Trade (Business) Cycle

The trade (business) cycle refers to changes in real GDP over time. This is actual growth, and it tends to move above and below the long-term trend growth rate.

Key points on the cycle

There are four recognisable points in the cycle:

• Peak / Boom

• Slowdown / Downturn

• Recession

• Recovery

Output gaps and what they mean

Positive output gap

A positive output gap happens when real GDP is above the trend, suggesting the economy is operating above normal capacity( unsustainable.e.g over using machinery  ). 

Negative output gap

A negative output gap happens when GDP is below the trend, implying spare capacity and weaker demand. 

The flow through phases

Economies often move through a repeated pattern: boom → slowdown → recession → recovery → boom. In reality, the cycle is not smooth or automatic.

Boom

A boom is a period of rapid economic growth and high economic activity.

Characteristics of a boom

• High/increasing real GDP growth

• Falling unemployment and more job vacancies

• Spare capacity reduced (the negative output gap shrinks, or a positive gap appears)

• High household and business confidence, encouraging risk-taking

• Rising inflation, usually demand-pull

Recession

A recession is two or more consecutive quarters of negative economic growth. For example after the 2008 recession (due to the financial crisis) the UK economy shrunk by 6%.

Characteristics of a recession

• Negative economic growth for two consecutive quarters (6 months) or more

• Rising unemployment

• A widening negative output gap and more spare capacity

• Low confidence among households and firms - animal spirits

• Lower inflation, and sometimes deflationary pressure if demand falls sharply

• Weak investment, as firms delay expansion due to uncertainty