understanding the economic cycle
National output in the British economy does not rise or fall at a uniform rate! Our economy experiences a regular trade or business cycle where the rate of growth of production, incomes and spending fluctuates over time. Statisticians calculate annual and quarterly movements in national output and these are then tracked to measure the cyclical movement of the economy. The level of UK real GDP between 1955 and 2001 is shown in the chart below.
When real GDP (or national output) is rising quickly the economy is said to be experiencing economic growth or recovery. A good example of this was the economic boom in the late 1980s. The economy was also enjoying a cyclical boom in 1997-98 - although the rate of growth was not as fast as a decade earlier.
When real output falls or when the growth of output is below its long run trend rate - then economic recession exists. There have been three recessions since the early 1970s. The last recession occurred just under a decade ago when national output fell throughout 1991 and for most of 1992.
Since then the British economy has enjoyed a period of sustained economic growth. Indeed the current upturn in the economic cycle is the longest period of economic growth for over thirty years. The chart below shows the percentage rate of growth of UK real national output over recent years.
Stages of the Economic Cycle
i) Economic Boom
A boom occurs when national output is rising strongly at a rate faster than the trend rate of growth (or long-term growth rate) of about 2.5% per year. In boom conditions, output and employment are both expanding and the level of aggregate demand for goods and services is very high. Typically, businesses use the opportunity of a boom to raise output and also widen their profit margins.
Characteristics of an economic boom:
Strong and rising level of aggregate demand - often driven by fast growth of consumption
Rising employment and real wages
High demand for imported goods & services
Government tax revenues will be rising quickly
Company profits and investment increase
Increased utilization rate of existing resources
Danger of demand-pull and cost-push inflation if the economy overheats
ii) Economic Slowdown
A slowdown occurs when the rate of growth decelerates - but national output is still rising. If the economy continues to grow (albeit at a slower rate) without falling into outright recession, this is known as a soft-landing.
The Bank of England has been trying to engineer a soft-landing for Britain on at least two occasions since it was given independence in the setting of interest rates in May 1997. Interest rates rose from 6% to 7.5% between the summer of 1997 and the spring of 1998; and the Bank raised interest rates again during the latter half of 1999 in a bid to reduce the rate of growth of demand.
iii) Economic Recession
A recession means a fall in the level of real national output (i.e. a period when the rate of economic growth is negative). National output declines, leading to a contraction in employment, incomes and profits. The last recession in Britain lasted from the summer of 1990 through to the autumn of 1992. When real GDP reaches a low point at the end of the recession, the economy has reached the trough - economic recovery is imminent.
An economic slump is a prolonged and deep recession leading to a significant fall in output and average living standards.
Characteristics of an economic recession:
Declining aggregate demand for UK output
Contracting employment / rising unemployment
Sharp fall in business confidence & profits and a decrease in capital investment spending
De-stocking and heavy price discounting
Reduced inflationary pressure and falling demand for imports
Increased government borrowing Lower interest rates from central bank
iv) Economic Recovery
A recovery occurs when real national output picks up from the trough reached at the low point of the recession. The pace of recovery depends in part on how quickly aggregate demand starts to rise after the economic downturn. And, the extent to which producers raise output and rebuild their stock levels in anticipation of a rise in demand.
The last recession in the UK ended in the autumn of 1992. A much lower exchange rate following sterling's departure from the exchange rate mechanism, plus a sharp fall in interest rates provided a big stimulus to demand. National output grew by more than 3% in 1993 and over 4% in 1994 - a vigorous rebound from the effects of the 1990-92 recession.