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Business Cycle

What is the business cycle?

A business cycle is a periodic variation in the Gross Domestic Product (GDP) around its long-term average growth rate. It describes the expansion and contraction phases that an economy undergoes over time.

A business cycle is completed when it passes through one peak and one trough in succession. This process's duration is called the business cycle's length.

A peak is marked by a period of rapid economic growth, whereas a trough is marked by a relatively slow economic growth period. These are measured in terms of real GDP growth, which is adjusted for inflation.


Business Cycle Explained

Business cycles are fluctuations in macroeconomic activity that affect the growth and productivity of a nation. They can also be referred to as economic cycles or trade cycles. The National Bureau of Economic Research (NBER) is a private, non-profit, and non-partisan research organization in the US. It has a Business Cycle Dating Committee that maintains the historical record of the phases of the economy. The NBER uses various indicators to assess economic conditions, such as GDP, production, employment, aggregate demand, real income, and consumer spending.

The Keynesian economic theory stresses the role of demand in influencing the business cycle. It argues that the government should intervene to correct the economic deflation and achieve full employment when the aggregate demand decreases. On the other hand, the Real Business Cycle (RBC) and New Classical economics propose that the economy adjusts to a new equilibrium whenever there is a change in the aggregate supply. They claim that the economy has an automated mechanism and does not need government interference.

The economy of a capitalist country experiences periodic changes in the level of economic activity, which are called the business cycle phases: expansion, peak, contraction, and trough. These fluctuations may self-adjust over time, but the government and the central bank intervene with economic policies to smooth out the trade cycle effects. For example, the central bank can use monetary policies such as changing the interest rate or the money supply. Similarly, the government can use fiscal policy tools such as adjusting the tax rates and government spending. These actions are taken to prevent undesirable scenarios like stagflation or hyperinflation