Business cycle / Economic cycle / Recession / Depression
Encyclopedia of Business Terms and Methods, ISBN 978-1-929500-10-9. Copyright © 2011 by Marty J.Schmidt. Reviseds 14 January 2012.
The Meaning of Business Cycle, Economic Cycle, Recession, and Depression
The term business cycle is used in several ways by economists and business people.This item defines business cycle in context with related terms including economic cycle, recession, and depression.
- The primary meaning of business cycle refers to fluctuations in economic output in a country or countries, characterized by well known phases of a business cycle such as recession, depression, recovery, and expansion. The business cycle or economic cycle in this sense may be accompanied by changes in stock market prices, known as the stock market cycle. For more on these cycles and their phases, see the sections below.
- The term business cycle sometimes refers to stages in the life span of a single company. In this regard, important phases in a company's life may include: birth (or start up), growth, maturity, decline, and demise. Progress through these cycles may be impacted heavily by the economic business cycle (business cycle meaning number 1 above).
To accountants, companies are viewed as ongoing entities that will continue in business indefinitely. In reality, the vast majority of business start ups move through these stages and cease business within a few years or within the founder's life time at most. - The term business cycle also refers to phases in the life of an ongoing business covering a year or several years, whereby the company takes in revenues from normal operations for a year or more, re-evaluates business performance and growth prospects, adjusts or changes the business model (competitive strategy, marketing strategy, pricing and margin models, etc.), and then resumes business under the new model for a period before re-evaluating again.
• The Economic Business Cycle: Recession, Depression, Recovery and Expansion
• Recession and Depression Defined
• The Economic Business Cycle: Causes and Cures
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The Economic Business Cycle: Recession, Depression, Recovery and Expansion
The most familiar use of the terms business cycle or economic cycle refers to changes in economic activity within a country or countries. The cycle in this sense is defined in terms of economic output, especially the country's gross domestic product (GDP) (the market value of all goods and services produced within the country during a year). The image below shows how different named phases of the cycle correspond to increases or decreases in GDP:
Over time, the GDP of most countries tends to grow, as suggested by the "Long Range Growth" line in the figure. The long range growth curve may be considered a baseline, around which economic output may fluctuate as the economy enters different phases of the business cycle. Note that stock market prices (the Stock Market Cycle) tend to rise or fall in anticipation of changes in the economy (GDP).
In reality, the "cycle" tends to be as less predictable, less regular, and less smooth than the figure above suggests. The length, severity, and sequence of phases may differ from what is shown in the figure.
The business/economic cycle should not be confused with seasonality or seasonal fluctuations in business. Seasonal fluctuations tend to impact some businesses and industries more than others and they are tied predictably to calendar seasons or to short-lived fads. By contrast, the business/economic cycle has broad impacts across companies, across industries, and across calendar seasons.
While the business cycle is defined and measured primarily in terms of national GDP, progress through its phases is felt most keenly by individuals and businesses in terms of changes in:
- Employment or unemployment.
- Wholesale sales and retail sales.
- New building loans and new building starts, or building closures and property foreclosures.
- Business start ups and business growth, or business failures.
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Recession and Depression Defined
In the United States, recession is usually defined as two consecutive quarters of decline in the GDP. This definition is provided by the National Bureau of Economic Research (NEBR) and it is not, however, the only definition in use. An alternate definition even appears within the NEBR, from its Business Cycle Dating Committee. This committee reviews several economic indicators, including employment, real income, retail sales, and other factors, and defines a recession as the period of time between the "Peak" and the Trough" in the above chart.
The term recession was not used until the time of the Great Depression of 1929-33. Prior to that, any decrease in economic output was called a depression. "Recession" was coined at this time to distinguish between the severe conditions of the early 1930s, on the one hand, and lesser economic downturns, on the other hand, such as those occurring in 1910 and 1913.
The term depression is usually defined now simply as an economic downturn that is longer lasting and more severe than the more frequently occurring recessions. Sometimes, in order to define the term more formally, a depression is said to begin when GDP declines more than 10% from the most recent economic peak. By this criterion, the last two real depressions in the United States occurred:
- From 1929 to 1933—the Great Depression—where US GDP declined by nearly 33% and unemployment rose to 25%.
- In 1937-38, where GDP declined by more than 18% and unemployment reached 19%.
By contrast, US GDP declined at most 5% in the severe recession of 1973-75.
In general, periods of economic depression are characterized by greatly reduced GDP, as well as severely high measures of unemployment, foreclosures, business closures, and greatly reduced wholesale and retail sales activity.
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The Economic Business Cycle: Causes and Cures
During recessions and depressions governments and private industry alike are keenly motivated to act on measures that might move the economy back into recovery and expansion. Any attempt to remedy an economic downturn, however, has to start with some understanding of why downturns occur in the first place and which factors will trigger recovery. This subject is central to the field of macroeconomics and, not surprisingly, it is a field characterized by competing theories and speculation, and few established "laws."
A number of factors that are known to be associated with upturns or downturns in the economy, although the extent to which they are either causes or results is not known.
- An imbalance or balance between the country's money supply, inflation, and interest rates (in the United States, maintaining this balance is the responsibility of the Federal Reserve Board).
- Excessive government spending, especially deficit spending, either outside the country or on non productive domestic programs.
- Consumer and business optimism or pessimism, regarding business growth and inflation.
- Large increases or decreases in the price of oil.
- Weak demand for goods and services.
The latter situation, weak demand, is a central factor in so-called Keynesian economics (after John Maynard Keynes). Since the 1930's, governments with capitalist economies have held--to some degree--the Keynesian view that during recessions and depressions, the government should act to increase aggregate demand by (a) increasing the money supply, and or (b) increasing government spending, and or (c) reducing taxes.
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