US & World Economies US Economy GDP Growth & Recessions What Is the Business Cycle? The Business Cycle Explained By Kimberly Amadeo Kimberly Amadeo Kimberly Amadeo is an expert on U.S. and world economies and investing, with over 20 years of experience in economic analysis and business strategy. She is the President of the economic website World Money Watch. As a writer for The Balance, Kimberly provides insight on the state of the present-day economy, as well as past events that have had a lasting impact. learn about our editorial policies Updated on May 26, 2022 Reviewed by Robert C. Kelly Reviewed by Robert C. Kelly Robert Kelly is managing director of XTS Energy LLC, and has more than three decades of experience as a business executive. He is a professor of economics and has raised more than $4.5 billion in investment capital. learn about our financial review board Fact checked by J.R. Duren Fact checked by J.R. Duren J.R. is a terms editor at The Balance, a role in which he focuses on providing clear answers to common questions about personal finance and small business. J.R. has more than 10 years of experience reporting, writing, and editing. As an editor for The Balance, he has fact-checked, edited, and assigned hundreds of articles. learn about our editorial policies Share Tweet Pin Email In This Article View All In This Article Definition and Example of the Business Cycle How Does the Business Cycle Work? Notable Happenings Definition The business cycle is the natural rise and fall of economic growth that occurs over time. The cycle is a useful tool for analyzing the economy and can help you make better financial decisions. Photo: The Balance Definition and Example of the Business Cycle The business cycle is a term used by economists to describe the increase and decrease in economic activity over time. The economy is all activities that produce, trade, and consume goods and services within the U.S.—such as businesses, employees, and consumers. Thus, the measured amount of productivity is what the business cycle refers to. Alternate definition: The business cycle is the downward and upward fluctuations of the productivity level of the economy, along with its natural growth rate over a long period.Alternate names: Economic cycle, trade cycle When businesses are increasing production, they need more employees. As a result, more people are hired, there is more money to spend, and businesses make more profits and can focus on growth. The rate at which production and consumption change positively is called "economic expansion." It continues until circumstances occur that cause production to slow. If business production slows, not as many employees are needed. As a result, consumers have less spending money, and businesses reduce spending on growth. The rate at which production and consumption as a whole change negatively is called "economic contraction." How Does the Business Cycle Work? The duration of a business cycle is the period containing one expansion and contraction in sequence. One complete business cycle has four phases: expansion, peak, contraction, and trough. They don’t occur at regular intervals or lengths of time, but they do have recognizable indicators. It's important to understand that there are mini-fluctuations within an economic phase that can make it appear as if the economy is transitioning to another phase. The National Bureau of Economic Research (NBER) determines which cycle the economy is in using quarterly GDP growth rates. It also uses monthly economic indicators, such as employment, real personal income, industrial production, and retail sales. Note While you'll hear speculation in the media about the state of the economy, there is no official notice of what cycle the economy is in until it's already in progress—or complete—and the NBER has had a chance to analyze the data and declare it. Three factors cause each phase of the business cycle: the forces of supply and demand, the availability of capital, and consumer and investor confidence. The most critical is confidence in the future—when consumers and investors have faith in the future and policymakers, the economy tends to expand. It does the opposite when confidence levels drop. Expansion An economic expansion is a period of growth throughout an economy. Because productivity is increasing, it is generally represented on a curve as an upward movement. The expansion phase is also known as the economic recovery phase because it occurs after the economy has contracted for a long period. Gross domestic product is the measurement that is most used to indicate economic output. During the expansion phase, it increases. Economists consider a GDP growth rate range of between 2% to 3% to be healthy. Note The Federal Reserve's goal is to keep inflation, the measurement of the change in prices, at around 2%—also considered healthy by economists and officials. In an expansion, the stock market experiences rising prices, and investors are confident. Businesses receive more funding and make more, and consumers have more money to spend. An economy can remain in the expansion phase for years. The expansion phase nears its end when the economy begins to grow too fast. This is called "overheating"—the unemployment rate is well below the natural rate, and inflation is increasing. Stock market investors are in a state of "irrational exuberance" where they become overly enthusiastic about prices and believe they will continue to rise—this causes stock prices to rise to a point where they are very overvalued. Peak The peak is the second phase of the cycle. It occurs when all of the expansionary indicators begin to level off. The economy might take weeks or a year to transition into the contraction phase. The GPD growth rate falls below 2% and continues to decline. The peak is displayed on a graph as the highest portion of the curve before moving downward. Contraction The third phase is the contraction stage. It begins after the economy peaks and ends when GDP and other indicators cease to decrease. In this stage, the economy does not experience growth; instead, it shrinks. When the GDP rate turns negative, the economy enters a recession. Businesses lay off employees, the unemployment rate rises above normal levels, and prices begin to decline. A contraction is generally portrayed on a graph as the part of the curve that is consistently decreasing. Trough The trough is the fourth phase of the business cycle. The declining GDP begins to decrease its rate of negative change, eventually turning positive again. The economy begins a transition from the contraction phase to the expansion phase. A trough is displayed on a graph as the lowest point of the curve. The business cycle begins again when GDP begins to increase, and the curve moves upward consistently. Note The business cycle's four phases can be so severe that they have been called the "boom-and-bust cycle." How Is the Business Cycle Influenced? The government monitors the business cycle, and legislators attempt to influence it by implementing tax and spending changes. When the economy is expanding, taxes can be increased, and spending can be decreased. If it is contracting, the government can lower taxes and increase spending. This is called "fiscal policy." The Fed, the nation's central bank, influences the business cycle by targeting inflation and unemployment with targeted rates. It uses tools designed to change interest rates, lending, and borrowing by businesses, banks and consumers. This is called "monetary policy." The Fed lowers its target interest rates to encourage borrowing in attempts to end a contraction or trough. This is called expansionary monetary policy because they are attempting to push the business cycle back into the expansionary phase. To keep the economy from growing too quickly, the central bank raises its target interest rates to discourage borrowing and spending. This is called "contractionary monetary policy," because the bank is trying to contract economic output to keep expansion under control. Note The goal of fiscal and monetary policy is to keep the economy growing at a sustainable rate while creating enough jobs for everyone who wants one and being slow enough not to increase inflation. Notable Happenings The peak that preceded the 2008 recession occurred in the third quarter of 2007, when GDP growth was 2.4%. The 2008 recession was a rough one, because the economy immediately contracted by 1.6% in the first quarter of 2008. It rebounded 2.3% in the second quarter, an optimistic sign. However, it contracted 2.1% in the third quarter and then 8.5% in the fourth quarter. In the first quarter of 2009, it contracted by 4.6% . During 2008, the unemployment rate rose from 4.9% in January to 7.2% by December. The trough occurred at the end of the second quarter of 2009, according to the NBER. GDP only contracted by 0.7%. Unemployment, however, rose to 10.2% by October 2009 because it is a lagging indicator. The expansion phase started in the third quarter of 2009 when GDP rose 1.5%. Four years into the expansion phase, the unemployment rate was still above 7%, because the contraction phase moved the economy so low that it took much longer to recover. Key Takeaways The business cycle goes through four major phases: expansion, peak, contraction, and trough. All economies go through this cycle, though the length and intensity of each phase varies. The Federal Reserve helps to manage the cycle with monetary policy, while heads of state and governing bodies use fiscal policy.Consumer and investor confidence play roles in influencing economic performance and the phases in the cycle. Was this page helpful? Thanks for your feedback! Tell us why! Other Submit Sources The Balance uses only high-quality sources, including peer-reviewed studies, to support the facts within our articles. Read our editorial process to learn more about how we fact-check and keep our content accurate, reliable, and trustworthy. National Bureau of Economic Research. "The NBER's Business Cycle Dating Committee." Accessed Feb. 14, 2022. National Bureau of Economic Research. "The NBER's Business Cycle Dating Procedure: Frequently Asked Questions." Accessed Feb. 14, 2022. Congressional Research Service. "Introduction to U.S. Economy: The Business Cycle and Growth." Accessed Feb. 14, 2022. Federal Reserve Bank of San Francisco. "Confidence and the Business Cycle." Accessed Feb. 14, 2022. Stanford University. "The Facts of Economic Growth," Pages 5-8. Accessed Feb. 14, 2022. Federal Reserve. "What Economic Goals Does the Federal Reserve Seek To Achieve Through Its Monetary Policy?" Accessed Feb. 14, 2022. Federal Reserve Bank of St. Louis. "Asset Bubbles: Detecting and Measuring Them Are Not Easy Tasks." Accessed Feb. 14, 2022. International Monetary Fund. "Recession: When Bad Times Prevail." Accessed Feb. 14, 2022. Boston College University. "What Are the Sources of Boom-Bust Cycles?" Page 1. Accessed Feb. 14, 2022. Congressional Research Service. "Introduction to U.S. Economy: Fiscal Policy," Page 1. Accessed Feb. 14, 2022. Bureau of Economic Analysis. "National Data: National Income and Product Accounts: Table 1.1.1. Percent Change From Preceding Period in Real Gross Domestic Product." Accessed Feb. 14, 2022. Bureau of Labor Statistics. "The Employment Situation: December 2008." Accessed Feb. 14, 2022. Bureau of Labor Statistics. "The Employment Situation: January 2008." Accessed Feb. 14, 2022. National Bureau of Economic Research. "Business Cycle Dating Committee, National Bureau of Economic Research, September 20, 2010." Accessed Feb. 14, 2022. Bureau of Labor Statistics. "Unemployment in October 2009." Accessed Feb. 14, 2022. Bureau of Labor Statistics. "Labor Force Statistics From the Current Population Survey," Set range from 2007 to 2013. Accessed Feb. 14, 2022.