What Are Business Cycles?

Market economies have a history of booms and busts called business cycles. The study of these economic cycles is important for making economic and policy decisions. The track record of precisely predicting when the business cycle moves from an expansion to a contraction or when a boom ends with a bust is not great. But the ability to understand when the economy is about to change direction can be critical for workforce planning, timing strategic investments, and mitigating risks due to rising costs or shortfalls in demand.

Business cycles are measured by looking at a variety of indicators that reflect the flows of transactions between households and firms in the economy. History shows that these indicators undergo alternating periods of rises and falls. The business cycle framework was established by economists to study the ups and downs in economic activity.

In the early 20th century, the National Bureau of Economic Research (NBER) was one of the first organizations to establish a research program on the measurement and analysis of market fluctuations. NBER developed a standardized approach to describing and measuring business cycles based on observed economic statistics that are now used around world as one basis for forecasting economic movements. In the United States, NBER has organized a Business Cycle Dating Committee, which uses a variety of data points to determine when recessions have occurred in the US economy. The Conference Board’s indicator program follows this lead and applies it globally, with indicators such as leading and coincident indexes designed for predicting future trends in the US and other economies.

The common elements of economic activity that recur in the history of market economies around the world can be used to predict when these economic movements will occur. This is what helps business executives and policymakers to foresee and adjust their hiring, spending, or investments as the economy evolves. Investors also rely on these common patterns to make decisions about asset allocations. The expansion periods denote the phase of the business cycle when overall economic activity is growing, with rising outputs and incomes, sales, and employment. A peak in the business cycle occurs when economic activity reaches its highest point and begins to slow down or turn down. The contraction phase begins when economic activity starts to fall, or economic growth becomes negative. The trough in the business cycle marks the lowest point of the contraction phase, when incomes and output reach their lowest point and the economy starts to expand again. 

Data used to determine when recessions have occurred include indicators of employment, sales (or demand), personal income, and industrial production along with GDP. For example, in the US, the NBER’s Business Cycle Dating Committee considers a diverse set of indicators including employees on nonagricultural payrolls, the industrial production index, manufacturing and trade sales, and personal income less transfer payments to identify beginning and end dates of recessions. Those variables can be combined into coincident economic indexes, which are broad measures of monthly economic activity.  The coincident index, thus, summarizes a group of economic indicators that are analyzed to look for consistent patterns in the business cycle. The index aggregation helps to pinpoint more precisely when recessions have occurred. A recession chronology developed from The Conference Board Coincident Economic Index® for the US corresponds closely to the committee’s decisions, which often occur months, if not years, after the turning point. Hence, The Conference Board global indicators program relies on coincident indexes to help define expansion and contraction periods for economies around the world with a great degree of accuracy. 

For a more detailed description of these topics, please see this article.