What is the stage of the business cycle that follows a recession or depression?

1. Career development
2. Business Cycle: Definition and Stages

By Ellis Burgin

Updated May 9, 2022 | Published November 12, 2020

Updated May 9, 2022

Published November 12, 2020

Ellis Burgin is a seasoned content writer with extensive experience in the finance, accounting, marketing and management industries.

When you work in business or finance, you may expect the economy to undergo periodic fluctuations. These cycles can have a substantial effect on spending, which may influence your industry or your organization. By preparing for these variations, you can ensure that your organization experiences more positive experiences during such periods of variation.

In this article, we discuss how a business cycle works and explore the main stages.

What is a business cycle?

A business cycle is the natural expansion and contraction of economic growth that happens in an economy over a period of time. The rise and fall of an economy's gross domestic product (GDP) defines the start and end of a business cycle, which is also known as an economic cycle or a trade cycle. A business cycle accounts for the growth and decline of economic activity over time.

Members of an economy can manage a business cycle using a variety of tools. Central banks can use monetary policy to reduce interest rates, which can encourage spending and investments. The legislature can use fiscal policy to encourage or slow down economic growth.

Related: How to Calculate Per Capita (Plus Definition and How It's Used)

Stages of a business cycle

Business cycles can last for virtually any length of time. The duration of a business cycle is the amount of time it takes to complete all five stages:

1. Expansion

A business cycle always starts with the expansion stage. During this stage, there are clear positive economic indicators, including growth in income, employment, demand, supply and profit. Throughout an expansion, the frequency of investments from private and public entities increases, and both businesses and individuals generally repay their debts on time.

Related: Economic Demand: Definition, Determinants and Types

2. Peak

When the economy becomes saturated and upward growth can no longer continue, the business cycle enters the peak stage. Wages, employment rates and prices for goods and services are as high as they can go, given the current economic conditions. At this point, these economic indicators cease to rise further. Many businesses and individuals may reexamine their budgets in anticipation of a decline in economic activity.

3. Recession

The recession stage starts as soon as expansion ends and economic activity begins to decline. It lasts until the GDP returns to the point that marked the beginning of the expansion stage. During a recession, demand begins to decline almost immediately, but producers fail to adjust their output until the market has excess supply. Positive economic indicators like prices and wages start to fall at this point.

4. Depression

The depression stage begins once the GDP falls below the pre-expansion level or the steady growth line. During a depression, unemployment rates rise dramatically, while economic growth declines steadily. A depression lasts until economic activity can't decrease in value any further or outside investment occurs that stimulates the economy.

Related: 10 Recession-Proof Jobs

5. Trough

When the depression stage reaches its lowest point, a business cycle enters the trough stage. At this point, the economy experiences negative economic growth, as the production of goods and services decreases and wages reach their lowest point. Regardless of the severity of a business cycle, the trough is always the lowest point in relation to economic growth. 

6. Recovery

After the GDP reaches its lowest point in the cycle, the recovery stage commences. During this stage, the economy begins to recover and reverse the negative trends. Demand increases and supply soon follows. Eventually, investments resume, and employment and production begin to rise. The recovery stage lasts until the GDP returns to a steady growth line. Once it reaches this point, the current business cycle ends and a new one begins as it enters the expansion stage again.

How are business cycles measured?

Economists measure business cycles in terms of time and severity:

Business cycle timing

The National Bureau of Economic Research (NBER) establishes the dates of every business cycle based on extensive economic research. In almost every case, the NBER sets the dates for each stage of a business cycle in retrospect, often months or more than a year after the fact.

As a general rule, expansions tend to last longer than recessions in the U.S. Since the mid-19th century, expansion duration has increased steadily from 27 to 103 months.

Related: 15 Ideas for What To Do With an Economic Development Degree

Recession severity

To communicate the severity of a business cycle, economists measure the recession and expansion stages separately. The severity of the recession stage is based on three metrics:

• Depth: How severe is the recession stage?

• Diffusion: How widespread has the recession stage become in the national economy?

• Duration: How long has the recession stage lasted?

Expansion severity

Economists also consider three metrics to determine the severity of the expansion stage:

• Pronounced: How noticeable or significant is the expansion stage?

• Pervasive: How many aspects of the economy has the expansion stage reached?

• Persistent: Has the expansion stage lasted for longer than usual?

Why are business cycles important?

Understanding how these cycles work is critical for professionals in business, finance and economics. If you have a sense of what stage of the business cycle the economy is currently in, you can make more informed strategic decisions.

Investors tend to make investments during the expansion phase, but they often become overconfident and over-inflate prices during the peak stage. During a recession or a depression, investors stop buying and begin selling instead, pushing prices down. 

As an investor, you may know which assets are likely to perform well at different stages of the business cycle so you can make better financial decisions. Although market cycles are separate from business cycles, an economy's stock market often follows its business cycle closely.

The stock market generally performs well during the expansion stage and may become a bull market if the GDP growth rate remains high and inflation and unemployment stay low. During the contraction stage, growth slows substantially and prices decrease, causing a bear market. A bull market indicates positive growth, while a bear market indicates negative.