For economic's The Business Cycle - Term Paper Example

The paper discusses the business cycle in the context of economic activity. Some causes of business cycle are discussed shortly. Economic indicators are analyzed to examine the trends in business cycle. Recession which is the defining part of a business cycle has been explored in this paper. Fiscal and monetary policies have been examined as control measures for economic recession. Some leading economic indicators such as: unemployment rate, labor cost index, commodity prices, change in business inventories, and work productivity that predict the future health of economy have also been explored in the paper. Stock market which in the modern economies forms basis for decision making by many investors has been suggested as an area of further research. THE OUTLINE Definition of Business Cycles Business cycle is the periodic and changing levels of economic activity. Generally business cycles describe the fluctuations that occur in the economic demand-side which is measured by the Gross Domestic Product. Causes of business cycle: Theses causes are categorized into two: economic and non-economic factors. Economic indicators for predicting business cycle: Some of these indicators are: inflation rate, Gross Domestic Product (GDP), and unemployment rate, among others. Nature of economic indicators: Economic indicators can have the following characteristics in relation to the manner in which they fluctuate with changes in economic growth: procyclic, countercyclic, or acyclic. Also the economic indicators can be said to be coincident, lagging, or leading depending on the time they take to respond to the changes of economy. Relationship between recession and business cycle: Recession is the defining part of a business cycle. If an economy does not experience recession, then it implies that the economy would not experience business cycle. Recession Correction measures: The measures used are fiscal and monetary policy. The leading economic indicators: These include: unemployment rate, labor cost index, commodity prices, change in business inventories, and work productivity. Stock market as an area of further research: Due to the fact that less information is available regarding the relationship between stock market and the economy, there is need for researcher to provide valid and reliable information on this matter. BUSINESS CYCLES Business cycle is the periodic and changing levels of economic activity. It is measured by the changes in real gross domestic product and other economic variables (Berqstrom, & Vredin, 94). Business cycle does not occur regularly and can not be predicted (Berqstrom, & Vredin, 94). It occurs randomly and that’s why it’s unpredictable. A business cycle occurs in a succession of four phases. These are: contraction, trough, expansion, and peak (Berqstrom, & Vredin, 95). Contraction brings about slowed rate of economic activity. Trough is the turning point of a business cycle from economic contraction to economic expansion (Berqstrom, & Vredin, 95). An expansion is the acceleration of economic activity pace, where as peak is the turning point of a business cycle from economic expansion to economic contraction (Berqstrom, & Vredin, 95). Generally business cycles describe the fluctuations that occur in the economic demand-side which is measured by the Gross Domestic Product (Berqstrom, & Vredin, 96). The gross domestic product keeps changing with time because of some reasons that may be economic or non-economic (Berqstrom, & Vredin, 96). Changes in interest rates and taxes as a result of implementation of government policies are some of economic reasons that may result to changes in GDP (Berqstrom, & Vredin, 97). For example, if government uses a lot of resources in war and fails to increase taxes, the increase in its demand will not only cause increase of war material output, but also rise in the defense workers take-home pay (Berqstrom, & Vredin, 99). On the other side non-economic factors are many in number and may include: man-made disasters, drought, and war among others (Berqstrom, & Vredin, 99). The real business cycle is built on the idea that, business cycles are driven purely by the shocks of technology rather than expectation changes and monetary shocks (Berqstrom, & Vredin, 98). Shocks in purchases of government also appear in real business cycle theory (Berqstrom, & Vredin, 98). Since business cycle is related to total economic activity, the economic indicators are used to predict the trends in business cycle. These economic indicators include: inflation rate, Gross Domestic Product (GDP), and unemployment rate, among others (Mitchel, 79). These indicators which are just economic statistics shows how healthy the economy is and how the economy might be in future (Mitchel, 79). Investors rely mostly on these economic indicators to make decision when and where to invest. In case the economic indicators at one point in time prove otherwise than they had previously indicated, investors may decide to use different investing strategy (Mitchel, 80). The economic indicators tend to differ in their relationship to the business cycle or economy. Economic indicators can either procyclic, countercyclic, or acyclic characteristics (Mitchel, 81). Economic indicator is said to be procyclic if it moves in the same direction with performance of economy (Mitchel, 81). This implies that if the economy was performing well the indicator will be increasing in magnitude, where as if the economy was experiencing recession the indicator will be decreasing in value (Mitchel, 81). A cuntercyclic is where we have the economic statistic moving in the opposite direction with the economic performance (Mitchel, 81). For example, during the periods of poor economic performance, unemployment rates increase in magnitude (Mitchel, 81). Lastly, an economic indicator is referred as acyclic if it portrays no relationship with the economic health. Such indicators are of no use in studying business cycles (Mitchel, 82). The indicators of economy can be coincident, lagging, or leading, which show the timing of their fluctuations in relation to how the aggregate economy is changing (Mitchel, 82). Indicators which fluctuate prior to economic change a said to be leading (Mitchel, 82). For example, returns in stock market often start to decline prior to decline of the economy, and improve prior to the end of an economic recession. In business cycles, investors rely mostly on leading economic indicators to make decision as they are good in predicting what the economy might be in time to come (Mitchel, 82). Indicator that does not fluctuate until the economy changes after some period is referred to as lagged economic indicator (Mitchel, 83). For example, the rate of unemployment continues to increase for the first three quarters after the economy began to perform better (Mitchel, 83). Economic indicator that changes at the same time with the change of the aggregate economy is referred to as coincident economic indicator (Mitchel, 83). An example of coincident economic indicator is Gross Domestic Product. Recession is the defining part of a business cycle. If an economy does not experience recession, then it implies that the economy would not experience business cycle (Knoop, 120). The economy in this case will be undergoing a prolonged period of economic expansion. For example, since 1992 up to 2000, the United States economy has recorded the longest period without experiencing recession (Knoop, 120). Before the emergency of depression in 1930s, policy makers did nothing to counteract the business cycle driving forces, but allowed the economy to take its course (Knoop, 122). However, after experiencing the subsequent severe recessions, policy makers came up with the fiscal and monetary policies to counteract these forces (Knoop, 123). The monetary policies are also even applied by the modern economists to smoothen the business cycle. The fiscal policies entail changes in government spending and taxes. During recession periods in an economy, a government or policy implementers can employ both increment of government spending and tax cut to correct the recession (Knoop, 124). For example, in 2001 when the United States experienced recession in its economy, the government ordered for a tax reduction and an increase in government expenditure (Knoop, 124). In 2003 the impact of this was felt in the economy, as it had grown by 7 percent (Knoop, 124). On the other hand, monetary policy entails increase or decrease in rates of interest. The decrease or increase in interest rates affects business investment. Changes in rate of interests also influence the rate of consumption (Knoop, 125). Having the knowledge on the key economic indicators, economists can try to forecast the changes in inflation rate and the Gross Domestic Product. However, some economic statistics may indicate conflicting signals and result to a controversial conclusion (Burns, & Wesley, 130). Using these economic indicators policy makers are able to interpret and respond to business cycles (Burns, & Wesley, 130). As mentioned earlier, the real Gross Domestic Product and unemployment rate are significant macroeconomic variables in interpretation and reaction to business cycles by economic policy makers (Burns, & Wesley, 131). The desire by the economic policy makers to smoothen the business cycle mainly involves minimizing the variation magnitude of economic growth (Burns, & Wesley, 134). As mentioned earlier above, policy makers in an economy predict the move of economy by observing the leading economic indicators. The leading economic indicators for predicting business cycles are: Unemployment Rate The estimated full-employment rate is 2/3 of the total costs of production for a business (Mitchel, 111). If this rate falls below the estimated rate, there will be shortage of labor required for production (Mitchel, 111). In the process of business expansion by producers, the cost of production tends to increase as the producers have to increase wage rate to attract the unemployed members. The increasing cost in production due to the increased wage rates translate into increase in prices of goods and services and raise in the rate of inflation (Mitchel, 111). Labor Cost Index The labor cost index measures the cost of production in terms of salaries, wages, and benefits given to employees in a firm (Mitchel, 117). Increase in this index implies an increase in cost of production. Where the consumer demand is strong, the producer can transfer this burden to consumers by increasing the prices of commodities which results to higher inflation rates in the economy (Wassels, 117). Commodity prices Higher prices of raw materials are transferred on to the final commodity. This has relationship with the inflation rates (Mitchel, 119). Changes in Business Inventories Suddenly increase in demand for consumer good results to exhaustion of business inventories (Mitchel, 119). As the producers work towards meeting the increased demand and to reestablish inventories to the required level, there are high chances of inflation (Mitchel, 119). Work productivity gain Policy makers can determine business cycles by observing work productivity gains. This economic factor refers to output per given worker (Mitchel, 120). Increasing work productivity gain has a negative relationship inflation rate. If work productivity per worker goes up there is reduction in production cost that ultimately results into lower prices of goods and services and decreased inflation rate (Mitchel, 122). Despite the above economic leading indicators, investors have relied heavily on stock market to determine the trends in business cycle. It has been observed for so long that when there is decline in the stock market, the economy follows suit (James, & Hoover, 20). However, less information is available on whether stock markets may result to better or worse performance of economy. This is an area that needs further research to establish the relationship between the stock market and business cycle or economy (James, & Hoover, 22). There have been arguments that stock market has no direct effect on the economy as a whole. The stock market only acts as mirror that corrects beliefs of people about what may happen in the economy, but can not be said to be a certain indicator of economy (James, & Hoover, 27). The fact that many investors rely on stock market conditions to make decision on whether to invest or not, there is need for researchers to come up with reliable information that can be used as a base for decision making by investors. The belief that stock market can be used to determine the economic growth will lead to an error if reliable information will not be provided by researchers (James, & Hoover, 27). Many investors have had the belief that if factor A comes before B, then A causes B. In connection to this, the expectations on economic decline cause the decline in stock market (James, & Hoover, 34). Many investors are relying on this principle which to some point may be misleading. This has resulted to what is called propter hoc fallacy (James, & Hoover, 36). Investors are normally right when they forecast the rate of economic growth, and act accordingly in making their decision (James, & Hoover, 39). However, if the economy behaves otherwise the investors will have made the wrong decision. For this matter, there is need for intensive research on effect of stock market on economic activity, and if there are intermediate factors that may influence the relationship between the stock market and economic activity in determining business cycle. REFERENCES: Berqstrom, Villy & Vredin, Anders. Measuring Business Cycles. New Jersey: John Wiley & Sons, 1994, p. 94-99 Burns, Arthur, & Wesley, Mitchell. Measuring Business Cycles. New York: National Bureau of Economic Research, 1946. 130-134 James, Hartley & Hoover, Kelvin. The Limits of Business cycle Research: Assessing the Real Business Cycle Model. Oxford Review of Economic Policy, 13.3, 1-51, 1997 Knoop, Todd. Recessions and Depressions: Understanding Business Cycles. Mahwah, NJ: Praeger, 2004, p. 120-125 Mitchel C. Wesley. What happens During Business Cycles: A Progress Report. New York: National Bureau of Economic Research, 1951, p.130, 132,133 Mitchell, Wesley. Business Cycles: The Problem and its Setting. New York: National Bureau of Economic Research, 1954, p. 79, 80-83 Romer, Christina. Remeasuring Business Cycle. Journal of Economic History, 54, 1994, 15-22 Wassels Walter J. Economics: Business Review Series. Oxford: Oxford University Press, 2000, 111, 117-122 Read More