Business Cycle Definition: 4 Phases of the Business Cycle

The term “business cycle” refers to the overall economic activity of a country—specifically, how that activity fluctuates in the aggregate and how it might follow patterns in a given period of time.

By definition of a cycle, a business cycle eventually loops back around to the beginning, forming a circle of steps, each one dependent on the previous. Some economists debate whether or not a business cycle must follow this same pattern every time or if it could skip or change stages to qualify as such. Some people refer to the business cycle as the economic cycle or the trade cycle, but all terms refer to the state of an economy.

The National Bureau of Economic Research (NBER) measures the business cycle of the US economy. To do that they use the quarterly GDP rates, economic data, and other economic indicators as a guide and do their forecasting accordingly. Other government agencies use this information, combined with national income accounting, to determine fiscal policy and set benchmarks for progress.

Knowing how the business cycle works and what phase the country is currently in helps determine what the future looks like and whether you, as a consumer and/or investor, should take action accordingly. For example, if you know the country is in a recession, you could follow the monetary policy of the Federal Reserve, also known as the Fed, and see what actions they’re taking to move the country to the next phase. You then would make your investments or financial decisions accordingly.

An economy’s typical business cycle follows the same four steps, involving high and low points. There is no set length of time for each step, as some steps could be short-term, while others could last years. The four phases of a common business cycle include:

1. 1. Expansion: In an expansion phase, the economic activity of a nation grows, the value of the real gross domestic product (real GDP) increases, and there are numerous goods and services available. The interest rate for loans is low, encouraging consumer spending and producing economic growth. Retail sales go up, the unemployment rate is low (sometimes a country even reaches a level of full employment), and the growth rate is high. The point at which the economic expansion has reached its apex before it goes into the next step is a peak phase.
2. 2. Crisis: A crisis occurs when some of the financial assets of a nation drop in value, typically by a large amount. This could be the result of a financial bubble, a banking panic, industrial production dips, or a stock market crash, although it is not limited to those fluctuations. This economic downturn is often a sign of an upcoming recession.
3. 3. Recession: A crisis becomes a recession when the economic activity of a nation shows significant decline as consumer spending slows substantially and there is volatility in the markets. This can happen when the factors that caused a crisis become worse or if an economic bubble pops, causing people’s possessions to lose value and aggregate demand to drop. At this point, a nation’s central bank—such as the United States Federal Reserve Bank—might step in to raise interest rates, which will discourage consumers and businesses from taking out loans.
4. 4. Recovery: As the recession ends, the economy hits one of its turning points, and the recovery process begins. This is when the nation’s economic conditions begin to adapt to the problems that caused the crisis and recession. The stock market can often be an indicator of a recovery cycle. The state of the economy is now on the rise and will be in a period of recovery until it enters expansion, beginning the cycle all over again.

The business cycle measures the ups and downs that a country’s economy takes over time, whereas the market cycle refers specifically to the stock market, and how the stock market’s prices go up and down as a whole over time.

A market cycle has similar properties to a business cycle, but it helps to think of it more like a wave than a circle. The stock market has a period of expansion, often known as a bull market. This is often connected to the business cycle, in that the economy is on the rise, and consumer confidence is high. The inverse of that is the bear market. When there is less consumer optimism and the economy is heading toward a recession, stock prices drop until they reach their eventual low point called a trough. Eventually, the market will pick back up again, heading toward a bull market, and the cycle repeats.

The National Bureau of Economic Research (NBER) Business Cycle Dating Committee records the history of business cycles in the United States. There are several notable examples of the phenomenon occurring, which are used to show its predictability.

The Great Depression is one notable occurrence of the business cycle in action. According to the NBER, the Great Depression began in 1929 and ended in 1933. Although policymakers at the time thought it was the end of the saga, there was another recession that lasted from 1937 to 1938. The US economy didn’t truly begin to recover until around the start of World War II.

The US economy started an expansion period in 2000, and then, beginning in late 2007, it went through the largest economic downturn since the Great Depression. The Great Recession, as it would be known, was a global financial crisis caused by the bursting of a housing bubble; it resulted in a significant decline in the economy.

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