Understanding Business Cycles

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Introduction

A typical economy’s output of goods and services fluctuates around its longer-term path. We now turn our attention to those recurring, cyclical fluctuations in economic output. Some of the factors that influence short-term changes in the economy—such as changes in population, technology, and capital—are the same as those that affect long-term sustainable economic growth. But forces that cause shifts in aggregate demand and aggregate supply curves—such as expectations, political developments, natural disasters, and fiscal and monetary policy decisions—influence economies particularly in the short run.

We first describe a typical business cycle and its phases. While each cycle is different, analysts and investors need to be familiar with the typical cycle phases and what they mean for the expectations and decisions of businesses and households that influence the performance of sectors and companies. These behaviors also impact financial conditions and risk appetite, thus impacting the setting of expectations and choices of portfolio exposures to different investment sectors or styles.

In the sections that follow, we describe credit cycles, introduce several theories of business cycles, and explain how different economic schools of thought interpret the business cycle and their recommendations with respect to it. We also discuss variables that demonstrate predictable relationships with the economy, focusing on those whose movements have value in predicting the future course of the economy. We then proceed to explain measures and features of unemployment and inflation.