Economic cycles are regular and repetitive periods in the economy. The overall progress or trend in the economic growth is usually known to be accompanied by periods of fluctuations in the economic activity and includes, contraction and expansion, investment, increase and decrease in the income levels, level of employments, price fluctuations, interest rate changes and so on.
The economic cycle comprises of 4 stages which are:
- Economic Recovery
- Economic Expansion
- Overheating of the economy
- Economic Recession
Economic recovery is when a nation’s economy hits rock bottom and marks a new start to the economic cycle which is the recovery stage. In this phase, we usually see a lot of restructuring with lot of investment being put in, in order to meet the growth targets and to restore consumer confidence. The economic recovery phase is usually short but with its fair share of exceptions. For example, the Great Depression in the 1930′s which continued for ten years.
Economic expansion, duly marked by peak economic activity is the stage when the economy is at its full potential marked by increase in production, consumption, wages, etc. This is the highest point in the economic cycle and during this phase, inflation pressure is higher.
Overheating of the economy marks the important turning point between growth and signs of recession. Inflation is key during this stage as money continues to change hands. As inflation rises, so does the general prices as well resulting in a decline of consumption and investment. Sectors such as manufacturing and production usually tend to sell their overstocked inventories at reduced prices indicating the market shift into recession.
Economic recession is the aftermath of the overheating which results in job losses and significantly reduced consumption and consumer confidence. During this phase, money changes hands at a much slower pace marked by reduced lending thus impacting production and manufacturing outputs. Some economists believe that recession usually lasts for a minimum period of six months.
Economic Cycles and Interest Rates
Interest rates play a key role as they help move the economic cycle from one phase to another. Typically, we see low interest rates during the recovery phase indicating the focus on injecting cash into the markets in order to boost the economy, this results in the yield curve showing an upward trend that marks renewed confidence in the markets.
During the phase of expansion, interest rates play a role mostly to contain inflation as this is a stage that is growth driven. At this stage the yield curve is usually known to be flat.
In the overheating phase, we see that the interest rates start rising resulting in a lower yield curve. Short term rates see an increase but there is a drop in the long term rates which acts as a reversal point in the yield curve.
During the recession phase, interest rates drop to their lowest points in an effort to boost the economy. Near zero interest rates are not unusual as the short rates tend to drop, thus forming a flat yield curve.
Economic cycles are most often associated with the changes in the output volumes which is measured by the GDP which is the most reliable and important economic indicator for growth for any economy. However, the exception to this is during the recovery phase, where it is identified by the pace of growth and not the GDP.
Economic Cycles – Different Types
Economic cycles are categorized into long and short cycles and are named after their researchers. Some of these include:
- 7 – 11 year investment cycle studied by Clement Juglar
- 15 – 25 year infrastructure investment cycle, studied by Simon Kuznets
- Kondratieff cycle that usually lasts 45 to 60 years, studied by Nikolai Kondratiev and so on.
To conclude, economic acitivity is related to periods of small economic cycles. For example, there is an increased activity in the retail sector towards the end of the year, marking the holiday season, while other sectors such as agriculture, construction are seasonally variable.