Understanding Business Cycle

The measure of the health of our economy is the Gross Domestic Product, GDP. It measures the value of all goods and services produced in the United States including consumption, investments, government spending, and exports minus imports. The GDP is reported by the government on a quarterly basis.

GDP goes through periods of time where it gets bigger and smaller. When GDP gets bigger it means that businesses are expanding and is called business expansion. When GDP gets smaller it means that business is shrinking and is called contraction. The business cycle has 4 stages: expansion, peak, contraction, & trough.

Since data is reported historically, we only know the health of the economy for the previous quarter and not how healthy we are in the current quarter. GDP is not a leading indicator for an investor because it takes the measure of economic health in the past. Do not invest using a GDP report.

In an expansion, business is growing and can be measured by the following being higher: GDP, consumer demand, corporate sales, manufacturing output, wages, savings, real estate prices, and stock market. Along with these going higher, the Federal Reserve, Fed, is raising interest rates and slowing the money supply to fight inflation.

At a peak, these things stop growing and the Fed is holding interest rates and the supply of money.

In a contraction, everything flips and we have lower: GDP, consumer demand, corporate sales, manufacturing output, wages, savings, real estate prices and stock market. The Fed is lowering interest rates and increasing the money supply to stimulate the economy to avoid a recession or depression. A recession is 6 months of contraction while a depression is 18 months of contraction. Another definition is a recession is when your neighbor loses their job and a depression is when you lose your job.

At a bottom things stop falling and the Fed is holding interest rates and the supply of money.

Watching stock prices, interest rates and commodity prices tell us where we are in a business cycle.

The next blog will be on where the United States economy and global ecomony are in the current business cycle.