Meanings of Economic and Business Cycles

The somewhat cumbersome and abstract definition for the term business cycle is “fluctuation in the degree of utilization of the production potential of an economy”. Translated, this statement means that an economy does not always generate the same production, but that it is higher in one period and lower in another.

  • The occupancy rate is influenced by factors such as demand, the level of employment, or the interest rates on consumer and investment loans. If one of these influencing factors changes, there will be changes in capacity utilization and thus economic fluctuations.
  • The economic fluctuations are usually cyclical. They go through the phases of boom, recession, depression and expansion one after the other.
  • There are three types of business cycle: seasonal cycles (a few months), business cycle fluctuations (several years), structural fluctuations (up to 60 years).

Cycles of the business cycle

In a “normal” economic environment, economic cycles are completely normal. Different industries go through different economic phases independently of one another. In total, these are then considered across the entire economy and can be interpreted in the context of gross domestic product (GDP). For example, if half of all motorists in Germany switch to bicycles, the bicycle industry will experience a boom from an economic point of view. On the other hand, the automotive and petroleum industries are falling into a depression. The economic cycles are designated as follows:

  • Boom – limitless demand, boom
  • Recession – downturn, falling demand
  • Depression – low phase without asking
  • Expansion – upswing phase with increasing demand again

Differences in Business Cycles

Economics distinguishes three types of business cycle:

  • Seasonal cycles with a duration of a few months, in winter, for example, due to weather conditions in the construction industry.
  • The past has shown that economic fluctuations last for several years. They result from an imbalance between supply and demand, which has arisen with a time lag.
  • Structural fluctuations can last up to 60 years. They result from a fundamental change in an economic system. This could be caused by changes in key industries. Structural fluctuations have a massive impact on the labor market. There is only very limited scope for political action.

Economy and politics

A country’s government is unlikely to intervene when the economy is expanding or booming. A recession is already viewed critically, a depression requires action on the part of politicians and the central bank. For politicians, the tax is the most common means of preventing the economy from slipping into a depression. Direct subsidies on the one hand, and indirect subsidies in the form of tax relief on the other hand, are the most frequent levers. On the part of central banks, interest rate cuts are the most popular means of providing liquidity and thus stimulating demand again.

The economic cycles in detail

Each cycle is shaped by certain facts, but also by psychological influences.

The boom

At the apex of a boom, the current sentiments of market participants are positive, but expectations are negative. The peak of the boom is characterized by the following features:

  • No further price increases
  • Stagnation in sales
  • Smaller companies are disappearing from the market
  • Concentration and consolidation processes through takeovers

The downturn (recession)

The downturn is accompanied by negative current feelings, but the future prospects are assessed as positive. The recession is noticeable through these facts:

  • High stocks
  • No investment
  • Decrease in overtime, increase in short-time work
  • Declining stock market prices
  • Rise in unemployment, lack of demand
  • Stagnating prices, hardly any wage increases

The Depression

During a depression, market participants are consistently pessimistic, but see positive signals in the future. An economic downturn is accompanied by the following phenomena:

  • Massive rise in unemployment
  • Stock prices are falling rapidly
  • There are deflationary tendencies in the price formation process
  • Investments no longer take place
  • Interest rates are falling to a low point
  • Increase in the shadow economy

The boom (expansion)

The upturn agrees with both a currently positive mood among market participants and positive expectations for the future. The upswing is characterized by the following criteria:

  • Unemployment is falling
  • Inventories are falling
  • Production rises again
  • Stock market prices rise
  • The deflationary price trend shows slight signs of inflation
  • Increase in household consumption

The economic forecasts

The business climate index of the Ifo Institute for Economic Research is one of the most important economic barometers. Once a month, the Ifo Institute asks 7,000 managers how they rate the economic development of their company over the next twelve months. The German Institute for Economic Research (DIW) evaluates the figures of the Federal Statistical Office with regard to production, sales, incoming orders and sales tax payments once a quarter in order to be able to make a forecast for the coming quarter based on this. Interestingly, the number of new vehicle registrations also provides an indicator of economic development.

Economic and Business Cycles