The Trade Cycle
Understanding the trade (business/economic) cycle
- The trade cycle shows which the stage of economic growth a country is in as well as recurring trends in the rates of economic growth. Economies are erratic in nature and, as a result, they go through stages of booms and busts.
- The trend tends to be that a boom is followed by a recession, leading an economy towards the slump stage. Then from the slump there is a recovery period which takes the economy back to a boom. The cycle repeats itself over time.
- When the economy begins recovering from a slump and moves back towards a boom, the economy is said to be in the recovery stage or upswing.
- On the other hand, when an economy moves from boom to slump, the economy is said to be in a recession or downswing.
- The cycle is depicted on the graph below:
- Anywhere on the graph where the actual output curve is higher than the trend output curve, there is a positive output gap. This is because the economy is performing better than the long-term trend output would suggest.
- At the peak, the economy is said to be in a boom which means it has rapid economic growth.
- Anywhere on the graph below the trend output curve means there is a negative output gap. The economy’s actual output is lower than the expected long-term trend output.
- At the bottom of the actual output curve is the slump, this is when economic growth is at its lowest and so is output.
- Automatic stabilisers and discretionary policy are used to restrict the erratic nature of the actual output line – causing it to tend towards to the trend output.
The characteristics of booms and recessions
- High rates of economic growth.
- These periods tend to be unstable and cause high levels of inflation.
- The economy is at full capacity or has a positive output gap.
- There is near full employment present.
- As output has increased in the economy, there is more money which leads to higher levels of disposable income and thus increased levels of consumption. Therefore, demand increases causing demand-pull inflation.
- Governments have a healthier budget as they are getting more money in via taxes while spending less on benefits due to increased levels of employment (automatic stabilisers).
- During times of boom, there is high consumer confidence which leads to increased spending which again shifts AD outward. Firms also feel the same confidence (animal spirits) and expectations better which leads to more investment into the economy, again causing an outward shift in AD.
- Negative economic growth (for at least two consecutive quarters).
- There are negative output gaps as the economy isn’t at full productive potential.
- Could cause deflation but most certainly cause low inflation rates.
- There is unemployment, in particular demand-deficient (cyclical) unemployment due to the low employment rates leading to less disposable incomes which causes less consumption.
- There are usually lowered interest rates as a way to persuade people to spend more (by lowering the cost of borrowing), but as there is low consumer and business confidence in these periods, it is unlikely that there will be a profound increase in spending.
- The government budgets get worse as there is more spending on welfare benefits with less income via taxation due to lower employment levels.