The term business cycle also known as economic cycle stands for fluctuations in production as well as economic activity and is characterized by recession, fiscal recovery, growth, as well as fiscal decline (Sheffrin 10). There are a number of theories which explain business cycles. These include but not limited to: real business cycle theory, Keynesian business cycle theory, and Australian business cycle theory (Sheffrin 12).
Real business cycle theory argues that business cycles are driven absolutely by shocks in technology as opposed to monetary shocks or expectation changes. These technological shocks include: inventions, bad weather, increase in the prices of imported oil and stricter safety as well as environmental regulations. These changes in turn affect the effectiveness of capital and/or labor hence affect the decisions of workers as well as firms thereby influencing their production and buying habits. The end result is an effect on output (Sheffrin 13).
The Austrian business cycle theory on the other hand argues that business cycles are caused by surplus creation of bank credit normally motivated by central banks through highly reduced interest rates. This in turn causes an explosion in money supply leading to misallocation of resources as a result of falsified interest rate signals. As market forces correct this anomaly, the mal-investments are liquidated and this eventually leads to a contraction in money supply (Sheffrin 14).
Lastly, Keynesian theory argues that private sector decisions occasionally result to ineffective macroeconomic outcomes. The theory therefore suggests an intervention by the public sector either by monetary policy actions by the central bank or fiscal policy actions by the government in order to steady output over the business cycle (Sheffrin 15).
The business cycle is characterized by four distinct phases throughout its long term growth trend. These are:
Expansion is characterized by record sales and profits by businesses. Businesses therefore expand facilities in an effort to prepare for continued sales growth. Banks at this stage are very willing to lend as they predict increased cash flows but at an higher interest rate as a result of loans high demand. As a result of high profits and sales, companies pay high wages. Continued rise in prices, wages and interest rates ultimately lead to a stop in the expansion of product demand as well as new hiring and lending and at this point, the economy is said to be at peak (Morgan 21).
Peak is the upper turning point of the business cycle. At peak point, sales no longer expand and the economy starts slowing down which eventually result to a contraction. Contraction is marked by a slowdown in the pace of economic activity. Trough on the other hand is just the lower turning point of a business cycle. Its here where a contraction turns into an expansion (Morgan 22).
Forecasting is done with the aim of providing an aid to decision making as well as planning for the future. Forecasting methods include but not limited to Inventory control/ production planning, which involves forecasting product demand in order to enable us plan on how to control raw materials as well as finished goods stock and also plan production schedule (Morgan 24). Investment policy as a method involves predicting financial information like exchange rates, prices of shares and interest rates. Lastly, Economic policy as a forecasting method involves the prediction of economic information such as unemployment, economic growth and inflation rate in order to enable the government and businesses to plan for the future (Morgan 25).
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Currently, the U.S. Economy is in the trough phase of business cycle. This as mentioned is a phase that marks a turn from contraction to expansion. The economy experienced a contraction from mid- 2008 till the third quarter of 2009 (Jeanne 13). This was occasioned by the global economic downturn, the sub - prime mortgage crisis, investment bank failures, failing home prices and tight credit. Reports indicate that, since September 2010, there has been a pleasing gain in jobs as compared to the previous year. About 130.2 million jobs were recorded and this marked an increase by about 344,000 from the year before. The same period has also witnessed a decrease in rents for commercial real estate. All these attest to the fact that the economy is moving gradually from contraction to expansion hence in the trough phase (Jeanne 13).
Inflation refers to an increase in credit as well as the amount of money in an economy as compared to the goods and services in supply. Inflation normally results to rise in prices of goods and services (Sheffrin 5). Companies are therefore forced to pay their employees higher salaries which commensurate with the cost of living. For these companies to afford the high salaries, they are forced to reduce the number of employees and retain the number they can comfortably sustain. This shows that inflation leads to loss of employment (Sheffrin 6).
Two economic stimulus packages have been witnessed in the U.S. Since the economic recession began. The first one was given by president Bush which was about $700 billion. President Obama gave $787 billion in his ambitious plan to create 3million to 4 million jobs (Jeanne 14). These stimulus packages were given following the global economic downturn, the sub - prime mortgage crisis, investment bank failures, failing home prices and tight credit. Obama's package involved $288 billion in tax cuts, $224 billion in extended unemployment benefits, education and health care, and $275 billion for job creation which would make use of federal contracts, grants and loans. The stimulus package worked as about 130.2 million jobs had been created by September 2010 which marked an increase by about 344,000 from the year before (Jeanne 15).
In conclusion, this paper has discussed a number of theories which explain business cycles which have included real business cycle theory, Keynesian business cycle theory, and Australian business cycle theory. Four business phases which characterize a business cycle have been discussed which include expansion, peak, trough and contraction. Forecasting on the other hand has been seen to involve methods such as Inventory control/ production planning , Investment policy and Economic policy. Inflation, an increase in credit as well as the amount of money in an economy as compared to the goods and services in supply has been noted to lead to increase in unemployment.