A business cycle is the general term economists use to describe periods of growth and contraction within the national economy. Economic business cycles are relatively unpredictable because they occur at irregular intervals in time. However, when they do occur, the four phases of a business cycle tend to follow the pattern of contraction, trough, expansion and peak.
Times of Economic Contraction in a Business Cycle
An economic contraction means the national economy is shrinking as a whole. This often means the national unemployment rate is rising as businesses begin to reduce output. As people begin to lose their jobs, consumer spending often decreases causing overall retail sales in the country to decline. During times of economic contraction, the Federal Reserve Board or the Fed may reduce interest rates to boost business and consumer spending in an effort to prevent further economic contraction and attempt to avoid a recession.
The Trough in a Business Cycle
The trough phase of the business cycle is transition phase between economic contraction and expansion and usually indicates a recession. Economic output is the lowest and unemployment is generally the highest they have been in recent years. During this phase, the Gross Domestic Product, or GDP, which is the total value of goods and services produced in the country, is negative. A positive GDP is an indicator that the economy is coming out of a trough and moving into expansion, the next phase of the business cycle.
However, if GDP growth is positive for one or two quarters and then becomes negative again, it is an indicator of a “double-dip” recession. A double dip recession is when the economy recovers for a short period during a recession but not for long enough to indicate economic growth.
The Expansion Phase of a Business Cycle
When the economy experiences two to three consecutive quarters of economic growth, it indicates that the economy is coming out of the trough or recessionary phase of the business cycle and moving into the expansion phase. During this time, businesses begin to grow, increasing jobs and decreasing unemployment. Output begins to increase and GDP growth is positive. During expansion personal income is also often on the rise, leaving people with more disposable income. This then often leads to an increase in consumer spending.
The Peak of a Business Cycle
The peak phase of the business cycle is the transition between economic expansion and contraction. An economic peak is when economic output and unemployment are generally at the highest levels they have been in recent years and the GDP continues along a positive growth pattern. Economists do not view peaks as a positive events and see them as an economy that is growing too quickly.
When the economy expands or grows too rapidly, inflation rates rise and the value of the dollar falls. A peak is often an indicator of an upcoming economic contraction.