The business cycle is the fluctuation of total economic activity over time. Recessions occur when total economic output, measured by Gross Domestic Product (GDP), grows at a negative rate for at least two quarters in a row. These downturns occur after the economy reaches its peak. Once GDP growth becomes positive again, the economy rebounds from a trough and begins expansion. The National Bureau of Economic Research (NBER) Dating Committee is the most accepted resource for dating recessions.

Unemployment moves through a cycle within expansions as well. After the economy adds jobs consistently during the beginning stages of an expansion, it approaches full employment. Once full employment is reached, real wages tend to increase. Real wage growth typically ends in two scenarios: when inflation reduces workers’ purchasing power, or when the economy hits its peak, starting the business cycle once more.

We can visualize how unemployment changes with GDP growth over time in Figures 1 & 2.

Source for both Figure 1 & 2: Federal Reserve Bank of St. Louis.

Dips in GDP growth correspond with higher unemployment, and unemployment tends to be at its lowest at the end of an expansion period. Macroeconomists term this relationship Okun’s Law after the American economist Arthur Okun who first observed this relationship. This relationship has held up empirically since it was first proposed in 1962. Figure 3 demonstrates this relationship’s consistency.

Source: Federal Reserve Bank of St. Louis.

The nature of the business cycle has not remained constant in the long term. When the United States economy was consistently growing at upwards of 3% annually, the economy went through the business cycle in shorter, more volatile intervals. However, after a recession in the early 1980s, the business cycle became less acute and more predictable, with expansions lasting longer than in previous economic eras. This dynamic is termed the Great Moderation, as economic growth also moderated with the business cycle. In fact, the two longest expansions in United States history have occurred within the last 20 years, even though year-over-year growth decreased relative to pre 1980s levels. The lengthening of expansions becomes clear when we visualize each expansion in Figure 3.

Source: NBER Dating Committee.

Reflection Questions:

• How have business cycles affected me and my community in the past?
• If we are currently at the beginning of an expansion, what type of macroeconomic trends should I expect?
• Which is preferable: longer expansions with smaller year-to-year growth, or shorter expansions with higher growth, more similar to pre-Great Moderation business cycles?
• How does the business cycle affect the way I vote?