Economies do not grow in a straight line; they move through a repeating rhythm of ups and downs called the business cycle. Periods of growth give way to slowdowns, which bottom out and give way to growth again. Recognizing where the economy sits in this cycle helps make sense of headlines and set realistic expectations.
The four phases
The business cycle has four broad phases: expansion, peak, contraction, and trough. During expansion, output, jobs, and spending grow. At the peak, growth tops out and the economy is running hot. Contraction, or recession, is the downturn that follows, and the trough is the low point before a new expansion begins.
Expansion and peak
In an expansion, businesses hire, consumers spend, and confidence builds, often for years at a time. As the economy approaches its peak, capacity gets tight, wages and prices rise, and inflation can build. The peak marks the transition from growth to decline, though it is usually only obvious in hindsight. Overheating at the peak often sows the seeds of the next downturn.
Contraction and trough
Contraction is when activity falls, unemployment rises, and spending pulls back, sometimes meeting the definition of a recession. Eventually the decline slows and reaches a trough, the cycle's low point. At the trough, conditions are weak but stop worsening, setting the stage for recovery. Policymakers usually respond with lower rates and support to hasten the turn.
Why cycles happen and how long they last
Cycles arise from swings in confidence, credit, and investment, plus outside shocks that knock the economy off a steady path. They are irregular, so no two are alike in length or depth, and expansions have often lasted years while recessions tend to be shorter. Attempts to predict exact turning points are notoriously unreliable. What is dependable is that expansions and contractions keep alternating over time.
The US expansion that ran from 2009 to early 2020 was the longest on record, a decade of growth and falling unemployment. It ended abruptly with a pandemic-driven contraction, which hit a trough within a couple of months before a new expansion began.
Key takeaways
- The business cycle moves through expansion, peak, contraction, and trough.
- Expansions bring growth and hiring; peaks often bring overheating and inflation.
- Contractions raise unemployment before the economy troughs and recovers.
- Cycles are irregular in length and depth and hard to time precisely.
Common mistakes
- Assuming an expansion will continue indefinitely because it has lasted long.
- Trying to time investments precisely to the cycle's turning points.
- Confusing a temporary soft patch with a full contraction.
FAQ
How long does a typical business cycle last?
There is no fixed length; postwar US expansions have ranged from about one year to over a decade, and contractions are usually much shorter.
Who decides when a phase begins and ends?
In the United States, the National Bureau of Economic Research dates the peaks and troughs after reviewing a range of economic data.