The business cycle and the macroeconomy
The wider economy rises and falls in cycles, affecting sales, costs, hiring, and investment for nearly every business.
The business cycle
The economy moves through expansion (growing output and employment), peak, contraction or recession (falling output), and trough before recovering. In the US, the National Bureau of Economic Research dates recessions; recent examples include 2007-2009 and the brief COVID-19 recession of 2020.
How cycles affect businesses
In expansions, demand rises, businesses hire and invest, and profits usually grow. In recessions, demand falls, especially for durable goods (cars, appliances) and luxuries, while necessities are more stable. Some businesses, such as discount retailers, may even benefit when customers trade down.
Inflation
Inflation is a general rise in prices over time. Moderate inflation is normal; many central banks target about 2%. High inflation raises businesses' costs, complicates pricing and planning, and erodes customers' purchasing power. In 2021-2022, inflation surged in many countries, peaking around 9% in the US in mid-2022.
Unemployment and the labour market
Unemployment rises in recessions and falls in expansions. When unemployment is low, businesses compete harder for workers, raising wages; when it is high, hiring is easier but customers have less to spend. Labour shortages in 2021-2022 pushed many employers to raise pay and improve benefits.
Fiscal policy
Fiscal policy is government spending and taxation. In recessions, governments may cut taxes or increase spending to boost demand, as with large stimulus packages in 2020-2021. Tax changes directly affect business profits and investment decisions.
Monetary policy and interest rates
Central banks, such as the US Federal Reserve, set short-term interest rates. Lower rates make borrowing cheaper, encouraging business investment and consumer spending; higher rates cool demand to fight inflation. The Fed raised rates sharply in 2022-2023, raising borrowing costs for businesses.
Planning for uncertainty
Businesses manage economic uncertainty by monitoring indicators, building cash reserves, keeping costs flexible, diversifying products and markets, and using scenario planning to prepare for different futures. Companies that entered the 2008 crisis or 2020 pandemic with strong balance sheets were better able to survive.
Worked example
A furniture maker sees orders fall 25% as a recession begins and interest rates are high, since customers delay big purchases. It cuts overtime, delays a planned factory expansion, offers financing deals, and promotes lower-priced lines. When the recovery comes and rates fall, it restarts the expansion plan. Matching decisions to the cycle helps it survive.
Key takeaways
The business cycle moves through expansion, peak, contraction, and trough. Recessions hit durable goods and luxuries hardest. Inflation raises costs and complicates pricing; US inflation peaked around 9% in 2022. Low unemployment raises wages. Fiscal policy uses spending and taxes; monetary policy uses interest rates. Businesses manage uncertainty with reserves, flexibility, diversification, and scenario planning.
Flashcard
Expansion, peak, contraction, trough
Check your understanding
Which product's sales are most likely to fall sharply in a recession?