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Cycles and Economic Oscillations

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Abstract

The economy of any country has 4 main phases: Depression, recovery, boom, and recession. In each economic cycle, there will be industries that will perform better than others, depending on which variables are growing the most, what is the situation and what are the policies taken by the central bank and the government. For investors, it is important to know in what economic cycle the economy is to make decisions about what assets to buy. In addition to these economic phases, the economy of the most important countries such as the United States, China, and some of the Europeans, can affect the cycles of other economies that can be called emerging and underdeveloped.

The economy of the countries is not stable in any case, they always have oscillations that are called economic cycles. The economic cycles are the recurrent increases and decreases in the economic activity of each country and therefore also the economic sectors are facing these fluctuations in the economy. These oscillations do not occur in the same way or in its magnitude since in each period the factors that affect an economy are different. In some periods of time, its most important sectors will stop growing due to internal or external factors, shocks from external economies or natural disasters, causing the magnitude and effect in the economy to be different over time.

There are four recognizable phases in the economic cycles experienced by all economies:

  • Depression or crisis: The lowest point of the economic cycle. When the economy is in this phase it is common that the main indicators of the economy are at low rates such as employability, consumption, the price of goods decreases or remains stable (low inflation rates) and the gross domestic product of a country is far from its potential. Given this situation, it is normal for the profitability margins of companies and banks to decrease during this point of the economic cycle.
  • Recovery: Phase in which the behavior of the economy begins to improve, there is a phase of better economic growth, better levels of employment, more positive margins, greater expansion of the domestic product and an increase in the price index in response to a better demand for goods and services by consumers and businesses.
  • Boom: The highest point of the business cycle. When the economy is at this point, production is in its potential, or in some cases, above. Because the economy is at its best there is full employment and as production is at its highest point with the lowest possible unemployment there is no possibility of better economic growth. In addition, since there is full employment, wages are higher due to the low supply of labor and consumption is also largely due to these higher wages
  • Recession or contraction: It’s the Economic phase where growth stops or slows down.  Production, investment, trade, and employment rates, as well as the wages of people, stalls or, even, decreases. The margins of the companies drop again, and the revenues of the government diminish. If the recession or contraction occurs in a severe and prolonged way, it may lead the economy to a crisis, signaling the beginning of a depression.

Economic cycles can be calculated by analyzing some economic variables. The most used are the gross domestic product of a country, inflation, and unemployment among others. Keep in mind that some variables are pro-cyclical, and this means that they increase when the economy grows and decrease when the economy decreases such as GDP and inflation and there are other variables that are countercyclical which grow when the economy gets worse such as unemployment. There are others that are acyclic, and this indicates that they are not very correlated with the behavior of the economy.

As there was mentioned earlier, economic variables are never constant, they are always fluctuating around a trend. These fluctuations are common in all the economies of the world, but there are always facts that explain why these variables fluctuate in a different way in time. It is strange to see two periods in time that have the same economic factors developing so the recessions are not the same as the booms because they are generated by different factors.

Fluctuations lack periodicity, but they are recurrent. In addition, when growth is above the trend, the variables are correlated so that when the economy starts to grow, investment also increases, which magnifies booms or recessions because one variable affects the others. What the economists have found is that among all the variables, the most volatile is the investment over the product and the consumption due to the risk aversion of many investors and the expectations they have. When the economy begins to show signs of stagnation, investors are the first to change assets and invest in another country.

For the world economy, it is important to follow the economic cycle of countries that drive global growth, such as the United States, the countries belonging to the European Union and China. When these economies enter phases of depression or recession this affects the other economies because in a world as globalized as the current one if a country does not grow to its potential this will affect its domestic consumption and end up affecting products that are exported to these countries. This is the reason why global growth since 2007 has not been very good in general because there are countries that are not growing at what they should according to their potential. In the next part of the article, we will explain how the current economic cycle of the United States and then the countries of the European Union are.

During much of the 1990s, the United States economy recorded an expansionary phase that ended with the economic crisis of 2000 to 2001 generated by several factors including the crisis of technology companies. The boom of these years was also due to the formation of capital in the high technology sector, where such was the increase in investment that boosted the domestic product which in turn boosted consumption and employment. But such was the euphoria of the investors, that overvaluation was generated in the United States stock market of the main companies added to a great appreciation of the dollar. This appreciation of the dollar allowed increasing the purchasing power of the citizens which generated imbalances and causing a deficit in the current account of the balance of payments, increasing the indebtedness and high prices of some assets.

The exhaustion of the expansion was manifested by drastic drops in the margins of the companies that ended up affecting the stock market indexes and this frightened away the investors, which drastically reduced the investment. To respond to this crisis, the monetary authorities used fiscal policies (higher spending, lower taxes) and expansive monetary policies (nominal interest rates and low real rates to encourage consumption). These measures allowed consumption to replace investment as the engine of the economy but created the basis for the crisis of 2007.

The measures to recover from the economic cycle of depression in the United States economy raised the debt of government households while companies began to see their margins improve due to lower debt costs and higher domestic consumption. The dollar was also depreciated due to the decrease in rates, which encouraged exports, but this effect was paralyzed when in 2004 monetary policy stopped the depreciation. The crisis of 2007 was a subject exposed in the article Problems and crisis in the economy.

After the crisis of 2007 and its continued depression, the recovery phase began in 2009. Since 1949, the United States economy has had 11 expansion phases and 11 recession phases. The expansion phases have had an average of 21 consecutive quarters growing. The longest phase of expansion has been of 39 quarters that was from 1991 to the year 2000 with a growth in that period of 43% of the domestic product. The most significant growth was 53.7% between 1961 and 1969. On the other hand, the shortest economic cycle lasted 4 quarters between 1980 and 1981.

The current economic cycle of the United States is above average in its growth phase, growing close to 32 consecutive quarters since the third of 2009, but the growth has not been of the same magnitude as the most euphoric episodes of the past. Although each economic cycle is different, and patterns are not always repeated, there are indications that global economic cycles are slower in their recovery if the origin of the crisis was a financial crisis like the one in 2007 where several banks went bankrupt and others were weak in their balance sheets and this indicates why the growth has not been the same as in other periods of time. The growth rate has not been very high in the United States since domestic demand (Consumption and Investment) has been weak in several quarters showing the consequences of the crisis.

In conclusion, the United States is in a period of boom economic cycle and some analysts predict that as the period of growth is so long, it is likely that in 2018 or 2019 the economy stops growing and enters a period of recession in its economic cycle.

For many investors, economic cycles are a useful tool used to allocate their resources in booming or growing economies or know which sectors can grow if a country is in recession. Clearly all sectors are affected by crises, but there are some sectors that do better during these difficult times than others that depend more on the economic cycle as dependent sectors of consumption that is one of the most affected.

Now we will analyze which economic cycle Europe is in. The indicator of economic sentiment has increased in recent quarters in the euro area, which shows that investors’ expectations are positive on the general growth of the eurozone. As can be observed in the following graph, the indicator of economic sentiment is correlated with the behavior of the gross domestic product, so it is expected that in the following quarters the eurozone will continue to grow, showing that they are booming in their economic cycle.

Graph 36. (2017, October) European Business Cycle Indicators. Retrieved December 3, 2017. From https://ec.europa.eu/info/sites/info/files/economy-finance/tp019_en.pdf.

If the eurozone is analyzed by sectors, it can be seen in the figures that the industry and services sectors grew while construction and consumption have not shown higher growth, which indicates that these variables are stable. In the following graph, you can see the confidence that exists about the growth of the industry in the European area.

Graph 37. (2017, October) European Business Cycle Indicators. Retrieved December 3, 2017. From https://ec.europa.eu/info/sites/info/files/economy-finance/tp019_en.pdf.

During the third quarter, the highest levels were seen in all sectors for approximately six years. The country where you see the best performance of the economy, with even better expectations, is in Italy. Then comes France, Poland, Holland, and Spain. The expectations about Germany and England are not so good, and their indicators have remained stagnant.

The central bank’s forecasts were raised in one of its last meetings in the third quarter on production and prices in the eurozone. If we compare these forecasts with their expectations in the previous quarters has seen improvement in these which indicates that the expectations are positive and indicates that the countries of the eurozone are in their growth or boom phase.

The only exception with negative expectations is England, where the index of economic sentiment is negative. In other countries, there has been an increase in the utilization capacity in manufacturing for five consecutive quarters. In the services sector, there are positive expectations because positive symptoms are seen in domestic demand so in the following quarters should increase production, added to employment, investment and therefore the sectors that are related to these indicators.

In conclusion, the main economic zones of the world are in an expansive phase of their economies, such as the United States and the European zone, so other countries such as emerging countries and others have positive prospects, but some analysts predict that in next few years the US cycle may end and enter a period of recession which would affect the growth of the countries that trade more with this country. The most important thing is to understand that all economies move in these cycles and economic oscillations so entering a recession is not serious if governments take counter-cyclical measures to reactivate the economy. Another factor to consider is the change of the Chinese economic model, a fact that can also affect some countries that saw China as an importer of raw materials such as coal and oil. As the trajectory of the economies of China, the United States and the eurozone follow, they will determine world growth in the coming years.

©Forex.Academy

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