What is the Business Cycle
The business cycle describes the rise and fall in production output of goods and services in an economy. Business cycles are generally measured using rise and fall in real – inflation-adjusted – gross domestic product (GDP), which includes output from the household and nonprofit sector and the government sector, as well as business output. “Output cycle” is therefore a better description of what is measured. The business or output cycle should not be confused with market cycles, measured using broad stock market indices; or the debt cycle, referring to the rise and fall in household and government debt.
BREAKING DOWN Business Cycle
The business cycle or output cycle is often visualized in terms of consistent expansions and contraction, almost like a sine wave. Actual fluctuations in real GDP, however, are far from consistent.
After World War II, expansions were mostly associated with population growth, urban sprawl and the advent of consumerism. By the 1970s, growth came more from debt injections from consumer credit cards, mortgages, commercial and industrial loans (as opposed to equity funding), followed by the dotcom speculation, and then more mortgage debt. Fiscal and regulatory policy, technology and demographics have also had an effect on the business cycle, as have external events such as the oil price spikes of 1973-74 and 1979.
Measuring the Business Cycle
Expansion is measured from the trough (or bottom) of the previous business cycle to the peak of the current cycle, while recession is measured from the peak to the trough. In the United States, the Business Cycle Dating Committee of the National Bureau of Economic Research (NBER) determines the dates for business cycles. Committee members do this by looking at real GDP and other indicators including real income, employment, industrial production, and wholesale-retail sales. Combining these measures with debt and market measures helps understand the causes of expansions.
Choosing June 2009 as the trough for the most recent recession was difficult for NBER committee members. When they looked at the data, 10 measures hit lows in the period from June to December 2009. The recession began in December 2007 and lasted 18 months, making it the longest downturn recession since World War II. Previously the longest postwar recessions were those of 1973-75 and 1981-82, both of which lasted 16 months.
The Business Cycle’s Effect on Markets
Recessions can extract a tremendous toll on stock markets. Most major equity indexes around the world endured declines of over 50% in the 18-month period of the Great Recession, which was the worst global contraction since the 1930s Depression. Global equities also underwent a significant correction in the 2001 recession, with the Nasdaq Composite among the worst-hit: the index plunged by almost 80% from its 2001 peak to its 2002 low. Importantly, recessions due to credit bubbles bursting are far worse on income and consumption than from stock market speculative bubbles bursting.