Understanding the Business Cycle

In investing, it is important to be attuned to the stagse the economy cycles through called the business cycle. To help discern which part of the business cycle the economy is in, the National Board of Economic Research officially declares the peaks and troughs. However, this might not happen until months after that part of the cycle has either started or ended.

What is the Average Duration of a Business Cycle

In years past, it used to be thought that business cycles were regular with predictable durations. However, today, we know them to be fairly irregular, varying in frequency, magnitude and duration.

According to investopedia.com, since World War II, most business cycles have lasted three to five years from peak to peak. The average duration of an expansion is 44.8 months and the average duration of a recession is 11 months. As a comparison, the Great Depression – which saw a decline in economic activity from 1929 to 1933 – lasted 43 months. This historical overview can help guide our expectations about the economy’s cycle but one must remember that it is not set in stone.

Portions of the Business Cycle Defined

  • Peak: This is everyone’s favorite time. Businesses and investors are happy. The Gross Domestic Product is at its maximum output and employment levels are high. Income and prices are increasing which sets up a risk for inflation. Even though this is an ideal economic state, it is impossible for the economy to maintain itself at this level forever.
  • Recession: This is where we experience the fall of the economy. Employment levels, production and output decline. Wages and prices level off. The country’s Gross Domestic Product provides the measure of economic growth. If it is negative for two consecutive quarters, a recession is declared. A recession generally lasts from six to 18 months. During a recession, interest rates usually drop to stimulate the economy. Lower interest rates encourage more people to borrow money.
  • Trough: When a recession hits the bottom, the economy levels out into a period known as a trough. In essence, it’s a transition marker. This is the period between recession and expansion/recovery. Output and employment may stagnate until stimulated into economic recovery.
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  • Expansion/Recovery: This is a period of economic growth. Employment, production, and output begin to increase towards an economic peak. According to investopedia.com, expansions last on average about three to four years but have been known to last anywhere from 12 months to more than 10 years. Much of the 60s was a time of expansion which lasted almost nine years. Perhaps there are measures we can take and things we can do to speed along the economy’s recovery. Or perhaps we can wait and trust the economy will cycle through it as usual.