A business cycle, also known as a "trade cycle" or "economic cycle," is a series of stages in the economy's expansion and contraction. It is constantly repeated and is primarily measured by the rise and fall of a country's gross domestic product (GDP). A business cycle goes through four distinct stages, known as phases, over the course of its life: boom, recession, depression, and recovery. All nations with capitalistic economies experience business cycles. These natural periods of growth and decline will occur in all such economies, though not all at the same time. However, due to increased globalization, business cycles occur at similar times across countries more frequently than they did previously. This article will highlight the various aspects of a business cycle that is important for UPSC aspirants.

What is a Business Cycle?

• Income growth in any economy occurs by increasing the level of production in the economy, i.e., real gross national product (GNP).
• It means that development necessitates greater growth, i.e., higher levels of economic activity.
• The government of an economy strives to maintain a higher level of economic activity by enacting appropriate economic policies.
• However, the economy frequently fails to achieve this goal. As a result, economies fluctuate between the best and worst levels of economic activity, referred to in economics as a boom and a depression, respectively.
• They can be categorized as different stages of an economy's economic activities.
• Between boom and bust, there may be many other economic activity situations, such as stagnation, slowdown, recession, and recovery.
• Economists refer to fluctuations in the level of economic activity between depressions and booms as the business cycle or trade cycle, with recession and recovery serving as the main intermediate stages.
• Stagnation and slowdown are also intermediate stages of the business cycle.

Stages of a Business Cycle

Stages of Business Cycle

Depression

• Despite the fact that depression only visited the world economy once, in 1929, economists have identified enough characteristics to identify it.
• The following are some of the major characteristics of depression:
  • an extremely low aggregate demand in the economy causes activities to decelerate;
  • the inflation being comparatively lower;
  • the employment avenues start shrinking forcing the unemployment rate to grow fast;
  • to keep the business going, production houses go for forced labor cuts or retrenchment (to cut down production cost and be competitive in the market,), etc.
• During the depression, economic situations become so chaotic that governments have almost no control over the economy.
• The 1929 Great Depression gave rise to ideas of strong government intervention in the economy, such as deficit financing and monetary management, and so on.

Recovery

• To survive, an economy attempts to break out of its low-production phase.
• When an economy is in a low-production phase, it may be a depression, a recession, or a slowdown, with the latter being the worst and most common.
• Governments take many new fiscal and monetary measures to boost demand and production, and eventually an economy recovers.
• The business cycle of recovery may exhibit the following major economic characteristics:
  • an increase in aggregate (total) demand, which must be accompanied by an increase in the level of production;
  • the production process expands and new investments become appealing;
  • as demand rises, inflation rises as well, making borrowing cheaper for investors;
  • with an increase in production, new employment avenues are created and the unemployment rate begins to fall; and so on.
• With the aforementioned symptoms, people's income rises, creating new demand, and a cycle of demand and production (supply) begins to play hand-in-hand to help the economy recover.
• To stimulate an economy, governments typically implement tax breaks, interest rate reductions, wage increases for their employees, and other measures.
• The incorporation of innovations by entrepreneurs and the search for new frontiers of an enterprise play a critical role in the recovery process, provided that these activities are initially subsidized by governments.
• With the assistance of the aforementioned measures, the Euro-American economies recovered from the Great Depression.
• Such recoveries have occurred numerous times around the world as economies recovered from slowing or recessionary phases.

Boom

• A strong upward fluctuation in economic activity is referred to as a boom.
• As economies try to recover from the slowdown, recession, and depression, the measures taken by governments and the private sector may place economic activities in such a way that the economic systems fail to digest. This is the peak period of the boom.
• The following are the major economic characteristics of a boom:
  • an accelerated and prolonged increase in demand;
  • demand peaks to levels that exceed sustainable output/production levels;
  • the economy heats up and a demand-supply lag is visible;
  • market forces mismatch (i.e., demand and supply disequilibrium) and tend to create a situation in which inflation begins to rise.
  • the economy may face structural issues such as a lack of investible capital, lower savings, a falling standard of living, and the emergence of a sellers' market.
• The recovery phase is beneficial to the economy, and it progresses to the boom stage, which is preferable. However, there are some drawbacks to the boom.
• Typically, a boom is followed by a price increase. Because a boom is characterized by a strong upward fluctuation in an economy, the supply-side pattern of the economy begins to lag behind the accelerated aggregate demand.
• The dilemma of recovery, on the other hand, puts every economy on the path to boom—this was the experience in the developed world during the 1990s, particularly in the US economy.
• The same scenario played out in India after the economy recovered from the recessionary period of 1996–97 by 2002–03 when inflation reached nearly 8% for a few months.
• The majority of experts believed that the Indian economy was in a boom phase at the time, and we have seen how the government has struggled to keep inflation around the 5% mark.
• By mid-2007, even the government admitted that the economy was overheating. The symptoms of overheating are as follows:
  • there is a decline in aggregate demand as demand falls overall;
  • as demand falls, the level of production (output) in the economy falls as well.
  • as producers reduce their production levels, new employment opportunities are not created—thus the employment growth rate falls;
  • as demand continues to fall, producers usually begin cutting down their labor force to adjust their overhead expenditure and the cost of production (labor-cut is not 'forced' here, but 'voluntary')—resulting in an increase in the unemployment rate; and
  • if the government fails to rescue the economy from the phase of recession.

Recession

• This is similar to the 'depression' phase — and it is fatal for economies because it can lead to depression if not handled with care and in a timely manner.
• The financial crises that followed the US 'sub-prime crisis' in almost the entire Euro-American economies have essentially brought in 'severe recessionary' trends.
• Major characteristics of recession, which are similar to those of 'depression' can be summarised as follows:
  • there is a general decline in demand as economic activity slows;
  • inflation remains low or shows further signs of falling;
  • employment falls/unemployment rises; and
  • industries resort to 'price cuts' to maintain their business.
• In the fiscal year 1996–97, the Indian economy was engulfed in a recessionary cycle, owing primarily to a general decline in domestic as well as foreign demand, which was precipitated by the South East Asian Currency Crisis of the mid-1990s.
• The entire economic reform plan in India was derailed, and the economy was only able to recover by the end of 2001–02.
• The following are the standard treatments that a government can do to bring the economy out of a slump:
  • Direct and indirect taxes should be reduced so that consumers have higher disposable incomes (income after paying direct tax, i.e., income tax) on the one hand and goods become cheaper on the other, resulting in an increase in demand.
  • The burden of direct taxes, particularly income tax, dividend tax, and interest tax, is reduced in order to increase disposable income.
  • Salaries and wages should be revised by the government to encourage general consumer spending (as the Government of India did without much deliberation in 1996–97 when it implemented the recommendations of the fifth pay commission).
  • Indirect taxes, such as customs duty, excise duty, and sales tax, should be reduced so that manufactured goods reach the market at lower prices.
  • The government usually follows a cheap money supply policy by lowering interest rates across the board and liberalizing the lending procedure.
  • Tax breaks for new investments in the economy are announced.
• Technical recession is defined by the World Bank and IMF as well.
  • A technical recession occurs when an economy's GDP falls for two consecutive quarters.
• Though agencies use data on employment, oil demand, and other factors to declare a global recession, it is also defined by the global economic growth rate—a global growth rate of less than 2.5 percent is considered technical recession (2.5 percent is the threshold growth rate for technical global recession).

International Recession Events

• Gulf War Recession (July 1990 – March 1991): Iraq’s invasion of Kuwait resulted in a spike in the price of oil in 1990, which caused manufacturing trade sales to decline.
• The 9/11 Recession (March 2001 – November 2001): Various factors contributed to this, such as the collapse of the dotcom bubble, the 9/11 attacks that lead to mild contraction of the U.S. economy.
• The Subprime mortgage crisis/ Great Recession (2007): This period was characterized by a general recession observed in national economies globally. It was concluded as the most severe economic and financial meltdown since the Great Depression by the IMF.

Conclusion

A business cycle includes various events that result in economic fluctuations in a nations growth. Increased economic instability and uncertainty have the potential to discourage investments thereby reducing growth. Further lack of innovations may put an economy on the path of a slump and other unforeseen disasters.