Business Cycle and Macroeconomic Indicators

The Business Cycle

The business cycle is the term used to describe the short-run fluctuations in expenditure, output and income that occur around an increase in real GDP over the long run.

The business cycle is a depiction, so you can’t really get asked to draw it.

Typically the cycle is described as having two phases and two turning points:

• The expansion or upswing phase;
• The upper turning point (the peak of the cycle);
• The contraction or downswing phase; and
• The lower turning point (trough)

A full business cycle may take between 7-9 years (a very big generalisation), with expansions tending to occur slowly as an expansion develops, followed by a relatively sharp period of contraction.

The upward sloping green line represents the long term growth that results from increases in population and the labour force; the stock of capital equipment; technological change and improving productivity.

• Bolded contribute to the long run growth

The blue line depicts a regular cycle of contraction and expansion.

You can easily say that the green line is the long term growth while the blue line being the actual growth.

Characteristics of Each Phase

The expansion is a period during which real GDP is increasing.

• It is associated with an increase in production (output of goods and services), which results in greater use of productive factors such as labour; more wages (in aggregate) and higher levels of spending.
• The expansion phase of the cycle features some typical characteristics:
  • Rising business investment in the capital equipment needed to produce goods and services;
  • Rising levels of household consumption spending, particularly on discretionary items (not essential);
  • Confidence in household and business sectors;
  • Higher business profitability;
  • Relatively high utilisation of productive capacity;
  • Increasing labour market participation (more people participating); and
  • Falling cyclical unemployment
• The expansion phase can’t last forever, as economic activity is limited by the economy’s productive capacity – how many workers there are to make the products, how many consumers there are to purchase them; how much capital equipment is available for workers to use; and how productive they are.
• The level of economic activity will reach a peak (upper turning point)

As the cycle peaks, the increases of income, and output expenditure that characterised the expansion start to level off.

• Rising prices leads to uncertainty, and households and firms adjust their expectations about the future and reduce their planned spending.
• Inventories (stocks of goods that have not sold) rise – a signal that firms should cut production.

The contraction is the period during which real GDP is falling.

• Businesses record a fall in sales, and respond to this reduction in demand by producing fewer goods and services. As a result, the use of productive input falls.
• Unemployment rises, households incomes fall and spending on goods and services declines
• The business cycle model also uses the term ‘recession’ for the period of economic contraction, but, the term is often reserved for times when there has been two successive quarters (3-month periods) of negative growth.
• Contractions are characterised by:
  • Rising levels of cyclical unemployment;
  • Reduced company profits;
  • Lower sales of consumer durables;
  • Lower levels of consumer and business confidence;
  • Stable, or sometimes lower prices;
  • Higher savings rates; and
  • Lower interest rates

Periods of contraction tend to be relatively short and sharp compared to periods of expansion, and the lower turning point marks the end of the contraction and the start of a new growth period.

• This may feature firms replacing or updating worn out capital equipment, in which case investment spending resumes.
  • Replacement Investment
• Businesses might undertake product and process innovation (new products and more efficient processes) to stay in business, attract buyers and gain a ‘competitive advantage’ over their rivals.
  • Innovation
• The level of economic activity and confidence gradually rises as the economy starts to expand again.
  • Decrease in Price Levels (Increase in demand -> stimulate economy)
• In modern economies, the end of the contraction could also be supported by fiscal and monetary policy.
  • Expansionary Policies

This is why the economy does not stay in a trough.

The Business cycle model depicts a fairly smooth and regular transition from one period of the cycle to another.

Note: This is unusual in the real economy since fluctuations in economic activity can vary both in length and amplitudes.

Economic Indicators

Information about the current state of the economy is important for many household, business and government decisions.

• Gross Domestic Product
• Consumer Price Index (CPI)
• Average weekly earnings (AWE)
• Business hiring intentions
• Labour force statistics e.g. participation and unemployment rates
• Business spending on capital equipment (ie investment)
• Motor vehicle registrations
• Building approvals
• Industrial and agricultural production
• Interest rate
• Levels of public and private debt
• Tourism data (such as hotel occupancy rates and tourist arrivals)
• Exchange rates
• Stock market indices eg the ASX ALL-ordinates Index

Most data collection involves lags.

• Even GDP data suffers a lag between the collection and publication of data

Economic Indicators

Leading Indicators	Coincident Indicators	Lagging Indicators
Share prices Building approvals Levels of stock (inventory) held by firms Manufacturers’ new orders Business and consumer confidence Consumer expectations New employment vacancies New business start-ups	GDP Manufacturing output Sales of consumer durables Production of building materials Retail sales Job advertisements Motor vehicle sales Money supply Capacity utilization	Interest rates Consumer debt Unemployment rate Bankruptcies Inflation rate (CPI)

Leading Indicators: predict a trend in the business cycle several months down the track.

Coincident Indicators (still lag but not as much): appear to move in-line with the level of economic activity, like manufacturing output, production of building materials, sales of consumer durables, retail sales; and the growth of GDP

Lagging Indicators: are not expected to show any change until after trends in the rest of the economy have been confirmed.