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The business cycle

You can describe the phases of the business cycle, explain how recessions are dated in the US, and say why the cycle matters for markets.

Economies move in waves

Some years, jobs are easy to find, shops are busy and companies expand. Other years, layoffs make headlines and spending dries up.

These swings are not random noise. Economies tend to move in waves of growth and decline. The waves affect company profits, interest rates and how investors feel, so they leave marks on almost every chart. This lesson explains the pattern, how its turns are officially dated, and why that dating always comes late.

Expansion, peak, contraction, trough

The business cycle is the rise and fall of economic activity over time. It has four phases:

Expansion: output, jobs and incomes grow.
Peak: growth tops out, often with tight labor markets and rising prices.
Contraction: activity falls. A long and broad contraction is a recession.
Trough: the low point, after which a new expansion begins.

A recession is commonly described as two quarters in a row of falling GDP. That is a rule of thumb. In the United States, the official dates come from the Business Cycle Dating Committee of the National Bureau of Economic Research (NBER). Its definition emphasizes a significant decline in economic activity that is spread across the economy and lasts more than a few months. It looks at many data series, such as jobs, income, spending and production, not just GDP.

The chart shows yearly US growth. The NBER dates one recession from December 2007 to June 2009 and another, extremely short one, from February to April 2020.

Long expansions, short recessions

Since the Second World War, the pattern has been lopsided:

According to the NBER, US expansions between 1945 and 2020 lasted 64.2 months on average, recessions 10.3 months. The longest expansion ran 128 months, from June 2009 to February 2020.

Why it matters for markets:

Profits usually rise in expansions and fall in recessions, most strongly for cyclical companies such as carmakers or travel.
Interest rates tend to rise late in expansions, when central banks fight inflation, and fall in recessions.
Investors look ahead. Share prices often fall before a recession starts and recover before it officially ends.

The NBER announced the December 2007 peak only in December 2008, a year later. By then, US shares had already fallen sharply.

Common mistakes

Treating two negative quarters as the definition. In the US, the NBER decides, using many indicators.
Expecting a fixed rhythm. Cycles have lasted anywhere from months to more than ten years.
Waiting for official confirmation. By the time a recession is declared, markets have usually moved.
Assuming every slowdown becomes a recession. Growth can slow for a while and pick up again.

The takeaway

Economies grow in waves: long expansions and shorter recessions. No one can time the turns precisely, but the phase shapes profits and rates.

Check yourself

Quick quiz

4 questions. Instant feedback, nothing is saved.

1Tap the year in which US output shrank the most.

Tap the chart.

In 2009, real GDP fell by 2.6%, slightly more than the 2.1% fall in 2020.
2Who officially dates US recessions?

The NBER looks at a broad range of data. Two negative quarters of GDP is a common rule of thumb, not the official definition.
3According to the NBER, how did US expansions and recessions compare from 1945 to 2020?

Expansions have been much longer than recessions since the Second World War.
4Why are turning points hard to use in real time?

The NBER announced the December 2007 peak only in December 2008. Markets move long before turns are official.

of 4 correct.

Sources