Introduction

“Business cycles are a type of fluctuation found in the aggregate economic activity of nations that organize their work mainly in business enterprises: a cycle consists of 2 expansions occurring at about the same time in many economic activities, followed by similarly general recessions, contractions and revivals which merge into the expansion phase of the next cycle; this sequence of changes is recurrent but not periodic; in duration business cycles vary from more than one year to ten or twelve years; they are not divisible into shorter cycles of similar character with amplitudes approximating their own.”

This definition of the business cycle does not make explicit the notion of ‘aggregate economic activity’, leading some to argue in recent years that a satisfactory proxy for this concept is a country’s GDP, which is, after all, about as aggregate a measure of output as possible. On this narrow, output-based view, if one had available a monthly estimate of GDP, then its peaks and troughs would be all that would be needed to determine the peak and trough dates for the business cycle.  

What is a recession?

In this context, it is important to understand something of the mechanism that drives a business cycle. A recession occurs when a decline – however initiated or instigated – occurs in some measure of aggregate economic activity and causes cascading declines in the other key measures of activity. Thus, when a dip in sales causes a drop in production, triggering declines in employment and income, which in turn feed back into a further fall in sales, a vicious cycle results and a recession ensues. This domino effect of the transmission of economic weakness from sales to output to employment to income, feeding back into further weakness in all of these measures in turn, is what characterizes a recessionary downturn. At some point, the vicious cycle is broken and an analogous self-reinforcing virtuous cycle begins, with increases in output, employment, income and sales feeding into each other. That is the hallmark of a business cycle recovery. The transition points between the vicious and virtuous cycles mark the start and end dates of recessions. Under the circumstances, it is logical to base the choice of recession start and end dates not on output or employment in isolation, but on the consensus of the dates when output, income, employment and sales reach their respective turning points. To do any less is to do scant justice to the complexity of the phenomenon known as the business cycle 

However, because of its simplicity, two consecutive quarterly declines in GDP has become perhaps the most popular rule for determining the onset of recession. Yet, the use of such a rule may produce quite a nonsensical set of business cycle dates. One could well imagine a period of depressed economic activity associated with falling output and employment and with unemployment climbing, but with two clear quarterly declines in GDP happening to have a modestly positive intervening quarter. Similarly, to automatically conclude that a country was in recession simply because of two minutely negative quarterly growth rates in GDP. 

The above discussion describes classical business cycles that measure the ups and downs of the economy in terms of the absolute levels of the coincident indicators, i.e. indicators that gauge current economic activity. However, in the decades that followed the end of World War II, many economies like Japan and Germany saw long periods of rapid revival from wartime devastation, so that classical business cycle recessions seemed to have lost their relevance.  A growth cycle traces the ups and downs through deviations of the actual growth rate of the economy from its long-run trend rate of growth. In other words, a growth cycle upturn (downturn) is marked by growth higher (lower) than the long-run trend rate.

Economic slowdowns begin with reduced but still positive growth rates and can eventually develop into recessions. The high-growth phase typically coincides with the business cycle recovery, while the low-growth phase may correspond to the later stages leading to recession. Some slowdowns, however, continue to exhibit positive growth rates and are followed by renewed upturns in growth, not recessions. As a result, all classical business cycles associate with growth cycles, but not all growth cycles associate with classical cycles.  Of course, growth cycles, measured in terms of deviations from trend, necessitated the determination of the trend of the time series being analysed. However, while growth cycles are not hard to identify in a historical time series, they are difficult to measure accurately on a real-time basis  This is because any measure of the most recent trend is necessarily an estimate and subject to revisions, so it is difficult to come to a precise determination of growth cycle dates, at least in real time.  

This difficulty makes growth cycle analysis less than ideal as a tool for monitoring and forecasting economic cycles in real time, even though it may be useful for the purposes of historical analysis. This is one reason that by the late 1980s, Moore had started moving towards the use of growth rate cycles for the measurement of series which manifested few actual cyclical declines, but did show cyclical slowdowns. 

Growth rate cycles are simply the cyclical upswings and downswings in the growth rate of economic activity. The growth rate used is the "six-month smoothed growth rate" concept, initiated by Moore to eliminate the need for the sort of extrapolation of the past trend needed in growth cycle analysis. This smoothed growth rate is based on the ratio of the latest month's figure to its average over the preceding twelve months (and therefore centred about six months before the latest month). Unlike the more commonly used 12-month change, it is not very sensitive to any idiosyncratic occurrences 12 months earlier. A number of such advantages make the six-month smoothed growth rate a useful concept in cyclical analysis. Cyclical turns in this growth rate define the growth rate cycle. 

Features of Business Cycle

    From the above definitions, we can draw the following features.

• Cyclical fluctuations are recurring in nature.
• A business cycle contains self-generating forces which tend to terminate one phase and bring the other phase of the cycle.
• A business cycle is cumulative self-reinforcing.
• Business cycles are prevailing in their impacts. They affect virtually every part of the economy.
• Keynes pointed out that a trade cycle is characterized by the presence of crisis.
• Business cycles by and large follow a pattern of development.
• Business cycles occur periodically. It is synchronic in nature which means that changes not occur only in single industry, but in the whole industry.
• Business cycles are international in character.
• Investment and consumption of durable goods are most affected by business cycles
• One of the important features of business cycles is that consumption of non durable goods and services does not change much during the phases of different trade cycles.
• The cycle will not have identical spacing, and thereby, asymmetric nature of the cycle exhibits a different time period of occurrence.
• Most of the macroeconomic variables are affected by the cyclical movement. In the upswing phase, output, prices, employment, income shows a upward trend, while an opposite trend is observed in downswing phase. Even though the trend is similar, but the magnitude of impact may be different. 

Five Phases of a Business Cycle

Business cycles are characterized by boom in one period and collapse in the subsequent period in the economic activities of a country. These fluctuations in the economic activities are termed as phases of business cycles. The fluctuations are compared with ebb and flow. The upward and downward fluctuations in the cumulative economic magnitudes of a country show variations in different economic activities in terms of production, investment, employment, credits, prices, and wages. Such changes represent different phases of business cycles. 

The different phases of business cycles are shown in Figure-1:

There are basically two important phases in a business cycle that are prosperity and depression. The other phases that are expansion, peak, trough and recovery are intermediary phases.

Figure-2 shows the graphical representation of different phases of a business cycle:

As shown in Figure-2, the steady growth line represents the growth of economy when there are no business cycles. On the other hand, the line of cycle shows the business cycles that move up and down the steady growth line. The different phases of a business cycle (as shown in Figure-2) are explained below. 

1. Expansion:

The line of cycle that moves above the steady growth line represents the expansion phase of a business cycle. In the expansion phase, there is an increase in various economic factors, such as production, employment, output, wages, profits, demand and supply of products, and sales. In addition, in the expansion phase, the prices of factor of production and output increases simultaneously. In this phase, debtors are generally in good financial condition to repay their debts; therefore, creditors lend money at higher interest rates. This leads to an increase in the flow of money.

In expansion phase, due to increase in investment opportunities, idle funds of organizations or individuals are utilized for various investment purposes. Therefore, in such a case, the cash inflow and outflow of businesses are equal. This expansion continues till the economic conditions are favorable. The various characteristics of economy in its expansion phase are increase in output, increase in investment, increase in employment, increase in aggregate demand, and increase in sales, increase in profits, increase in wholesale and retail prices, increase in per capita output and rise in standard of living. There is absence of involuntary unemployment but structural and frictional unemployment prevails in the economy. So when expansion gathered momentum we have prosperity in the economy and in this phase gap between potential GNP and actual GNP is zero. It means in this phase level of production is at maximum. So in prosperity phase there is a high level of effective demand, employment and income. People enjoy a high standard of living also.

2. Peak:

The growth in the expansion phase eventually slows down and reaches to its peak. This phase is known as peak phase. In other words, peak phase refers to the phase in which the increase in growth rate of business cycle achieves its maximum limit. In peak phase, the economic factors, such as production, profit, sales, and employment, are higher, but do not increase further. In peak phase, there is a gradual decrease in the demand of various products due to increase in the prices of input. The increase in the prices of input leads to an increase in the prices of final products, while the income of individuals remains constant. This also leads consumers to restructure their monthly budget. As a result, the demand for products, such as jewellery, homes, automobiles, refrigerators and other durables, starts falling. In this stages of prosperity, it may happened sometimes that banks start reducing credit or profit expectations change adversely and trader become doubtful about future state of the economy. However different economists have different views regarding the possible reasons for the end of boom phase and start of downswing in economic activity. Some have argued that the contraction in bank credit may cause downswing and in the eyes of others, sudden collapse of expected rate of profit is a major cause of downswing.

3. Recession:

As discussed earlier, in peak phase, there is a gradual decrease in the demand of various products due to increase in the prices of input. When the decline in the demand of products becomes rapid and steady, the recession phase takes place. In recession phase, all the economic factors, such as production, prices, saving and investment, starts decreasing. Generally, producers are unaware of decrease in the demand of products and they continue to produce goods and services. In such a case, the supply of products exceeds the demand. Over the time, producers realize the surplus of supply when the cost of manufacturing of a product is more than profit generated. This condition firstly experienced by few industries and slowly spread to all industries. This situation is firstly considered as a small fluctuation in the market, but as the problem exists for a longer duration, producers start noticing it. Consequently, producers avoid any type of further investment in factor of production, such as labor, machinery, and furniture. This leads to the reduction in the prices of factor, which results in the decline of demand of inputs as well as output.  In this phase, economic activities slide down their normal level. In this phase not only output decreases but the level of employment also reduce and the result of this there is fall in GNP also.

As there is presence of involuntary unemployment in the economy, output and trade declines, profit and wages fall as a result income also, decline in investment and aggregate demand. In depression phase there is fall in interest rates also and with low rate of interest people demand for money holding increases. All construction activities come to an end. Durable consumer goods and capital goods industries are hit badly. In short all economic activities touch the bottom.  

4. Trough:

During the trough phase, the economic activities of a country decline below the normal level. In this phase, the growth rate of an economy becomes negative. In addition, in trough phase, there is a rapid decline in national income and expenditure. In this phase, it becomes difficult for debtors to pay off their debts. As a result, the rate of interest decreases; therefore, banks do not prefer to lend money. Consequently, banks face the situation of increase in their cash balances. Apart from this, the level of economic output of a country becomes low and unemployment becomes high. In addition, in trough phase, investors do not invest in stock markets. In trough phase, many weak organizations leave industries or rather dissolve. At this point, an economy reaches to the lowest level of shrinking. When economic activities touch the bottom level, the phase of trough is reached. It is a phase where capital stock is allowed to depreciation even without replacement. Technology advancement makes the capital goods obsolete. In this situation if a bank starts expanding credit facilities for the advancement of technology, new types of machines and other capital goods then it brings a recovery in the economy.

5. Recovery:

As discussed above, in trough phase, an economy reaches to the lowest level of shrinking. This lowest level is the limit to which an economy shrinks. Once the economy touches the lowest level, it happens to be the end of negativism and beginning of positivism. This leads to reversal of the process of business cycle. As a result, individuals and organizations start developing a positive attitude toward the various economic factors, such as investment, employment, and production. This process of reversal starts from the labor market. Consequently, organizations discontinue laying off individuals and start hiring but in limited number. At this stage, wages provided by organizations to individuals is less as compared to their skills and abilities. This marks the beginning of the recovery phase.

In recovery phase, consumers increase their rate of consumption, as they assume that there would be no further reduction in the prices of products. As a result, the demand for consumer products increases.  In this phase, some firm’s plans investment, some going for renovation programmes and some undertakes both. This step will generate construction activities in both capital and consumer goods sector. As a result factor of production fully utilized wages and other input prices move upward. Thought it may not in a uniform rate but in increasing trend. So when this process gathered momentum, economy again enters into the phase of recovery and then expansion. Thus the business cycle going on. In addition in recovery phase, bankers start utilizing their accumulated cash balances by declining the lending rate and increasing investment in various securities and bonds. Similarly, adopting a positive approach other private investors also start investing in the stock market As a result, security prices increase and rate of interest decreases.

Price mechanism plays a very important role in the recovery phase of economy. As discussed earlier, during recession the rate at which the price of factor of production falls is greater than the rate of reduction in the prices of final products. Therefore producers are always able to earn a certain amount of profit, which increases at trough stage. The increase in profit also continues in the recovery phase. Apart from this, in recovery phase, some of the depreciated capital goods are replaced by producers and some are maintained by them. As a result, investment and employment by organizations increases. As this process gains momentum an economy again enters into the phase of expansion. Thus, a business cycle gets completed.