Question

What is the business cycle? How has American government responded to it over time?

Answer 1

A business cycle is typically characterized by four phases—recession, recovery, growth, and decline—that repeat themselves over time. Economists note, however, that complete business cycles vary in length. The duration of business cycles can be anywhere from about two to twelve years, with most cycles averaging six years in length. Some business analysts use the business cycle model and terminology to study and explain fluctuations in business inventory and other individual elements of corporate operations. But the term "business cycle" is still primarily associated with larger (industry-wide, regional, national, or even international) business trends.

STAGES OF A BUSINESS CYCLE

Recession

A recession—also sometimes referred to as a trough—is a period of reduced economic activity in which levels of buying, selling, production, and employment typically diminish. This is the most unwelcome stage of the business cycle for business owners and consumers alike. A particularly severe recession is known as a depression.

Recovery

Also known as an upturn, the recovery stage of the business cycle is the point at which the economy "troughs" out and starts working its way up to better financial footing.

Growth

Economic growth is in essence a period of sustained expansion. Hallmarks of this part of the business cycle include increased consumer confidence, which translates into higher levels of business activity. Because the economy tends to operate at or near full capacity during periods of prosperity, growth periods are generally accompanied by inflationary pressures.

Decline

Also referred to as a contraction or downturn, a decline basically marks the end of the period of growth in the business cycle. Declines are characterized by decreased levels of consumer purchases (especially of durable goods) and, subsequently, reduced production by businesses.

Business cycles refer to the regular cyclical pattern of economic boom (expansions) and bust (recessions). Recessions are characterized by falling output and employment; at the opposite end of the spectrum is an “overheating” economy, characterized by unsustainably rapid economic growth and rising inflation. Capital investment spending is the most cyclical component of economic output, whereas consumption is one of the least cyclical. Government can temper booms and busts through the use of monetary and fiscal policy. Monetary policy refers to changes in overnight interest rates by the Federal Reserve. When the Fed wishes to stimulate economic activity, it reduces interest rates; to curb economic activity, it raises rates. Fiscal policy refers to changes in the federal budget deficit. An increasing deficit stimulates economic activity, whereas a decreasing deficit curbs it. By their nature, policy changes to influence the business cycle affect the economy only temporarily because booms and busts are transient. In recent decades, expansions have become longer and recessions shallower, perhaps because of improved stabilization policy, or perhaps because of good luck.

Long-term growth receives less attention from policymakers than cyclical growth. Yet in a broader view of history, long-term growth is the more important of the two because it is the key to raising living standards. Long-term growth is caused by increases in labor, capital, and productivity. Policy changes in the areas of education, taxation, competition, basic research, and infrastructure can influence the economy’s long-term growth rate, but only at the margins. Long-term growth has altered very little over most of U.S. history despite a broad array of policy changes. That fact is less surprising when one considers that the main contributor to long-term growth is technological progress, over which the government has little direct influence. In recent years, long-term growth has accelerated modestly because of higher productivity growth, driven mainly by what is popularly referred to as the “information technology (IT) revolution.” Although the government had little direct influence over the IT revolution, it provided an environment in which those technological changes were allowed to thrive, which likely explains why many other economies did not experience a similar productivity acceleration.