3.1.4—Business cycle

The business cycle describes expansions, peaks, contractions and troughs around a trend.

Output, employment and inflation need not move together; shocks and policy affect duration.

Use multiple indicators to identify the phase.

Falling output with rising unemployment suggests contraction even if one sector grows.

A recession rule is not a universal law.

Plot real output against time with a rising long-run trend labelled potential output. Actual output moving above and below that trend creates short-term expansions and contractions: a peak precedes contraction and a trough precedes recovery. The vertical distance from potential output is an output gap, while movement of the trend itself represents a change in productive capacity. Do not confuse a slower expansion with an absolute fall in real output.