Why are there business cycles

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I Accept Show Purposes. Your Money. Personal Finance. Your Practice. Popular Courses. Part Of. Introduction to Economic Depression. History of Economic Depression. Government Actions. Economy Economics. Table of Contents Expand. What Is a Business Cycle? Measuring and Dating Business Cycles.

The Varieties of Cyclical Experience. Stock Prices and the Business Cycle. Key Takeaways Business cycles are comprised of concerted cyclical upswings and downswings in the broad measures of economic activity—output, employment, income, and sales. The alternating phases of the business cycle are expansions and contractions also called recessions.

Recessions start at the peak of the business cycle—when an expansion ends—and end at the trough of the business cycle, when the next expansion begins. Article Sources. Investopedia requires writers to use primary sources to support their work. These include white papers, government data, original reporting, and interviews with industry experts.

We also reference original research from other reputable publishers where appropriate. You can learn more about the standards we follow in producing accurate, unbiased content in our editorial policy. Compare Accounts. The offers that appear in this table are from partnerships from which Investopedia receives compensation.

This compensation may impact how and where listings appear. Investopedia does not include all offers available in the marketplace. Related Terms Trough Definition A trough, in economic terms, can refer to a stage in the business cycle where activity is bottoming, or where prices are bottoming, before a rise. The Conference Board CB The Conference Board CB is a not-for-profit research organization which distributes vital economic information to its peer-to-peer business members.

Economic Cycle Definition The economic cycle is the ebb and flow of the economy between times of expansion and contraction. Peak A peak refers to the pinnacle point of economic growth in a business cycle before the market enters into a period of contraction.

What Is Inflation? Take note, for at any point in time, you may be in any one of the following:. This stage is where a slowdown in GDP growth is observed. The growth rate goes down to 1 to 2 percent and eventually turns into negative growth, hence, a contraction of the national output.

The recession in was a cruel one where GDP immediately contracted by 1. The trough stage takes place when the economy is turning a corner, with the growth rate still being negative, just not as bad as before. Based on NBER record, the trough phase for the crisis occurred during the second quarter of when the U. The expansion stage refers to that period of positive GDP growth after the economic contraction.

During the recent crisis, this phase started in the third quarter of when the national output managed to grow by 1. This was a result of the stimulus spending of the U. The expansion phase continues until today.

In this part of the business cycle, a healthy GDP growth rate should be in the range of 2 to 3 percent. It is said that because of the nasty contraction phase in , the economic expansion has been slow in generating jobs. The peak phase refers to the period when the healthy economic growth starts to slow down.

It is typically the last positive growth before a contraction starts again. It is not easy to predict when the economic expansion is likely to peak, but you have to be wary if the economy grows by 4 percent or higher as the peak can be just around the corner. In the crisis, the peak transpired during the fourth quarter of One very critical factor that can influence the business cycle is the confidence of investors and consumers, and of business people and politicians.

It is the confidence of consumers that can increase the demand for goods and services. Once the demand rises, business establishments consequently hire new people to work, and as more people get jobs, this further stimulates greater demand. When this is sustained, the economy can expand.

When the demand rises above supply, the economy can reach a point of saturation. Unless the rising demand is balanced out by higher taxes or interest rates, then the peak of the expansion cannot be that far.

As the growth peaks, contraction can start. In this phase, people tend to panic and lose confidence. You can always recognize a peak by two things: First, the media says that the expansion will never end. Second, it seems everyone and their brother are making tons of money from whatever the asset bubble is.

A contraction causes a recession. They are a rapid increase in interest rates, a financial crisis, or runaway inflation. Fear and panic replace confidence. Investors sell stocks and buy bonds, gold, and the U. Consumers lose their jobs, sell their homes, and stop buying anything but necessities. Businesses lay off workers and hoard cash. Consumers must regain confidence before the economy can enter a new expansion phase.

That often requires intervention with monetary or fiscal policy. In an ideal world, they work together. That, unfortunately, doesn't occur often enough. Monetary policy is how the nation's central bank uses its tools to manage the economic cycle. It adjusts liquidity by changing interest rates and the money supply. Expansion: Central banks try to keep the core inflation rate around 2 percent to create a healthy expectation of inflation.

Peak: Central banks raise interest rates during expansion to avoid the irrational exuberance of a peak. That is called contractionary monetary policy.

If needed, they will sell Treasury bonds and other assets during open market operations. Contraction: At this point, a stock market correction may indicate that assets are overvalued. The Fed can switch to expansionary monetary policy if economic growth slows or even turns negative. It will lower interest rates and buy Treasurys in open market operations. Trough: Central banks pull out all the tools to jump-start the economy out of a trough.

In , the Fed used a variety of innovative tools to keeps banks from collapsing. It also expanded its open market operations in a program called quantitative easing.

Fiscal policy is what elected officials use to change the business cycle. As a result, they don't take advantage of the power of fiscal policy. Expansion : When the economy is in the expansion phase, politicians are content because their constituents are happy. They will pursue other policies, such as foreign affairs, defense, or immigration.