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Business cycles

by Viv B. Hall

New Zealand’s business cycles are strongly influenced by international factors. The Korean War wool boom triggered a phase of expansion, while the oil shocks of the 1970s and the US sub-prime mortgage crisis began periods of contraction.


What is a business cycle?

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.

Footnotes
    • Arthur F. Burns and Wesley C. Mitchell, Measuring business cycles. New York: National Bureau of Economic Research, 1946, p. 3. Back
    • NBER, 21 October 2003, p. 1. Back

New Zealand’s business cycles

Classical cycles

Since the Second World War there have been nine cycles of expansion and contraction in New Zealand. Even excluding the 39-quarter expansion to December 2007, the average duration of each of the eight expansion phases has been more than five years. This is considerably longer than the average contraction phase, which is one year.

New Zealand’s classical business cycles have displayed an unusual level of volatility, especially in contraction phases.

Automatic stabilisers

 

When economic activity wanes, more unemployment benefits are paid, so government spending increases while the tax take falls. The government is pumping more money into the economy than it is taking out, so activity is boosted. As economic expansion takes off, unemployment payments fall, and the tax take rises. In both phases the government softens the rise or fall, but without any explicit policy action – a phenomenon known as automatic stabilisation.

 

They have also been diverse, with no established pattern in terms of length or cause. However, expansions have typically died not of ‘old age’, but because of an event or series of events. These have included international price and output shocks, unusually dry climatic conditions, financial conditions, and a combination of automatic stabilisers and fiscal policies.

The course of a particular cycle can be influenced by the degree of liberalisation in the economy, and by asset prices (especially housing), monetary policy and the exchange rate.

Growth cycles

New Zealand has had two high-growth/low-volatility periods of long expansion and short contraction – from the second quarter of 1954 to the fourth quarter of 1976, and from the second quarter of 1992 until the end of 2007.

It has also had two periods of low growth/high volatility – from the second quarter of 1947 until the first quarter of 1954, and from the first quarter of 1977 until the fourth quarter of 1991.

New Zealand’s real gross domestic product (GDP) growth cycles have been quite volatile compared to those of its major trading partners, such as Australia and the US.

The extent to which New Zealand’s growth cycle has synchronised with those of its major trading partners has varied considerably since the 1980s. While there has generally not been a strong correspondence, New Zealand’s cycles have been most closely associated with those of Australia and the US. The exceptions have been during the economic reforms of the mid-1980s and early 1990s, the 1997–98 Asian financial crisis which coincided with two summer droughts, and the 2001 US recession.


Causes and consequences of fluctuations

International causes

International factors have been primarily responsible for changes in the direction of New Zealand’s cycles, notably commodity prices and exchange rate crises, although domestic influences have also had some impact.

Specific external factors which have triggered turning points in New Zealand business cycles – both classical and growth cycles – have included:

  • the Korean War wool boom of the early 1950s
  • the two oil shocks of 1973–74 and 1978–79
  • the Asian financial crisis of 1997–98
  • the sub-prime mortgage crisis of 2007–8, which originated in the US.

Domestic factors

Unusually severe climatic conditions leading to drought in key parts of the country have been important triggers on several occasions. Net immigration levels and residential housing cycles have also been important, as were the economic reforms of the mid-1980s to early 1990s. However, no major slowdown or recession appears to have been triggered by domestic factors alone.

Monetary and fiscal policy

Monetary and macroeconomic fiscal policy can lessen or amplify cycles. The evidence in this area is relatively new, and comes mostly from growth-cycle models. It seems that fiscal policy (government spending and taxation) has more impact than monetary policy (Reserve Bank control of the money supply) but that terms-of-trade shocks have had a much greater influence than either.

Business cycles and economic growth

There are compelling arguments to suggest that economic growth and business-cycle processes are inextricably linked, and for empirical and policy purposes should be treated in an integrated manner.

The fundamental drivers of potential economic growth over the medium to long term, such as technical progress and improved productivity, are independent of short-run business cycle movements. But these drivers can have an impact on individual cycles in the short term.

A period of economic growth may also coincide with the expansion phase of a business cycle.

Volatile business-cycle movements can hurt economic growth rates in the long term. On a number of occasions, short-term international and domestic economic shocks have led to considerable volatility in a country’s business cycles. This can create greater uncertainty, which hurts economic growth. But it may also inspire individual producers to adopt greater efficiencies and international competitiveness.


External links and sources

More suggestions and sources

More links and websites


How to cite this page: Viv B. Hall, 'Business cycles', Te Ara - the Encyclopedia of New Zealand, http://www.TeAra.govt.nz/en/business-cycles/print (accessed 16 July 2019)

Story by Viv B. Hall, published 11 Mar 2010