Business Cycles - Literature review Example

Name) (Instructors Name) (Course) (Date) Business Cycles 1.0 Introduction Typically, the business world is dependent upon the economic growth and performance, which is often driven by many factors. Accordingly, each recession is often different and usually triggered by a diverse set of factors. In effect, a recession often results in a wide latitude with respect to analyzing blame for any witnessed contraction, among economists and other experts. For instance, whereas the 2001 recession started in March, many businesses will often link it to the 2001 terrorist attacks that occurred in the U.S in September. Others will want to associate the 2001 recession with the corporate scandals that ensued after the terrorist attacks, the incessant Middle East crisis, oil shock while others have blamed it on the burgeoning of the Federal Reserve interest rates. Even though such external shocks contribute to the precipitation of a recession, seldom are they the cause. It is, therefore, important to note that recession and growth are mainly controlled by the Business Cycle, which is defined as waves of economic as well as money activity that forms a regular pattern. As such, this paper seeks to define the business cycles in detail. Further, it will also discuss the four phases of business cycle and the most common characteristics related to business cycles. 2.0 Definition of Business Cycle As indicated in the introduction every recession is unique and as such they have unique recovery characteristics. During the recovery after the 2001 recession, statistics indicates that the job market stayed weak for a long period while the growth was rallying (Justiniano, Primiceri, & Tambalotti p.138). The most fascinating thing about the 2001 recovery was the radically accelerated loss of manufacturing jobs. Nonetheless, as it has been indicated before, there are often common patterns that are characterized by all recessions as well as all recoveries, which can often be used to comprehend and predict the timing of turns in the Business Cycle. According to Sørensen & Whitta-Jacobsen, (p.2) six decades of observation has indicated that in the course of a typical recession, incomes fall, employees are fired, the spending is limited, and the output declines. Equally, through an analysis of the historical records, one would realize that in the course of any recession, four fundamental aspects decline all together: employment, output, income, and sales. As Beaudry (P.461) states, the comovement of the above four factors is often key to any economy with regards to the degree of growth or recession. Occasionally, a temporary dip of any of the four variables may occur, however, during a recession all the four variables decline together. On the other hand, as it has been analyzed before, some mild recessions are usually accompanied by a slowed income growth while other variables are not affected. Besides, Beaudry (p.463) notes that during a cyclical downturn the decline of sales, employment, output as well as income, feed on one another thus mounting into an avalanche. Accordingly, when jobs are lost, the incomes of most consumers fall thus leading. Consequently, consumers are forced to buy less, which as forces companies to produce less thus needing few employees. In effect, companies will often carry out major layoffs, which again would leads to an additional drop in the income indexes, which in turn leads to a decline in sales as well as a further drop in the output and the cycle continues. In essence, as Stadermann et al. (p.650) puts, when jobs are lost in one or several industries, individuals’ spending in various sectors also reduces. This effect, which affects several industries, thus forces the downtown to spread from one industry to the other thus engulfing most parts of the economy. As experts explicate, these are the reasons recessions usually spread from one region to the other. During cyclical upturns, the vicious cycle is often fascinating as it turns virtuous thereby indicating a mirror image of an accommodating economy; the employment, income, sales as well as the output increase altogether.. The Virtuous Cycle From the illustration on the diagram above, it is evident that when individuals buy more, various industries also produce more, which in turn forces them to employ more people and eventually causes a rise in the incomes. The overall effect often spread from industry to industry, economy to economy, region to region and in the end, most economies are encompassed by the expansion or growth. In essence, the delineated observations ultimately form the typical definition of business cycles in the various market economies as established by Wesley Mitchell, a renowned economist, in 1927. Importantly, there are four key points as far as business cycle is concerned. First, business cycles are vacillations in comprehensive economic activities. Second, a cycle incorporates simultaneous expansions in various economic activities, ensued by corresponding global recessions. The other the important key point is that the sequence of changes is often recurrent and not periodic. In other words, cycles can stay from one to twelve years. Last but yet important, business cycles cannot be divided into smaller cycles of the same magnitude as well as character. With the above definition, it is easy to assess whether a recession has begun or not and thereby easy to avoid the common misconception associated with the definition of recession. The most common misleading definition of a recession is that if the GDP has undergone two consecutive down quarters, the recession has started. Therefore, as Angeletos et al. (p.320) notes the GDP is only a measure of a country’s economy output. Thus, if the sales, income as well employment do not fall concurrently, the brief period associated with negative output growth would not automatically spread thus recession would not be experienced. That is why Angeletos et al. (p.321) notes that the simplistic rules associated with a recession and business cycles can more often lead to greater risk when decision makers are weighing their options. For instance, when statistics indicated that the GDP was declining for the first three consecutive quarters of 2001, the U.S Treasury posited that the economy was not in recession (Stadermann et al., p.650). Later in August the same year, when a report containing the revised data came out, the GDP indicated that each of the three consecutive quarters of 2001 had been negative. Accordingly, this is when the reality of a downturn downed on a significant number of doubters, 16 months long after it had begun. Equally, it took fifteen months after the recession had started in 1998 for many to accept finally, that Japan was undergoing a recession period Angeletos et al. (p.322) 3.0 The phases of Business Cycle Typically, there often four stages associated with business cycle. These steps include the prosperity, recession, depression and recovery. The 4 Phases of a Business Cycle Source: Beaudry, Paul, and Franck Portier. (P.458) 3.1 The Prosperity Phase To begin with, the prosperity phase is closely related to what is commonly known as the upswing, expansion or boom of the economy (Morley & Piger p.301). During the expansion phase, the employment as well as the output increases. Besides, the production and the employment of resources is at the possible uppermost level as there are enough productive resources. Also, the economy does not experience involuntary unemployment thus the unemployment that may exist is associated with structural and frictional types. This indicates that when expansion gains momentum and a country’s economy has prosperity, the gap between real GNP as well as the probable GNP is often zero. In other words, the production level is at its maximum. Moreover, during prosperity, a significant amount of investment is often witnessed and the demand for durable goods is as well high. The rise of prices is also witnessed during the prosperity phase but people usually enjoy a high living standard as the economic activity level is high. However, the prosperity or expansion phase comes to a halt when the financial institutions start reducing credit, businesses become pessimistic with regards to the future economic state and the prospects of profits change adversely. However, Morley and Piger (p.306) note that economists usually differ when it comes to delineating the possible causes related to the end of prosperity thus leading to the downswing of entire economic activities. For instance, monetarists maintain that the end of prosperity is caused by the contraction in the bank credit. Conversely, Keynes maintains that the sudden downfall of the expected profit levels is majorly caused by the negative predictions of businesspeople, which in turn reduces the investment in the economy (Stadermann et al., p.652). Thus, the prosperity phase is associated with characteristics such as high rate of output as well as trade, effective demand, interest rates, employment, and income. Moreover, the phase is also characterized by a high rate of marginal efficiency of capital as well as investment. 3.2 The Recession Phase During this stage, a turning point is experienced, whereby the prosperity is no longer in existence as such, the economy slowly gets into a depression status. At this stage, the economy is characterized by a slowdown in economic activities. In essence, when the demand for consumer goods starts to fall, the overproductions, as well as the expected future, plans also slow down. Also, during the recession stage, the output production, prices and profits, income and employment start to decline. Furthermore, the businesspeople lose their confidence thus becoming pessimistic about the economy thus reducing their investment activities. Equally, the people, as well as the banks, begin to look for greater liquidity thus forcing the credit to contract. Even more aggravatingly, the expansion of business that was characterized in the prosperity stage stops, which in turn forces the stock market to fall. The recession period is also characterized by the cancelation of orders thus individuals are laid off. With the rapid layoffs, the income, as well as the aggregate demand, also falls. However, the recession period usually last for a shorter period. 3.3 The Depression Stage Also referred to as the contraction stage, the depression stage is associated with the recession phase as it is a continuous decline in the employment, income, output as well as prices and profits. The standard of living falls in general thus allowing depression to set in. Some experts usually refer to this phase as the downsizing of the economy. During the depression stage, the GNP levels also decline and as such involuntary unemployment burgeons on a significant scale. Since businesspeople are still pessimistic at this phase, the investment levels will drop thus resulting in a fall in the purchase of goods and services (Justiniano p.136). Justiniano (p.136) also maintain that in the course of the depression phases, the prices of goods and services also fall rapidly due to the decline in the typical aggregate demand. Another significant characteristic of this phase is the fall of interest rates, which is associated with an increase in individuals’ demand for money holdings. Justiniano (p.136) also notes that capacity is usually in excess since various industries are generating capital as well as consumer goods bellow the normal or expected capacity because of lack of demand in the market. On the other hand, durable consumer and capital goods industries are usually hit during the depression phase because of low purchasing power. Economists warn that severe depression of the economic often occurs when there is a serious recession as well. For example, the 1929-1933 depression is still remembered to date because of its high intensity, which resulted in significant human suffering. In general, the main key features associated with the depression phase include fall in the volume of income, trade, output, demand, and consumption. Further, there is significant deflation, a rise of unemployment, the decline in the interest rates, business pessimism, and decline of the Marginal Efficiency of Capital (MEC) as well as investment. Last but yet importantly, there is usually under-utilization of resources and the general economic activity is at its lowermost, which in turn causes a decline in the prices as wells the profits thus forcing the economy to reach its Trough. 3.4 The Recovery Stage The depression phase is usually temporary as at that particular period the government, as well as other stakeholders, will work hard towards the revival of the economy. With the right strategies and economic efforts, the economy again goes back to prosperity. In other words, the recovery phase is often the turning point from depression to expansion, often referred to as the revival house. This period is characterized by the rapid recovery of the economy thus rise and expansion of economic activities. After the government, as well as other important players in the economy, have come up with new measures to help revive the economy, the demand slowly burgeons, the production also start to increase, which often causes a rise of investment in various industries. According to Beaudry, Paul and Portier (p.463), during the recovery phase the employment, output, income, prices and profits rise. Also, the businesspeople are now optimistic and as such can invest back in the economy. Beaudry (p.464) notes that investment is a significant aspect of any economy as it means that people with more wealth are willing to circulate part of their money to sustain individuals with low or no sources of income. Therefore, the stimulation of investment results in the revival of the economy as the banks can expand their credit limits; the stock markets on the other side are also activated. The recovery stage is also characterized by the circulation of money in the economy thus the income and aggregated demand, production, profits and prices start to increase. As Paul (p.470) explicates, the recovery stage is typically anticipated, and businesses often capitalize on this stage to bounce back in their previous financial status. Paul (p.470) also indicates that similar to the prosperity phase, the recovery stages experience much inflation, while, during a depression, deflation is witnessed. He also notes that in economics, the level of economic activities can only fall within some limits, and the lowest of all is known as the trough, which often lasts for a longer period. Moreover, the capital stock is left to depreciate devoid of replacement and as such the enhancement of technology makes the prevailing capital stock outmoded. 4.0 The common features in Business Cycles Whereas various business cycles have different durations and intensity, they all have some common characteristics. One of the common features is that all business cycles transpire periodically. Even though they do not depict the same uniformity, they have some typical phases such as prosperity, depression, expansion and even trough. Moreover, the duration of business cycle usually varies; from a minimum of 2 to a maximum of 12 years (Morley & Piger p.211). The other significant feature is that business cycles are synchronic. In other words, they do not cause an alteration in a single industry, but they are all related to an embracing character. For instance, contraction or depression affects all the sectors of the economy simultaneously. On the other hand, recession would often pass from one sector of the economy to the other, and the chain goes on thereafter until the whole economy is trapped in recession. Similar example is related to work during the expansion phase, whereby prosperity will expand through different linkages of demand relations or input-output relations between different sectors of the economy. Third, as Morley and Piger (p.211) note, fluctuations happen in both the degree of production as well as simultaneously in other significant variables such as consumption, price level, investment, employment and the rate of interest. Fourth, the consumption and investment in durable consumer goods such as electronics, houses and vehicles are usually affected mostly by the cyclical fluctuations. John Maynard Keynes asserts that investment is known to be volatile as well as unstable since it largely depends on profit expectations of private businesspeople. Accordingly, these expectations often change from time to time thus characterizing investment as unstable. Besides, since the purchasing of consumer durable products can be tardy, the consumption of durable goods varies considerably in the of course of business cycles. The fifth significant characteristic of business cycles is that the purchases of non-durable goods such as foodstuff do not fluctuate much during the business cycle process. Statistics indicates that households usually maintain a significant stability with regards to the consumption of the non-durable goods. The other identified characteristic is that during depression and expansion, inventories of goods often get an immediate impact. That is, when depression hits the economy, the inventories will immediately begin to accumulate above the preferred level. In effect, it results in a decrease in the quantity of goods produced in various sectors. Contrastingly, during recovery, the inventories often fall below the preferred level. This in turn encourages businesspeople to purchase more goods thus forcing the production to rise; thereby stimulating investment in capital products. 5.0 Conclusion From the above discussion it is evident that business cycles are very significant to all economies as it is an international character, thus companies must learn business cycle trends to take precautions. In summation, the paper has defined business cycles in detail as well as illustrated the four distinct phased of business cycles. Lastly, the paper identified the most common features associated with business cycles. Works Cited Angeletos, George-Marios, and Jennifer La'O. "Noisy business cycles." NBER Macroeconomics Annual 2009, Volume 24. University of Chicago Press, 2010. 319-378. Baxter, Marianne, and Michael A. Kouparitsas. "Determinants of business cycle comovement: a robust analysis." Journal of Monetary Economics 52.1 (2005): 113-157. Beaudry, Paul, and Franck Portier. "When can changes in expectations cause business cycle fluctuations in neo-classical settings?." Journal of Economic Theory 135.1 (2007): 458 477. Justiniano, Alejandro, Giorgio E. Primiceri, and Andrea Tambalotti. "Investment shocks and business cycles." Journal of Monetary Economics 57.2 (2010): 132-145. Morley, James, and Jeremy Piger. "The asymmetric business cycle." Review of Economics and Statistics 94.1 (2012): 208-221. Sørensen, Peter Birch, and Hans Jørgen Whitta-Jacobsen. Introducing advanced macroeconomics: growth and business cycles. McGraw-Hill higher education, 2010. Stadermann, Hans-Joachim, and Otto Steiger. "John Maynard Keynes and the theory of the monetary economy." Handbook of the History of Economic Thought. Springer New York, 2012. 641-666. Read More