Businesses are principal components of a modern economy. They engage in the production, distribution and sale of goods and services. There are many kinds of businesses, from farms and factories to firms selling services like insurance.
Their level of economic activity fluctuates – over time it will increase or decrease, and then decrease or increase again. When fluctuations in many different businesses coincide, a cycle can be identified. Every business cycle has a peak and a trough. There is an expansion phase between its trough and peak, and a contraction phase between its peak and trough.
There are two types of business cycle:
- The classical cycle refers to rises and falls in total production.
- The growth cycle is concerned with fluctuations in the growth rate of production.
In addition to cycles in the whole economy, there are cycles in farm output, housing, and commodity prices.
The classic definition
The most widely-accepted definition of business cycles was provided in 1946 by Arthur Burns and Wesley Mitchell of the US National Bureau of Economic Research: ‘Business cycles are a type of fluctuation found in the aggregate economic activity of nations … a cycle consists of expansions occurring at about the same time in many economic activities, followed by similarly general … contractions.’1
Importance of business cycles
Individuals deciding whether to invest in machinery, or to hire or lay off staff, care about the cycles that are specific to their business. The overall level of economic activity may also affect their decisions.
A nation’s policy makers are concerned about business cycles because excessive or prolonged fluctuations can lead to too much inflation, or to not enough growth and too much unemployment.
Measuring business cycles
French physician Joseph Clément Juglar developed a pioneering analysis of business cycles around 1860. Since then, there have been a number of attempts to classify cycles by their typical duration. In 1939 Josef Schumpeter suggested that there were three types of cycle: short cycles of around three years, known as Kitchin cycles after economist Joseph Kitchin, who identified them; medium-term (Juglar) cycles of around 10 years, which are characteristic business cycles; and ‘long waves’, spanning 50 to 60 years, which were first identified by Nikolai Kondratiev. There remains controversy over the latter two, in part because of the diversity of cycles over time and amongst countries.
What is a recession?
It is commonly thought that a recession is two consecutive quarters of decline in real gross domestic product (GDP). The US National Bureau of Economic Research, however, defines a recession as ‘a significant decline in economic activity spread across the economy, lasting more than a few months, normally visible in real GDP, real income, employment, industrial production, and wholesale-retail sales’.2
Individual countries and economic decision-makers can measure their classical and growth cycles quite differently. In the United States, the National Bureau of Economic Research (NBER) compiles monthly and quarterly reference cycles. Its business-cycle dating committee has maintained a chronology of peaks and troughs in US business cycles that goes back to 1854.
Since 1971 economists have also used computer algorithms to automate the NBER’s method of dating turning points in individual monthly data series. For more than a decade a quarterly adaptation of this simple method has been used to date quarterly turning points in New Zealand’s real GDP series.