The business trade cycle, or simply ‘the trade cycle’ is the cycle that countries experience as all-round economic activity increases and decreases.
The trade cycle is a process that is important for countries to monitor as it has an impact on employment rates, inflation, economic performance and consumer spending. Central Banks also keep tabs on trade cycles as it influences monetary policies as well as short-term interest rates.
Each business trade cycle is made up of four different stages. These are expansion, peak, contraction and trough. These do not occur at regular intervals, however, they do have very recognisable features that help you to define when they do occur.
- Expansion – This stage occurs between a trough and a peak and is defined through a period of economic growth. Typically during this period, gross domestic product (GDP), which measures economic output, increases at around a 2/3% range. Unemployment levels reach their natural rates of around 4/5% and inflation is around its 2% target. The stock market is also in a state known as a ‘bull market’, where an investment’s price rises over an extended period. A well-managed economy can remain in the expansion stage for many years, this is known as a Goldilocks economy. However, this stage can reach its end when the economy starts to overheat. This is when the GDP growth rate reaches greater than 3%, inflation is higher than 2% and investors are in a state of irrational exuberance.
- Peak – This is the second stage of the business trade cycle. It is the period when the expansion stage transitions into the contraction phase. Here, the maximum limit of growth is attained, Economic indicators do not grow further as they are at their highest point. This stage marks the reversal point in the trend of economic growth where consumers being to restructure their budgets.
- Contraction – The third stage of the business trade cycle, contraction starts at the peak and ends at the trough. Here, economic growth weakens as GDP falls below 2%. When it turns negative, this is when a ‘recession’ occurs, resulting in increases in unemployment rates, people selling their homes, income decreases, stocks entering a bear market and investors beginning to sell. Three types of events can trigger the contraction stage. These are a rapid increase in interest rates, a financial crisis or runaway inflation.
- Trough – The fourth phase of the trade cycle is when the economy is at its lowest point. As a result of further declines in the prices and the demand and supply of both goods and services, the economy eventually reaches its negative saturation point. Here, there is extensive depletion of national income and expenditure. Before the economy can reach a new expansion stage, consumers must regain confidence again, often as a result of intervention with monetary or fiscal policies.
Who measures the business trade cycle?
The business trade cycle stages are determined by the National Bureau of Economic Research using GDP growth rates. It uses monthly economic indicators such as the sales of goods and services, employment and income levels to analyse the economy and classify which stage of the trade cycle a country is in.
Who manages the business trade cycle?
The government manages the business trade cycle and legislators use fiscal policy to influence the economy, using expansionary fiscal policy when they want to end a recession. Contractionary fiscal policy is implemented to keep economies from overheating. Central banks also influence the stages of a business trade cycle through the implementation of various monetary policies that impact the level of interest rates. The goal of economic policy is to keep the economy growing at a sustainable rate. It needs to be strong enough to create jobs for everyone who wants one but slew enough to avoid inflation.
Three factors are responsible for the initiation of each stage of the trade cycle, these are; the forces of supply and demand, the availability of capital and consumer confidence. The most important factor, however, is confidence in the future. Economies grow when there is faith in the future and in policymakers. Without this confidence and faith, economies tend to fail. This not only impacts interest rates but exchange rates also as the value of certain currencies begin to decrease. This, of course, has a massive impact on people who wish to send or transfer funds internationally as they begin to lose out by not getting value for their money.
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