Question

Consider the situation where there has been a decline in real GDP growth rates, inflation, and employment rates. What part of the business cycle do you think the economy is currently in? what other indicators could you use to confirm this?

Answer 1

A business cycle is a cycle of fluctuations in the Gross Domestic Product (GDP) around its long-term natural growth rate. It explains the expansion and contraction in economic activity that an economy experiences over time.

A business cycle is completed when it goes through a single boom and a single contraction in sequence. The time period to complete this sequence is called the length of the business cycle. A boom is characterized by a period of rapid economic growth whereas a period of relatively stagnated economic growth is a recession. These are measured in terms of the growth of the real GDP, which is inflation adjusted.

1 Expansion

The first stage in the business cycle is expansion. In this stage, there is an increase in positive economic indicators such as employment, income, output, wages, profits, demand, and supply of goods and services. Debtors are generally paying their debts on time, the velocity of the money supply is high, and investment is high. This process continues until economic conditions become favorable for expansion.

2 Peak

The economy then reaches a saturation point, or peak, which is the second stage of the business cycle. The maximum limit of growth is attained. The economic indicators do not grow further and are at their highest. Prices are at their peak. This stage marks the reversal in the trend of economic growth. Consumers tend to restructure their budget at this point.

3 Recession

The recession is the stage that follows the peak phase. The demand for goods and services starts declining rapidly and steadily in this phase. Producers do not notice the decrease in demand instantly and go on producing, which creates a situation of excess supply in the market. Prices tend to fall. All positive economic indicators such as income, output, wages, etc. consequently start to fall.

4 Depression

There is a commensurate rise in unemployment. The growth in the economy continues to decline, and as this falls below the steady growth line, the stage is called depression.

5 Trough

In the depression stage, the economy’s growth rate becomes negative. There is further decline until the prices of factors, as well as the demand and supply of goods and services, reach their lowest. The economy eventually reaches the trough. This is the lowest it can go. It is the negative saturation point for an economy. There is extensive depletion of national income and expenditure.

6 Recovery

After this stage, the economy comes to the stage of recovery. In this phase, there is a turnaround from the trough and the economy starts recovering from the negative growth rate. Demand starts to pick up due to the lowest prices and consequently, supply starts reacting, too. The economy develops a positive attitude towards investment and employment and hence, production starts increasing.

Employment also begins to rise and due to the accumulated cash balances with the bankers, lending also shows positive signals. In this phase, depreciated capital is replaced by producers, leading to new investment in the production process.

Recovery continues until the economy returns to steady growth levels. It completes one full business cycle of boom and contraction. The extreme points are the peak and the trough.

A recession is a macroeceonomic term that refers to a significant decline in general economic activity in a region, country, or the entire world that goes on for more than a few months. It is visible in industrial production, employment, real income, and wholesale-retail trade. The technical definition of a recession is two consecutive quarters of negative economic growth as measured by a country's gross domestic product (GDP

The economy is in recession if the real GDP rates, inflation, employment rates are declining. If the economy does not recover over a long period of time this would lead to recession Below are the indicators used to confirm this:

House Prices

Just as having a job helps consumers spend money, so increasing home values make consumers more confident in spending. This is because a home is a primary source of wealth and economic confidence for many U.S. households. We've typically seen home prices decline during recent recessions. Currently, house prices are increasing around 6% year-over-year. As such, the housing market is not a cause for concern currently. However, this can be a lagging indicator, in certain cases house prices may not fall until we're actually in a recession.

Unemployment

Consumer spending is about two thirds of the economy, and people predictably spend less when they are unemployed, hurting economic growth. It's perhaps unsurprising then, that recessions are accompanied by rising unemployment. Currently, unemployment is on a declining trend. However, the potential risk here is that there comes a point when unemployment simply can't go much lower. Some unemployment, called frictional unemployment by economists, is necessary as people transition in and out of the workforce and find jobs. So unemployment isn't a problem now, but we may be approaching a point where unemployment gets so low that it can't fall much further. At that point, recession becomes more of a risk as unemployment can't stay flat forever.

Stock Market

he prospect of recession is keenly watched by the markets, because stock earnings can tank in recessions, leading stock prices to decline. The market does tend to overreact though, and it can fall even when a recession is not coming. Therefore, this can be thought of as a hyperactive indicator, the market will likely fall as a recession approaches, but it can also signal false alarms frequently.