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The term business cycle or economic cycle
refers to economy-wide fluctuations in
production or economic activity over several
months or years, around a long-term growth
trend.
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peak (boom) - the upper turning of a
business cycle
contraction (slowdown) - A slowdown in the
pace of economic activity
recession ->trough - the lower turning point
of a business cycle, where a contraction turns
into an expansion
expansion - a speedup in the pace of
economic activity
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In an economic expansion, businesses experience
record sales and profits. They can hardly keep up
with demand. In anticipation of a continued sales
growth, inventories are built up and production
facilities are expanded.
This creates demand for suppliers of raw material
and equipment. The equipment takes time to be built
and installed. Banks are willing to lend given the
bright predictions of continued cash flows. A large
number of loan applications pushes banks to raise
interest rates which companies can afford to pay.
Companies find it difficult to hire all the employees
they need, and are forced to pay higher wages, for
instance, for overtime hours. But, that is not a serious
problem in light of healthy sales and profits.
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Furthermore, a strong consumer demand justifies raising
prices for many products. With higher wages, employees
are still able to buy in spite of higher prices; moreover,
anticipation of continued employment encourages them to
use consumer credit if their income is insufficient.
The overheating of the economy is evident in shortages of
employees, materials, equipment, loanable funds and
products.
These shortages imply inflation. Because of difficulties in
obtaining resources, this is no longer a good time to start
a business even if sales appear encouraging. Prices, wages
and interest rates continued rise puts eventually a stop to
further expanding product demand, new hiring and new
lending. The economy has reached its peak.
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Sales are no longer expanding. The economy starts slowing
down. The slow down is mild at first. As sales stop increasing,
inventories pile up.
Companies can adjust to that by reducing orders for raw
materials, avoiding overtime and resorting to sales promotions.
Suppliers start to feel the pinch and are forced to lay off a few
workers. These lay-offs are seen as a signal of potential hard
times ahead.
Employees prefer to set aside some wages, and reduce their
consumption. Sales start to drop as consumer demand shies
away.
Companies are now burdened by the loans they took out to
install new equipment. Their profits shrink with decreasing
revenues, still high employee salaries, and a large overhead.
The hardest hit are the manufacturers of equipment who see
their orders dwindle. Fewer and fewer businesses are started.
Often, plans to open business are cancelled. Some firms go out
of business.
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The slow down becomes a serious contraction. Surpluses are
everywhere: product inventories are bulging, excess capacity
causes newly purchased equipment to turn idle, banks have
loanable moneys that no project justifies, raw materials are not
needed, and employees are too many.
Lay-offs become widespread. Shrinking revenues force
companies to replace full-time employees by lower paid part
time and temporary workers (if labour unions do not intervene),
or even to ask for wage concessions from the existing staff.
Decreasing disposable income causes even more reduction in
product demand. Companies are forced to cut prices.
Revenues disappear and profits turn to losses. Businesses default
on their loans.
Highly leverages companies close down. These are bankruptcies
of large operations. In turn, these bankruptcies can cause some
banks to close as well.
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Pessimism and hardship are widespread. If the
loss of income is not too severe it is called a
recession, otherwise it is branded a depression.
Firms try to survive as they can selling off the
inventory on hand. More bankruptcies are
observed, but the number and the size of the
bankrupt firms are bottoming out.
All prices, interest rates and wages are at their
lowest.
Unemployment is ubiquitous. The unemployed
are ready to take any job.
The contraction has run its course. The economy
has reached its trough.
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The recovery starts. Having sold off their inventories,
companies start to place orders for new supplies.
Consumers have postponed some purchases and made do
with cars or appliance by repairing them. But this has gone
long enough, it is time to buy at least the indispensable;
moreover credit is cheap.
Families have saved up in hard times. Bank reserves are
plentiful and bankers are eager to lend anew, even at very
low rates.
Interest rates are indeed so low that some company
projects become attractive again.
New sales are observed in all sectors.
Companies start rehiring at the low wages first.
New businesses are started. Bankruptcies are less
noticeable. The economy is approaching expansion.
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In expansion, attitudes turn optimistic. Manufacturers
of durable goods see their order books fill up.
Employees are more secure in their jobs, and start
planning for vacations and renewed consumption.
Businesses no longer need to mark down their
inventory. The newly received merchandise from
suppliers reflects new fashion and attracts customers.
Sales continue to pick up, and healthy profit margins
bring back profits. Rehiring employees pushes the
unemployment rate down.
As the expansion becomes more and more
entrenched, memories of hard times vanish with their
warning, and anticipation of continued growth is
about to cause the economy to overheat anew.
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Internal reasons – in economy
◦ changes in consumption and investments
◦ changes in economic policy (monetary policy and
fiscal policy)
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External
◦ demographic changes
◦ political reasons
◦ inventions and innovations
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Real Business Cycle Theory (or RBC Theory)
Unlike other leading theories of the business
cycle, it sees recessions and periods of
economic growth as the efficient response to
exogenous changes in the real economic
environment:
◦ fuel prices grows rapidly
◦ important invention (e.g. computer, internet, justin-time inventory model etc.)
◦ wars
◦ dynamic increase of the birth rate
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The Austrian School says that recessions are
caused mainly by central government
intervention in the money supply.
Austrian School economists conclude that, if the
interest rate is held artificially low by the
government or central bank, then the demand for
loans will be higher than the actual supply of
willing lenders, and if the interest rate is
artificially high, the opposite situation will occur.
This pricing misinformation leads investors to
misallocate capital, borrowing and investing
either too much or too little in long-term
projects.
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In Austrian theory, depressions and
recessions are positive forces in-so-much
that they are the market's natural mechanism
of undoing the misallocation of resources
present during the “boom” or inflationary
phase.
Austrian School economists point to the dotcom investment frenzy and the U.S. housing
bubble as modern examples of artificially
abundant credit subsidizing unsustainable
malinvestment.
Source: http://www.econlib.org/library/Enc/BusinessCycles.html#lfHendersonCEE2017_figure_003
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Recession is a decline in the Gross Domestic
Product (GDP) for two or more consecutive
quarters.
A depression is any economic downturn
where real GDP declines by more than 10
percent. A recession is an economic
downturn that is less severe.
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Another set of models tries to derive the
business cycle from political decisions. The
partisan business cycle suggests that cycles
result from the successive elections of
administrations with different policy regimes.
Regime A adopts expansionary policies, resulting
in growth and inflation, but is voted out of office
when inflation becomes unacceptably high. The
replacement, Regime B, adopts contractionary
policies reducing inflation and growth, and the
downwards swing of the cycle. It is voted out of
office when unemployment is too high, being
replaced by Party A.
Leading Indicators
 Hours of production workers in manufacturing
 New claims for unemployment insurance
 Value of new orders for consumer goods
 S&P 500 Composite Stock Index
 New orders for plant and equipment
 Building permits for private houses
 Fraction of companies reporting slower deliveries
 Index of consumer confidence
 Change in commodity prices
 Money growth rate (M2)
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Consumer confidence, measured by the
Consumer Confidence Index (CCI), is defined
as the degree of optimism on the state of the
economy that consumers (like you and me)
are expressing through their activities of
savings and spending.
The CCI is prepared by the Conference Board,
and was first calculated in 1985.
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Each month the Conference Board surveys
5,000 U.S. households. The survey consists of
five questions that ask the respondents'
opinions about the following:
1.
2.
3.
4.
5.
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Current business conditions.
Business conditions for the next six months.
Current employment conditions.
Employment conditions for the next six months.
Total family income for the next six months.
Survey participants are asked to answer each
question as "positive", "negative" or "neutral".
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http://www.peoi.org/Courses/finanal/ch/ch1
5b2.html
http://economics.about.com/cs/businesscycl
es/a/depressions.htm
Czarny B. „Podstawy ekonomii”, PWE, 2002
www.wikipedia.org
http://www.investopedia.com/articles/05/01
0604.asp
http://pages.stern.nyu.edu/~nroubini/bci/bci
introduction.htm