Recession 

• It is a prolonged period (more than one quarter) of significantly below trend Real GDP growth. 
• It does not reach the severity of a true recession, but still involves a rise in unemployment and an economy that is performing below its potential.
• It is often associated with minimal price inflation because many people are out of work and may have to curtail discretionary spending, and as a result, inflation will remain low.

Double-deep recession 

• It  comes after an initial period of general economic decline.
• If a country experiences a double-dip recession, the impact on the economy will be worse than the initial recession. 
• In some cases, a double-dip recession has the ability to catapult a country into a depression and its recovery becomes difficult. 

Depression 

• It is defined as a severe and prolonged recession. 
• Generally, when an economy continues to suffer recession for two or more consecutive quarters, it is called depression.
• During the Depression, inflation was much lower. 
• In this phase, the level of productivity in an economy falls significantly. 
• Both the GDP and  GNP show a negative growth along with greater business failures and unemployment.

Recovery 

• It is a phase when the economy tries to come out of the low production phase. The low production phase may be a recession or depression.
• To recover the economy, the government as well as the central bank (RBI) take many fiscal and monetary measures to boost demand, investment and production. 
• Price mechanism plays a very important role in the recovery phase of the economy. 
• During a recession,  the rate at which the price of factor of production falls is greater than the rate of reduction in the prices of final products. Therefore producers are always able to earn a certain amount of profit.  The increase in profit also continues in the recovery phase. 
• Apart from this, in the recovery phase, some of the depreciated capital goods are replaced by producers and some are maintained by them. 
• As a result, investment and employment by organizations increases. As this process gains momentum an economy again enters into the phase of expansion. Thus, a business cycle gets completed.