by Vinayak Maheswaran

Created on: August 01, 2011

This is in contrast to focusing on long run trends, i.e. in understanding why some countries like China have had a long run growth rate exceeding 5% per year for a long time while others have had a growth rate of 0% for a long time. In this article, the focus is on short run fluctuations, i.e in understanding the quarter to quarter or month to month fluctuations in a given economy, like for example the 2008-09 recession in the US. These type of aggregate fluctuations are called business cycles.

Defining business cycles

The best definition is the one found in the book by Burns and Mitchell (1946) “Measuring Business Cycles",

“Business Cycles are a type of fluctuation found in the aggregate economic activity of nations that organize their work mainly in business enterprises. A cycle consists of expansions occurring at about the same time in many economic activities, followed by similarly general recessions, contractions and revivals which merge into the expansion phase of the next cycle; this sequence of changes is recurrent but not periodic; in duration business cycles vary from more than one year to ten or twelve years."

This definition concisely summarizes the four main features of business cycles.

1) Business Cycles are an aggregate phenomenon. That is they involve fluctuations in many economic activities hence in many economic variables, not only in GDP. Also note that fluctuations are in many economic activities but not in all activities. Therefore during a cycle some variables or activities do not follow the cycle or move in opposite directions to the cycle.

2) Business Cycles involve expansion and recessions. When economic activity is falling we are in a contraction or recession. The low point of the recession is called the trough. After the trough the economy expands till it reaches a peak. After a peak a new recession starts and so on.

3) Business cycles are recurrent but not periodic. Cycles are recurrent in the sense that they happen many times but are not periodic in the sense that they do not happen at predictable times and for predictable length of time. An example of recurrent and periodic cycle is the seasonal cycle. Note that the fact that are not periodic makes them harder to predict but also more interesting to analyze in the sense that if you get them right you can take advantage of it (while there is not much advantage in getting the date of Christmas right).

4) Duration. Expansion and recession phases can have different durations

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