Business cycle

Boom

A period when the rate of economic growth and the general level of economic activity is above average.

Boom Real GDP

• high consumption- high consumer confidence, more disposable incomes (employment because of expanding businesses), wealth effect of rising asset values

• High levels of borrowing (strong economic growth and low unemployment increase lenders’ confidence in borrowers’ ability to repay, leading to easier access to credit)= more spending using borrowed funds, increasing economic activity

• high investment- high business confidence, more funds for investment (strong demand, high profits)

• GDP is high, likely to be greater than 4%.

• The actual GDP is above potential GDP (the maximum sustainable level of economic output that an economy can produce when all resources (labor, capital, and technology) are fully employed at normal rates without causing inflation)

Inflation

• High, greater than 3%, prices are escalating as more people are in full-employment and incomes are rising

• Demand pull inflation- more people are in full employment with rising incomes, pushing aggregate demand above the economy’s productive capacity, causing prices to rise - fully utilized capital equipment can’t produce more and more output to meet rising demand, causing price increases

• Cost-push inflation- as firms increase production, competition for limited resources (labor, raw materials) drives up wages and input costs, passed onto consumers

• Wage price spiral- increased demand for labor gives workers bargaining power to demand higher wages, increasing businesses costs and leading to further price rises.

Retail sales

• high

• More disposable income- less unemployment, rising incomes

• High consumer confidence- optimistic about financial future

• More spending on durables and luxury goods because of income and confidence

• Easy access to credit (strong growth, low unemployment makes lenders confident about repayment)

• Wealth effect of rising asset values (e.g. houses, antiques)

Unemployment

• Low, possibly below the natural rate (4.0)

• Little or no cyclical unemployment- high consumer demand causes increased demand for labor to meet increased production, so there’s increased demand for labor to meet high consumer demand, less unemployment

• High labor participation- increased demand for labor causes improved job market confidence, less discouraged workers

• Business expansion creates jobs

Downswing

onset of downswing may appear dramatic, sometimes accompanied by high profile economic events such as falling stock prices (The Great Depression of 1929); a banking crisis (the Global Financial Crisis in 2008-09); or falling asset values (UK house prices 1989-1991; Japan 1992-1995).

Real GDP

• Low, lower than 3%, actual GDP is falling below potential GDP

• Reduced consumption spending because of lower confidence, rising interest rates, rising unemployment (less wages and income)

• Lower investment (reduced profits from increasing costs, low confidence and low demand, so they invest less) leads to falling output (less future production because of falling sales) and production (bottlenecks in supply), causing income to fall (less output- less workers)

• Higher interest rates (protection against loan default) raise borrowing costs, making investment less attractive.

Inflation

• Reduced demand – Consumers and businesses don’t demand more than the economy’s productive capacity, so there’s less upward pressure on prices (demand-pull inflation decreases).

• Lower production costs pressures – With lower demand, there’s less competition for resources like labor and materials, wages and input prices tend to rise more slowly or even fall. (cost push inflation falls or rises slowly)

• More unemployment- workers have less bargaining power about wages, reduces cost push inflation

Unemployment

Greater than 4.0%, rising above the natural rate of unemployment as businesses start to lay-off workers

• Cyclical unemployment- less demand for goods and services in the economy, so to reduce costs and stay profitable, businesses lay off workers: less employees to produce less output

Retail sales

Average to low, people are buying less goods and services, particularly durables as they start to save more with falling confidence in the market

• More unemployment- less disposable income

• Lower confidence- save more because of future uncertainty, less funds available for spending

• Less spending on durables and luxury goods- less income and confidence

• Opposite of wealth effect (falling asset values- less spending)

Trough

aggregate spending (income, consumption and investment) is below that necessary to sustain average levels of economic growth.

Real GDP

• Very low, much lower than 3% and possibly negative in a depression, actual GDP is well below potential GDP

• Resources (labor, capital) underutilized because of low demand, reducing output

• low consumption- low confidence, high unemployment, more saving than spending

• low investment- low confidence, low demand= less funds, uncertainty about profitability discourages investment

Inflation

• less demand and consumer spending- no upward pressure on prices (demand pull inflation)

• high unemployment- workers have little to no bargaining power, no cost push inflation

• firms lower prices to sell idle inventory and utilize production capacity

Unemployment

• Much greater than 4.0%, well above the natural rate of unemployment

• High cyclical unemployment- less demand, businesses lay off workers to reduce costs and remain profitable, laid off workers have less purchasing power, even less demand, even more workers get laid off

• High underemployment- low demand for labor (low demand for goods)

• Low labor participation- more discouraged workers, low job market confidence

Retail sales

• low confidence, more saving than spending

• high unemployment, lower income

• opposite of wealth effect, fallen asset values (houses)

• more spending on necessary non-durables (food) instead of durables and luxury goods- tighter credit conditions (loan default) so unable to finance durables and luxury goods, can be postponed

Upswing

;a;a;

GDP

• Low but rising, starting to move towards or into the 3%-4% range, actual GDP is moving up towards potential GDP

• Increasing consumer spending – Increased production and investment- more employment- more disposable income, ceteris paribus. Rising confidence. Increased spending on goods and services

• Rising business investment – Replacement of worn-out capital equipment, creating income which cycles through economy, creating more jobs and income for spending ceteris paribus. Innovation increases as firms fight for competitive advantage. Bank lending rates are low, so companies can afford financing projects to meet growing demand. Increased production leads to increased profit margins, increasing GDP

• Falling unemployment

Inflation

Low but rising, prices are starting to rise as demand for goods and services is increasing and business are producing more

• consumer spending increases aggregate demand, moving closer to economy’s capacity, putting upward pressure on prices (demand pull inflation)

• increasing production costs- higher demand for labor and resources drives wages and input prices up, (cost push inflation)

Unemployment

• Still above 4.0% (the natural rate of unemployment)

• improved business confidence- expansion and investment leads to job creation ceteris paribus

• higher demand- businesses increase production and need more labor- more hiring and hours to work/ more employment opportunities- cyclical unemployment, underemployment fall as labor participation rate increases.

Retail sales

• Increased incomes (falling unemployment) and increased confidence- more spending on goods and services

• Bank lending rates are low- people can start financing purchases of durables and luxury goods

Leading indicators

change before a direction becomes evident in the rest of the economy. They predict trends in economic activity. 

Examples

1. Share prices

• reflect investor expectations about future company profits and economic conditions

• grow- buy shares- push prices up

• increase happens before rise in production or spending- leading indicator of future economic activity

2. Building approvals

• before construction- must apply for approvals

• high confidence and strong demand- more approvals- more construction projects- signaling increased demand for materials, labor, capital and economic growth

• low confidence and weak demand- less approvals- less construction projects- signaling decreased demand for materials, labor, capital and declining economic activity.

• approval before economic activity- lead changes

3. Business and consumer confidence

• surveys measure optimism about future economic state

• high confidence- likely to spend and invest, increasing future economic growth

• changes in behavior and attitude occur ahead of actual spending data, confidence leads the economic outcomes

Coincident indicators

changes simultaneously in line with economic activity

Examples

GDP

GDP measures the total value of goods and services produced, directly showing the economy’s current size and health, so it changes simultaneously with economic activity.

Capacity utilization

Measures how much of production capacity is being used right now; high utilization shows strong current demand and economic activity, moving simultaneously **with the business cycle.

Job advertisements

The number of job ads reflects employers’ immediate hiring needs, so ads increase when the economy is strong and decrease during downturns e.g. increased demand during holiday season- more job ads for casuals.

Lagging indicators:

not expected to show any change until after trends in the rest of the economy have been confirmed. appear to react to developments that occurred some time in the past. 

Examples (cautious)

Consumer debt

• Consumer borrowing changes after shifts in income and spending, making it a lagging indicator because it follows income and spending changes caused by changes in economic activity due to different phases of the business cycle.

• During a boom, consumers increase debt only after incomes have risen and confidence is high, reflecting earlier improvements in income and employment.

• During a trough, consumers reduce borrowing after experiencing lower incomes and financial uncertainty, reflecting previous declines in income and employment.

Interest rates

• Central banks adjust interest rates based on confirmed economic data, such as inflation and growth rates, after a time lag to avoid reacting to temporary or misleading changes.

• During a boom, interest rates increase only after sustained economic expansion and rising inflation to moderate unsustainably high economic activity. During a trough, interest rates decrease after prolonged economic contraction to stimulate recovery and encourage borrowing. Central banks’ delayed response makes interest rates a lagging indicator.

Unemployment

• companies delay hiring new employees (associated costs of training and salaries) until economic recovery is established so unemployment is high even after growth resumes

• companies postpone layoffs (associated severance pay and loss of skilled staff) until economic downturn is established, so unemployment is low even after growth declines

• companies’ cautious attitude towards employment makes unemployment a lagging indicator of the business cycle