This article focuses on the business cycle in the United States economy. The business cycle, with its peaks, recessions, troughs, and expansions, will be described and analyzed. The concepts of economic contraction and expansion will be introduced. The process of determining and dating the business cycle will be described. The tactics for managing the business cycle, particularly risk management, will be summarized. Case studies of business-cycle sensitive industries will be investigated.
Keywords Business Cycle; Contraction; Expansion; Recession; Risk Management
Management: Business Cycle
The business cycle, which includes a peak, recession, trough, and expansion, is a cycle of economic contraction and expansion. A recession, as defined by the National Bureau of Economic Research, is 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. Expansion is considered the normal state of the economy. According to the National Bureau of Economic Research's Business Cycle Dating Committee, the most recent peak in the business cycle occurred in March 2001. This economic peak followed a ten-year expansion that began in 1991. The most recent trough in the business cycle, followed by an expansion, occurred in November 2001.
Business cycles refer to type of fluctuation found in the aggregate economic activity of nations that organize their work mainly in business enterprises. A complete business cycle consists of expansions occurring at about the same time in many economic activities, followed by similarly general recessions, contractions, and expansions or revivals. There are two types of business cycles: classical cycles and growth cycles. Classical cycles refer to hills and valleys in a series representing the general level of economic activity. Growth cycles refer to recurring fluctuations in the rate of growth of aggregate activity relative to the long-run trend rate of growth. The measurement and analysis of business cycles is crucial for the economic health of the public and private sectors. Economic indicator analysis is one of the main tools used in measuring and analyzing business cycles. Economic indicator analysis involves using leading and coincident indexes of economic activity as strong forecasting factors or tools (Boehm, 1999).
The business cycle is a prevalent concept, in part, due to the shared nature of the experience across the economy. The majority of economic sectors expand and contract together in the business cycle. Comovement refers to the synchronized movement of sectors of the economy during periods of economic recession and expansion (Christiano, 1998). Business cycles are created by severe economic and geopolitical shocks and crises. Examples of events that create turbulence sufficient to move the business cycle include recessions, inflation, war, terrorism, nuclear threats, housing bubbles, drought, disease, pandemics, earthquakes, tsunamis, rising oil-price shocks, Federal Reserve rate hikes, soaring budgets, trade deficits, and falling dollar values. The shocks and crises that cause economic contraction and recession include both exogenous and endogenous events (Navarro, 2006). Exogenous refers to change from outside the system and endogenous refers to change from inside the system.
Business-cycle sensitivity varies by industry and product. For example, durable goods manufacturers are sensitive to business cycle while nondurable and "necessary" services are not. In addition, industries that represent the early stages of the production chains are particularly sensitive to business cycles due to the need for businesses to adjust their inventory levels during business cycles (Schwartz, 1992). Despite the variations in business-cycle sensitivity by industry and product, business cycles are known to depress the strength of the aggregate economy. Knowing that business cycles reduce long-run growth, governments work to avoid and resolve economic recessions (Rafferty, 2004).
The history of the modern business cycle goes back to the late eighteenth century. The mid-midieval period of feudalism in Europe was a pre-capitalist period. This period was characterized by manor production with little market exchange and barter with little money and credit. Three specific differences between the pre-capitalist and capitalist economies created the modern business cycle. Business cycles require market exchange, production for profit, and money to be present in the economy. Thus the first business cycle did not appear until Europe transitioned from feudalism to capitalism. The first business cycles appeared in England in the 1790s along with industrial capitalism and the Industrial Revolution (Sherman, 2001). Business cycles, since the late 1800s, have tended to last between two and eight years.
The following section describes the processes of determining and dating the business cycle. This section serves as a foundation for later discussions of managing the business cycle and case studies of business-cycle sensitive industries.
The National Bureau of Economic Research (NBER), the United States' leading nonprofit economic research organization, determines and records dates for business cycles in the United States. The National Bureau of Economic Research published its first business cycle dates in 1929. The National Bureau of Economic Research, established in 1920, is a private, nonprofit, nonpartisan research organization dedicated to promoting a greater understanding of how the economy works. National Bureau of Economic Research associates, including 600 professors of economics and business, develop new statistical measurements, estimate quantitative models of economic behavior, assess the effects of public policies on the U.S. economy, and project the effects of alternative policy proposals. The National Bureau of Economic Research established itself as the predominant research organization on the topic of business cycles through the bureau's early research on the aggregate economy, business cycles, and long-term economic growth.
The National Bureau of Economic Research has developed a recession dating procedure. The recession dating procedure is standardized to assure continuity. The recession dating procedure takes a broad view of the economy to determine recessions, as recessions are never limited to one business sector. The committee prioritizes the gross domestic product (GDP), a strong measure of aggregate economy estimated by U.S. Department of Commerce, when determining whether or not a recession has occurred and in identifying the approximate dates of the peak and the trough. The National Bureau of Economic Research's Business Cycle Dating Committee uses monthly economic indicators to determine the months of peaks and troughs of a business cycle. The monthly economic indicators used by the Business Cycle Dating Committee to develop its business cycle chronology include monthly estimates of real GDP; personal income less transfer payments; employment; industrial production; and the volume of sales of the manufacturing and wholesale-retail sectors adjusted for price changes.
The National Bureau of Economic Research's Business Cycle Dating Committee keeps a historical chronology of the U.S. business cycle. The U.S. business cycle chronology identifies the dates of peaks and troughs that frame economic recession or expansion in the United States. The National Bureau of Economic Research's Business Cycle Dating Committee has recorded the following historical averages for US business cycle expansions and contractions:
- 1854-2001: 32 cycles
- 1854-1919: 16 cycles
- 1919-1945: 6 cycles
- 1945-2001: 10 cycles
According to the National Bureau of Economic Research's Business Cycle Dating Committee, and its historical chronology of the business cycle, the most recent peak occurred in March 2001 and the most recent trough occurred in November 2001.
Managing the Business Cycle
Business cycles have a profound effect on business...
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