Markets and Business
Riding the Economic Rollercoaster: What Are Business Cycles?
The Growth Projection
Ever attempted to predict how large the economy will be in two years' time? Unless you have a genie in a bottle, you're likely thinking. That's because the economy does not expand in a linear fashion. Rather, most of the time, it goes in waves in an unpredictable manner. Such up-and-down fluctuations in national production over time are referred to as business cycles.
Economists have found four major repeating phases that occur over time in nearly all market economies. Understanding these phases allows businesses, investors, and governments to make more informed decisions. So lets get into them!
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The Four Phases of the Cycle
1. Depression: This is the lowest point of the cycle. Demand drops well below what the economy can produce, leading to job losses and piles of unsold goods. Think of a factory with its machines switched off and workers sent home.
2. Recovery/Expansion: Things start looking up. Equipment wears out and needs replacing, so companies invest again. That investment creates jobs, more jobs mean more spending, encouraging more production. This chain reaction is known as the multiplier effect.
3. Boom: Now we’re at the top. Companies are hiring, producing, and selling as much as they can. But there’s a catch: resources (workers, raw materials) become scarce. Without more productivity, growth slows.
4. Recession: Sales start to lag behind expectations. Businesses cut back on investment and may even lay people off. Lower incomes mean less spending, which feeds back into lower production. If not handled carefully, this phase can deepen quickly.
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The Role of Policy
While these cycles often come from how businesses and consumers behave, economic policy can help smooth the ride.
Governments and central banks use fiscal policy (like public spending and taxes) and monetary policy (mainly interest rates) to stabilise the economy. They might increase spending or lower rates during a slowdown to boost demand. During a boom, they might tighten up to prevent overheating and inflation. There are also some “automatic stabilisers”, such as taxes related to economic activity, or expenditures that respond inversely to it. In this way, when the economy grows, the government saves a larger portion of national income to be spent during recessions. This is known as “smoothing the cycle.”
For example, after the 2020 pandemic shock, governments spent heavily to avoid a deep depression. But by 2022 and 2023, many central banks raised interest rates to control inflation that followed.
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Final Thoughts
No country can escape business cycles entirely, but good policies can reduce the bumps. Understanding these cycles can help everyone, from governments to households, make more informed decisions.