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Introduction to U.S. Economy: The Business Cycle and Growth
What is the Business Cycle?
Cycle Dating Committee at the National Bureau of
Over time, modern industrial economies tend to experience
Economic Research (NBER), an independent, nonprofit,
significant variations in economic activity. The economy
research group, is generally credited with identifying
shifts from periods of increasing economic activity, known
business cycles in the United States.
as economic expansions, to periods of decreasing economic
activity, known as recessions. Real gross domestic product
NBER does not define a recession as two consecutive
(GDP)—total economic output adjusted for inflation—is
quarters of declining real GDP, which is popular in the
the broadest measure of economic activity. The movement
financial press. Rather NBER uses a broader definition of a
of the economy through these alternating periods of growth
recession, as a period where there is a significant decline in
and contraction is known as the business cycle. There are
economic activity that spreads across the economy. NBER
four phases of the business cycle: the expansion, peak,
uses a number of indicators to measure economic activity,
contraction, and trough, as shown in Figure 1.
including real GDP, economy-wide employment, real sales,
and industrial production.
Figure 1. Stylized Depiction of the Business Cycle
Figure 2 presents real GDP between 1948 and part of 2018,
along with recessions, as identified by NBER, represented
with grey bars. Over this period, real GDP grew at an
average annual pace of 3.2%.
Figure 2. Real GDP and Recessions
1948:Q1–2018:Q3
Source: Congressional Research Service.
As the economy moves through the business cycle, a
number of additional economic indicators tend to shift
alongside GDP. During an economic expansion, economy-
wide employment, incomes, industrial production, and sales
all tend to increase alongside the rising real GDP.
Additionally, over the course of an economic expansion, the
rate of inflation tends to increase. During a recession, the
Source: US. Bureau of Economic Analysis.
opposite tends to occur, with decreasing employment,
Note: Grey bars represent recessions as defined by NBER.
incomes, production, sales, and a decrease in the rate of
inflation, occurring alongside falling real GDP. All of these
The economy tends to experience longer periods of
indicators do not shift simultaneously, but they tend to shift
expansion than contraction, especially since World War II
around the same time.
(WWII). Between 1945 and 2009, the end of the most
recent business cycle, the average expansion has lasted
Although these fluctuations in economic activity are
about 58 months, and the average recession has lasted about
referred to as a cycle, the economy generally does not
11 months. Between the 1850’s and WWII, the average
exhibit a regular and smooth cycle as shown in Figure 1.
expansion lasted less than half as long (about 26 months),
Predicting recessions and expansions is notoriously difficult
and the average recession lasted about twice as long (about
due to the irregular pattern of the business cycle; a single
21 months).
quarter of economic data is likely too short to be predictive
of a trend. During an expansion there may also be short
The most recent recession in the United States, the so-called
periods of decreasing economic activity interspersed within
Great Recession, began in December 2007 and ended in
an expansionary period, and vice versa.
June 2009, a total of 18 months. Since the 1850’s, in the
Dating the Business Cycles
United States, 13 recessions have lasted as long as or longer
than the Great Recession; however, all other recessions
Business cycles are dated according to the peaks and
occurred before the Great Depression of the 1930’s. The
troughs of economic activity. A single business cycle is
current economic expansion has been underway for 116
dated from peak to peak, or trough to trough. The Business
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link to page 1 Introduction to U.S. Economy: The Business Cycle and Growth
months, making it the second longest economic expansion
reason, fiscal and monetary policies are thought to be less
in the United States since the 1850’s so far.
effective over longer time periods, and continuous
stimulative policy is likely to increase the rate of inflation
Short-Term Economic Growth
over time.
In the short term, the business cycle is the largest
determinant of economic growth. The economy’s position
Consumer and Business Confidence
within the business cycle will largely determine whether
Changes in consumer or business confidence can impact
real GDP is growing or shrinking. For example, during the
aggregate demand as well. If individuals believe the
expansionary period immediately before the recession of
economy will perform poorly in the future, individuals are
2007-2009, real GDP grew at an average pace of about
likely to increase how much they save to prepare for lean
2.8% per year, whereas during that recession real GDP was
times in the future. The associated decrease in spending
shrinking by about the same percentage per year.
would lower aggregate demand. Similarly, if businesses
perceive that the economy is about to enter a recession, they
Over longer periods of time, the volatility of the business
are less likely to make investments in new machinery or
cycle fades to reveal the medium-term growth trend of the
factories because consumers would not be able to afford
economy. If one were to average the growth rate through an
their new products during the recession.
entire business cycle, it would reveal the medium-term
growth trend, shown as the dotted line in Figure 1. For
In large part, the recession of 2007-2009 was the result of
example, in the most recent complete business cycle,
previous overconfidence by individuals and businesses in
measured from peak to peak, real GDP grew at an average
the future performance of the economy, specifically the
pace of 2.5% per year.
housing sector. To simplify greatly, individuals, banks, and
investment firms all believed housing prices would
Potential Causes of the Business Cycle
continue to rise for some time, and incorporated these
In general, the business cycle is governed by aggregate
expectations into the mortgages and mortgage-related
demand (total spending) within the economy. Recessions
securities that were designed during this expansionary
occur as aggregate demand decreases, and expansions occur
period, causing an asset bubble. However, as the economy
as aggregate demand increases. The potential causes of
underperformed with respect to expectations, many
changing aggregate demand include changes in government
individuals could not afford to make payments on their
policy, consumer or business confidence, and external
mortgages. As mortgages continued to default, the
shocks to supply.
securities built on those mortgages began to decline in
value. As businesses and individuals realized that their
Government Policy
investments were not worth as much as they thought, they
Government policy, specifically monetary and fiscal policy,
engaged in a process of de-leveraging, decreasing the
can impact aggregate demand either directly or indirectly.
amount they spent on consumption or investment and
The legislature is largely responsible for fiscal policy in the
paying down their debts, which caused a decrease in
United States through changes in the level of government
aggregate demand as well. Decreasing aggregate demand
spending and tax revenue. The government can directly
resulted in the significant recession. Additionally, the
increase aggregate demand by spending more on goods and
financial crisis disrupted credit markets in such a way that
services, while keeping tax revenue constant. Additionally,
businesses or individuals wanting to make new investments
the government can indirectly increase aggregate demand
or purchases could not access the credit necessary to make
by reducing tax revenue, while keeping government
those purchases, further inhibiting aggregate demand.
spending constant. Reducing tax revenue increases the
amount of money in individuals’ and businesses’ wallets,
External Supply Shocks
allowing them to spend more on goods and services.
As part of a global economy, events outside of the United
States can often impact aggregate demand inside the United
Monetary policy can also be used to impact aggregate
States. For example, in 1979, the United States faced a
demand indirectly. The U.S. Federal Reserve implements
decrease in the supply of oil due to the Iranian Revolution.
monetary policy by changing short-term interest rates. For
The decrease in the supply of oil, and the associated spike
example, lowering interest rates can encourage businesses
in oil prices, caused the prices of many other goods to rise.
to make new investments and individuals to buy new goods,
The rise in prices led to decreased consumption and
because the lower interest rates make it less expensive to
investment by individuals and businesses, decreasing
borrow money.
aggregate demand and causing a recession.
Fiscal and monetary policy, when implemented
Additional CRS Resources
successfully, can help soften the business cycle. However,
CRS In Focus IF10408, Introduction to U.S. Economy:
when unsuccessful these policies may exacerbate the
GDP and Economic Growth, by Jeffrey M. Stupak and
fluctuations of the business cycle. Additionally, fiscal and
Mark P. Keightley.
monetary policies are most effective at shifting aggregate
demand, and therefore economic growth, in the short term.
Jeffrey M. Stupak, Analyst in Macroeconomic Policy
The effectiveness of these policies is believed to diminish
over time, as actors within the economy adjust to changes
IF10411
in government spending or the money supply. For this
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Introduction to U.S. Economy: The Business Cycle and Growth
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