BUSINESS CYCLES

Prof. (Dr) Vandana Bhavsar

WHAT IS A BUSINESS CYCLE?
 BUSINESS CYCLES
The business cycle occurs when
economic activity speeds up or slows
down.
Business cycles refer to fluctuations in
aggregate economic activity (real GDP is
the reference variable).
Alternating increases and decreases in the
level of business activity of varying
amplitude and length
 CHARACTERISTICS OF
BUSINESS CYCLES
Phases of expansion and contraction

Cycles occur across multiple

sectors/industries at the same time

Variables are related by co-movements

Cycles are recurrent, but not regular

Cycles are persistent

 BUSINESS CYCLE
Q Business cycles are the irregular expansions
and contractions in economic activity.

Potential output

Actual output

0
t (in years)
 BUSINESS CYCLE FACTS
Business cycle facts are best described by
characterizing co-movements
Coincident, leading and lagging
variables
Procyclical, countercyclical variables
The amplitude of fluctuations is also
useful in characterizing business cycle
facts.
 BUSINESS CYCLE
A business cycle is a swing in total national
output, income and employment, usually
lasting for a period of 2 to 10 years, marked by
widespread expansion or contraction in many
sectors of the economy.
Why do we say varying amplitude and
length?
Some downturns are mild and some are
severe
Some are short (a few months) and some
are long (over a year)
Do not confuse with seasonal fluctuations!
 THREE TYPES OF BUSINESS
CYCLE

Short-term cycle:
from 2 to 4 years, it results from the changes
in business inventories.
Medium-term cycle:
from 7 to 11 years, it refers to new business
investment.
Long-term cycle:
from 30 to 50 years, it results from the
technological innovation.
 THE PHASES OF THE BUSINESS
CYCLE
Expansion Recession Expansion
Total Output

Peak

Secular
growth
Trough trend

0
Jan.-Apr.- July- Oct.- Jan.-Apr.- July- Oct.- Jan.-Apr.-
Mar June Sept. Dec. Mar June Sept. Dec. Mar June
 PHASES OF BUSINESS CYCLE
Expansion (boom)
is a period in which output increases and approaches potential
GDP or perhaps even overshoots it. Production & Employment
up
Peak
the point at which recession begins, the highest point in real
GDP before a recession. Production & Employment highest,
inflationary pressures
Recession
the downturn of a business cycle. This is a period in which real
GDP declines for at least 2 consecutive quarter-years.
Production & Employment down
Trough
the lowest point of real GDP at the end of a recession.
Production & Employment lowest.
Revival
 CAUSES OF THE BUSINESS
CYCLE FLUCTUATIONS

Changes in business confidence

Alternating periods of stocking & de-

stocking

Changes in the amount of spending on

large consumer items

Changes in the government policies

 BUSINESS CYCLE IN INDIA
YEAR GROWTH REASONS
RATE
[%]

1966-67 -0.04 War with Pakistan

1971-72 1.63 War that carved out a
1972-73 -0.55 new nation - Bangladesh

1979-80 5.24 Oil shock

1991 1 Devaluation of Rupee
2001-02 3.77 WTC bombing
2008 2.67 USA subprime crisis
 BUSINESS CYCLE THEORIES
The External Theories find the root of the
business cycles in the fluctuations of
something outside the economic system
(wars, revolutions, elections, economic policy,
migrations, discoveries of new lands and
resources).
The Internal Theories look for mechanism
within the economic system itself (self-
generating business cycles)
Neoclassical Theories attribute the business
cycle to the expansion and contraction of
money and credit.
 contd..

Keynesian Theories attribute

fluctuations to the economic system itself.
They think that the macro economy is
prone to extended business cycles, with
high levels of unemployed resources for
long period of time. They further hold that
the government can stimulate the
economy.

Political Theories of business cycle

attribute fluctuations to politicians who
manipulate fiscal and monetary policies in
order to be reelected.
 CHARACTERISTICS OF PEAK
Strong and rising level of AD
Low levels of unemployment shortages of
labour occur pushing up wage rates
High levels of consumer borrowing & spending
Firms working at full capacity
Profit levels high
High demand for imported goods & services
Government tax revenues will be rising quickly
Inflation Increasing
Interest rates increasing
Boom in housing market
Increased utilisation rate of existing resources
Danger of demand-pull and cost-push inflation if
the economy overheats
 CHARACTERISTICS OF
RECESSION
General Slowdown In Economic Activity Over A Long
Period Of Time.
Declining Aggregate Demand
Businesses React By Holding Back Production.
Real GDP Falls.
Business Investment Also Falls.
Unemployment & Wages also decline
The Prices Of Many Commodities Fall.
Business confidence & Profits Fall,
The Demand For Credit Falls,
Interest Rates Generally Also Falls.
Bankruptcies Rate Rises.
Decrease In Fixed Capital Investment Spending
Falling Demand For Imports
Increased Government Borrowing
CHARACTERSITICS OF REVIVAL
Consumer confidence grows leading to
increased borrowing and spending
Firms increase output build up stock
levels
Spare capacity used, then
Investment occurs
Unemployment falls it make take more
than a year of recovery for large changes in
unemployment.
 BOOM GOOD OR BAD FOR
BUSINESS?
GOOD ISSUES BAD ISSUES
Easy to sell goods What if business is
Business grows at maximum
Take on new capacity?
workers How easy is it to
More investment in recruit new workers?
new technology If everyone is
Business profits employedwhat will
this do to wages?
Higher costs =
inflation!
 RECESSION IN U.S.
The United States housing market
correction a possible consequence
of United States housing bubble
and subprime mortgage crisis has
significantly contributed to a recession.
U.S. employers shed 63,000 jobs in
February 2008.
The unemployment rate of US grew to 8.5
percent in March 2009, and there have
been 5.1 million job losses till March 2009
since the recession began.
 HOW DOES IT WORK?
A borrower X with poor credit history approaches
a lender/financial institution B for loan.
Seeing his poor records, the financial institution
declines the mortgage to him at prime lending rates.
However, B has an appetite to take risk by
charging higher interest rate from X. This is called
sub prime rate and sub prime mortgage market. X
agrees to avail loan at sub prime rate.
B further securitizes these loans i.e. it converts
these home loans into financial securities, which
promise to pay a certain interest.
This is called investment in Mortgage Backed
Securities (MBS).
So where is the problem?
The sub prime home loans were given at
floating rate of interests.
So as interest rates increased, the rates on
floating home loans too went up, and so did
the monthly installments needed to service
these loans.
Simultaneously, the property prices
declined hitting the sub prime borrowers
who started defaulting.
Once, more and more sub prime
borrowers started defaulting, payments to
the institutional investors who had bought
the financial securities stopped, leading to
huge losses
 RECESSION: IMPACT ON
INDIA
Exports had declined by around 12 per cent
in November 2008.
There was a double-digit decline owing to
lack of demand from most of the buying
markets including the US, the UK, Japan and
other countries in the Euro zone. These are
Indias major export destinations.
Indian industry has also shrunk for the first
time in 15 years with a 0.4 per cent year-on-
year decline in October 2008. The growth was
about 12.2 per cent in October last. It had
been partly due to a dip of over 12 per cent in
Indias exports.
 EUROPEAN CRISIS
The European debt crisis is the shorthand term
for Europes struggle to pay the debts it has built
up in recent decades.
Five of the regions countries Greece, Portugal,
Ireland, Italy, and Spain [PIIGS] have, to varying
degrees, failed to generate enough economic
growth to make their ability to pay back
bondholders the guarantee it was intended to be.
Although these five were seen as being the
countries in immediate danger of a possible
default, the crisis has far-reaching consequences
that extend beyond their borders to the world as a
whole.
The reason for rising bond yields is simple: if
investors see higher risk associated with investing
in a countrys bonds, they will require a higher
return to compensate them for that risk.
This begins a vicious cycle: the demand for
higher yields equates to higher borrowing costs
for the country in crisis, which leads to further
fiscal strain, prompting investors to demand even
higher yields, and so on.
A general loss of investor confidence typically
causes the selling to affect not just the country in
question, but also other countries with similarly
weak finances an effect typically referred to as
contagion.
 HOW TO TACKLE THE
RECESSION
Government Measures.

The government attempt to control

fluctuations in economic growth

Aims to achieve growth at around trend

level.

The Government use Fiscal and Monetary

policy to achieve this objective.
 CURRENT CONDITION OF
WORLDS ECONOMY

According to IMF US economy is slowly

recovering - [2011]
Economic growth rate in US was 1.8%
Economic growth rate in India was 7.4%
Unemployment rate in India is 7%
World economic growth is 3.8%
 QUESTIONS FOR YOU
In a recession what happens to
Growth?
Consumer spending?
Employment?
Business confidence?
Would you INVEST or rationalise in a
downturn/slump?
Consumer confidence?
Would you spend, invest or borrow in a
downturn/slump?
 What would the impact be of a recession
in the following businesses?
Are there any
Gym membership products that we
would buy more of
Restaurants in a recession?
Tobacco companies
Construction firms
Car dealers Think back to
Jewellers elasticity and
luxury/inferior
Vegetable market stalls goods!
In a boom, what happens to .
Growth?
Consumer spending?
Employment?
Business confidence? Would you
INVEST or rationalise in a Boom?
Consumer confidence? Would you
spend, invest or borrow in a boom?
CONSTRUCTION PROJECTS AND
THE MULTIPLIER EFFECT
Major construction projects
such as the new National
Highways can have big
multiplier effects
Thousands of people are
employed within the project
Their incomes are re-
injected into the local
economy
Companies supplying to
the project will also increase
their own spending
THANK YOU