Macroeconomic Activity

The Business Cycle

The Business Cycle is the name given to the periodic fluctuations in the level of economic activity that arise from movements in the level of aggregate demand. We can say that this cycle moves through four distinct phases:

The Business Cycle

Contraction: This phase will usually follow a boom, or a period of rapid economic expansion. At this time the rate of growth in GDP may fall, while the number of new jobs being created may also fall. As a result, over time the rate of unemployment may increase. Also at this time any upward pressure that had previously been evident on prices will subside. Pressure on the current account deficit may also ease, as people reduce their demand for imported goods and services.
Recession: A recession is a phase in which the rate of growth is seen to be negative for two consecutive quarters. During this phase of the business cycle few new jobs will be created, and therefore the unemployment rate will continue to increase. (However, the rate of unemployment may not peak until after the recession has passed, as was the situation in Australia in the early 1990’s.) Also at this time inflation will be lower than previously experienced, and will not be a priority of the federal government in the short term. The balance on current account is likely to be very low due to reduced spending on imports.
Expansion: During a recession policies will be put in place to try and encourage economic expansion once again. Eventually confidence will return, and with it so will the level of investment. As this happens new jobs may be created, and the rate of growth will once again become positive. Prices may begin to rise, but it is unlikely that the government will focus on inflation, as it is important to get the economy growing steadily once again. The current account deficit may also slowly increase as the expansionary policy setting encourages spending once more, some of which will be on imports.
Boom: An economic boom is considered the peak of the business cycle. At this time growth reaches its highest point, and unemployment reaches its lowest point. However, also at this stage of the cycle we can expect higher rates of inflation (for example, in 1989/90 Australia experienced inflation of 8%) and an increasing current account deficit. As a result of these negative side effects, the policy makers will act to restrain growth. This may take the form of increased interest rates as implemented by the Reserve Bank of Australia.

In Australia, we estimate that the length of the business cycle is between seven and ten years. We can see that Australia experienced recessions in 1975, again in 1982/3 and then in 1990/91, so the suggested length certainly applied at that time. However, since 1991 Australia has experienced an extended period of positive growth – a longer continuous period of growth than at any other time in Australia’s history. And so the business cycle should be seen as a highly variable cycle – not one to which Australia conforms completely.

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