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The business cycle

In the long term, over many years, an economy will grow at a steady rate. However, the climb up the hillside of economic growth is actually quite rocky. Long-term growth is made up of many short-term steps. Each short-term step may last for five or ten years. Over this short-term period the economy goes through a cycle of growth and recession. This is called the trade or business cycle, and it has four stages: boom, slump, recession and recovery.

During a boom, everything is good. Demand for goods and services is high and business is going well. To meet demand, companies need to take on more staff, so unemployment is low. Confidence is in the air! Consumers feel confident about spending because their jobs seem secure. What is more, interest rates are reasonable, so people take out loans and use their credit cards. Low interest rates also encourage companies to invest in new capital, and businesses grow. Governments are happy too, because tax revenues are increasing. However, the government has to be careful. Boom economies are always in danger of overheating. Demand-pull or cost-push inflation will eventually bring the good times to an end.

When the slump comes, the economy continues to grow, but no so fast. Once inflation starts to rise, confidence falls. The government have probably put up interest rates to slow down borrowing. People with mortgages have to spend more money to pay off their debt, so they have less to spend on other things. Higher interest rates discourage business investment. Things are moving slowly, and people just hope that the economy will improve again. But will it?

If the government have not acted quickly enough, its fiscal and monetary policy changes may be too late. In this case, recession is inevitable. Some economists say a recession exists when the current rate of growth falls below the long-term rate of growth. Others say a recession is when there is no growth at all, and the economy actually shrinks. Whatever it is, a recession is bad news. Companies have to reduce costs because turnover is so low. They first thing they do is to lay off staff. If the recession is very bad, some companies may even go bankrupt and close. When this happens, thousands of workers may lose their jobs. As unemployment rises, the government needs to spend more on providing unemployment benefit for those who are out of work. In the worst recessions, these conditions can last for a number of years.

Eventually, with good government policy and a demand for goods or services from healthier economies abroad recovery will come. Slowly, confidence returns, investment grows and the cycle begins again.