The business cycle represents the fluctuations that a country’s economy faces over time. It is influenced by Gross Domestic Product (GDP), unemployment and the level of economic activity. Although there are growths and declines over time, business cycles usually move in a general upward trend to represent natural inflation as shown in Figure 1.
Stages of a Business Cycle
Business cycles have four defined stages:
Expansion – Signifies that economic activity is growing as shown through indicators such as employment, production, demand and supply and income. (Measured from the trough of the previous cycle to the peak of the current cycle)
Contraction – Indicates that an economy is slowing down as shown through decreased production, lower income and higher employment rates. (Measured from the peak of a cycle to its trough)
Peak – A peak is the highest point between the end of an economic expansion and the start of a contraction in a business cycle.
Trough – A trough is the lowest point between the end of an economic contraction and the start of a expansion in a business cycle.
Sometimes governments intervene in order to maintain economic stability.
The government makes decisions regarding a country’s expenditure and taxation through the Fiscal Policy. If a government wants to stimulate the economy they may either decrease taxation or increase demand for goods and services. These actions act as a catalyst for a chain reaction of economic productivity and growth. Increased demand requires higher production rates which subsequently means businesses require a larger work force. Therefore through the fiscal policy, the government is able to increase supply and demand and production as well as decrease unemployment rates
On the other hand if an economy is ‘overheating’ or growing too rapidly a government may decide to slow it down through taxes or by decreasing spending and therefore reduce production. Lower demand means slower production and individuals or businesses may suffer through job loss, lower income and less money which they can spend.
The Monetary Policy is the decisions a government makes in regards to monetary supply and interest rates. The Reserve bank of Australia (RBA) serves as the central bank and makes decisions on whether to increase or decrease the supply of money in an economy. They affect economic activity and ultimately the rate of inflation by setting the interest rates and hence influencing the behaviour of borrowers and lenders. By decreasing interest rates they can encourage a raise in economic activity as people are more likely to purchase goods and services, invest, trade shares or take out loans.
In determining monetary policy, the central bank must maintain price stability, full employment, and the economic prosperity and welfare of the Australian people. To achieve these objectives, the Bank has an ‘inflation target’ which seeks to keep consumer price inflation in the economy to 2–3 per cent, on average, over the medium term. Controlling inflation preserves the value of money and encourages strong and sustainable growth in the economy over the longer term.