Editor’s note: Mike Walden is a William Neal Reynolds Professor and extension economist in the Department of Agricultural and Resource Economics of N.C. State University’s College of Agriculture and Life Sciences. He teaches and writes on personal finance, economic outlook and public policy. His "You Decide" commentary is published every two weeks.
RALEIGH—There are natural cycles, human cycles and some say, weather cycles. But what about economic cycles? Is our economic world governed by regular movements in business and consumer activity? If so, why? And can these movements be controlled to our advantage?
These questions have tantalized economists for decades, if not centuries. And although economists disagree about the type and extent of economic cycles, most agree that some cyclical behavior is present in our business world.
The pattern of economic ups and downs that is widely accepted is called the business cycle. The business cycle contains four distinct parts. During expansion the economy is growing, jobs are being created, and incomes are rising. The peak is when the expansion tops out and the economy has hit its maximum, at least for the time being. Next comes recession, when the economy falters, jobs are cut, and incomes fall. Then, the economy bottoms out in the trough, and the whole process is repeated.
Each combination of expansion-peak-recession-trough is one complete business cycle. Since World War II, there have been 10 business cycles. Fortunately, the expansions are much longer than the recessions, on average, 57 months for an expansion compared with 10 months for a recession. The last recession lasted only eight months, from March to November 2001, while the preceding expansion covered 10 years.
It’s important to realize that business cycles are measured from the perspective of the entire economy, and not all parts of the national economy move at the same pace. For example, when the entire economy is in an expansion, some individual sectors may be struggling. The U.S. auto sector is a good example today. Similarly, every industry isn’t necessarily in a downturn during a recession. In the 2001 recession, the housing and construction industries continued to grow.
What causes business cycles? This is an age-old question that many brilliant minds have tried to answer. Unfortunately, there’s no single answer, although there are some usual suspects. Changes in the prices of key inputs in the economy, such as oil; overproduction or underproduction by businesses; mood swings by consumers from optimism to pessimism and back; and legal changes, especially involving taxes and international trade, are among the factors economists have found can propel the economic roller coaster.
The government does have tools it can use to moderate the economic ups and downs. The Federal Reserve can use its power over interest rates and the availability of money and credit to keep expansions from getting out of hand and from preventing, or at least moderating, recessions. Likewise, the president and Congress can use their taxing and spending powers to try to keep the economy growing at a more even pace.
Interestingly, some economists, like the late Milton Friedman, have argued that government meddling in the economy can actually lead to wider swings in the business cycle. This may be because it is difficult for the government (or economists, for that matter) to know exactly what’s happening to the economy in real time. So if we don’t know the condition of the patient, it’s hard to know what medicine to use. Also, even if government did know exactly where the economy stood, it sometimes takes policy makers and elected officials a while to agree to a course of action.
While the existence of the business cycle is generally accepted by economists and policy makers, another kind of economic cycle, called the long wave, is more controversial. Developed in the 19th century, the long wave says economies go through long periods of boom and bust lasting 50 or 60 years. Business cycles are just little blips on these waves. According to this idea, the economy is now in a declining part of a wave that should last several decades.
Just like the ocean tides, our economy appears to ebb and flow, although not quite in such a regular and predictable fashion. Whether these cycles are relatively short — 10 years — or very long — 50 or 60 years — is a matter of debate. Nevertheless, it does behoove you to pay attention to patterns in the economy so you can best decide how to ride the economic cycle.