What Is the Business Cycle?

The 4 Critical Stages

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Definition: The business cycle is the fluctuations of economic expansion and contraction that occur over time. It's also called the boom and bust cycle. The National Bureau of Economic Research (NBER) uses quarterly GDP growth rates to determine business cycle stages. It also uses monthly economic indicators, such as employment, real personal incomeindustrial production, and retail sales. The NBER defines the Current Phase of the Business Cycle.

The 4 Stages of the Business Cycle

Each business cycle has four phases. 

  1. Contraction - Economic growth weakens and becomes a recession. Stocks enter a bear market.
  2. Trough - The economy hits bottom. 
  3. Expansion - The economy starts growing again. It's signaled by a bull market. A well-managed economy can remain in the Expansion phase for years. That's called a Goldilocks economy.  Towards the end of this cycle, the economy overheats.  Inflation rises. Investors are in a state of "irrational exuberance." They create asset bubbles.
  4. Peak - The last month and quarter of growth before the recession starts. You usually don't know you are in a peak until it is too late.  

What GDP Can You Expect in Each Business Cycle Phase?

In the Contraction phase, GDP growth rates usually slow to the 1%-2% level and then turn negative. Mass layoffs will make headline news. The unemployment rate will slowly start to rise.


In the Trough phase, GDP growth may still be negative, but it's not as bad. It's clear that the economy is turning a corner. But the unemployment rate usually worsens. That's because it's a lagging indicator. Businesses will wait to hire new workers until they are sure the recession is over. 

In the Expansion phase, GDP growth turns positive again.

Most of the time, it's in the healthy 2-3% range. The end of the expansion phase occurs when the GDP growth rate is above 3% or 4% for more than a quarter. The natural rate of unemployment (around 4%) is reached.

In the Peak phase, the economy is growing at full capacity, near 3% to 4%.  It's usually been growing at 4% or higher for two or more quarters in a row. 

Who Manages the Business Cycle?

The goal of economic policy is to keep the economy in a healthy growth rate. That's  fast enough to create jobs for everyone who wants one but slow enough to avoid inflation. Unfortunately, many factors can cause an economy to spin out of control, or settle into depression. The most important, over-riding factor is confidence of investors, consumers, businesses, and politicians. The economy grows when there is faith in the future and in policymakers. It does the opposite when confidence drops.


The 2008 recession was so nasty because the economy immediately contracted 2.7% in the first quarter 2008, but rebounded 2% in the second quarter.

Everyone thought the downturn was over. The economy contracted another 1.9% in the third quarter, before plummeting a whopping 8.2% in the fourth quarter. The economy received another wallop in the first quarter of 2009. The economy contracted a brutal 5.4%. The unemployment rate rose from 5.0% in January to 7.3% by December. See 2008 GDP Statistics.

The trough occurred in the second quarter 2009, according to the NBER.  GDP contracted 0.5%. Unemployment rose to 9.5%.

The current expansion phase started in the third quarter 2009 when GDP rose 1.3%. That was thanks to the stimulus spending from the American Recovery and Reinvestment Act.  The unemployment rate continued to worsen. It reached 10.0% in October. Four years into the expansion phase, the unemployment rate was still above 7%. That's because the contraction phase was so harsh. 

The peak that preceded the 2008 recessions occurred in the third quarter 2007.  GDP growth was 2.7%. 

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