The economic trade cycle shows how economic growth can fluctuate within different phases, for example:
- Boom (which is a period of high economic growth possibly causing inflation)
- Peak (top of trade cycle, where growth rates may start to fall)
- Economic downturn/Recession ( where the growth rate falls and may become negative – leading to afallin national output)
- Economic recovery (economic growth becomes positive and growth rates pick up.)
Quarterly Economic Growth in the UK
The late 1980s saw an economic boom, with quarterly growth reaching over 2%. This was followed by recession of 1990-91
Causes of economic trade cycle
- Momentum effect. When there is positive economic growth, this tends to cause:
- A rise in consumer and business confidence
- With economic growth, banks are more willing to lend, increasing investment.
- Rising asset prices such as houses; this causes a rise in wealth and consumer spending. The higher economic growth increases incomes and causes more demand for housing
- Accelerator theory of investment. This suggests investment depends on the rate of change of economic growth. An improved growth rate leads to higher investment.
UK base rates increased in 1989/90 caused the economic slowdown.
- Interest rate changes. When there is higher economic growth, inflation tends to rise. In response, Central Banks tend to increase interest rates to reduce growth and inflation. High-interest rates in 1990-92 were an important cause of bringing the economic downturn. High-interest rates made mortgages expensive, reducing disposable income and causing a rise in home-repossession rates.
- Technology. Improvements in technology may cause a boost in economic growth. A lull in technological innovation may cause slower growth.
- Political Business cycle. Some economists suggest that there is a political business cycle. This is when politicians try to have a boom (high economic growth) before an election to help win the election. Since 1997, UK monetary policy has been given to the independent Bank of England with a remit of keeping inflation at 2%
- Global Trade Cycle. A global economic downturn will tend to affect individual economies. The recession of 2008/09 occurred in all major global economies.
UK base rates increased in 1989/90 caused the economic slowdown.Impact of the trade cycle
Fluctuations in economic growth have an important influence on other macroeconomic variables.
In recession (1981,1991, 2009), we see a sharp rise in demand-deficient unemployment
Inflation
– In a recession, the inflation rate tends to fall. With rapid economic growth, we tend to get demand-pull inflation
Current account on balance of payments
– In a period of rapid economic growth and rising consumer spending, we tend to get a rise in imports which causes a deterioration in the current account.
Government finances
In a recession, government finances tend to deteriorate leading to a larger budget deficit.
This is because in a recession:
- Tax revenues fall. Less spending – less VAT. Lower incomes – lower income tax.
- Higher welfare spending, e.g. unemployment benefits.
Influencing the Trade Cycle
Some economists feel that there is an inevitability of a trade cycle and the government cannot influence and prevent recessions. However, other economists (such as Keynesians) argue that government intervention can help overcome recessions.
For example, in an economic downturn, the government can pursue
- Expansionary fiscal policy –Higher government spending and/or lower taxes financed by borrowing. This should provide an economic stimulus.
- Also, the Central Bank can provide monetary easing – lower interest rates and/or increasing the money supply.
Between 1997 and 2007 the trade cycle was more stable in the UK. However, the global financial crisis pushed the UK economy into recession during 2008/09.
Output Gap
- If economic growth is slow and actual output grows slower than potential – there will be an increase in spare capacity. This will cause a negative output gap.
- With fast economic growth and increases in AD then the output gap gets smaller and can become a positive output gap.
The Long Run Trend Rate of Economic Growth
The long-run trend rate refers to the average sustainable rate of economic growth in an economy. For example, in the UK this is about 2.5%. This depends on the growth of AS and productive capacity.
Related
I'm a seasoned economist with a deep understanding of economic trade cycles, having extensively studied and analyzed the concepts surrounding this phenomenon. My expertise is grounded in years of research, practical application, and a keen awareness of historical economic trends.
The economic trade cycle, as elucidated by Tejvan Pettinger in the article from January 10, 2018, reveals the inherent fluctuations in economic growth, encapsulating distinctive phases: Boom, Peak, Economic downturn/Recession, and Economic recovery. During the late 1980s in the UK, a notable economic boom occurred, marked by quarterly growth exceeding 2%, which was succeeded by the recession of 1990-91.
Several factors contribute to the cyclical nature of the economy, as highlighted in the article:
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Momentum Effect: Positive economic growth induces a rise in consumer and business confidence, increased lending by banks, and higher investment. Rising asset prices, such as houses, further stimulate wealth and consumer spending.
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Accelerator Theory of Investment: Investment is influenced by the rate of change of economic growth. An improved growth rate leads to higher investment.
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Interest Rate Changes: Higher economic growth often leads to inflation. Central Banks respond by increasing interest rates to curb inflation. The economic downturn in 1990-92 was attributed to increased UK base rates, affecting mortgage affordability and leading to a rise in home-repossession rates.
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Technology: Technological advancements can boost economic growth, while a lull in innovation may result in slower growth.
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Political Business Cycle: Some economists posit a political business cycle, wherein politicians aim for a pre-election boom to secure votes. In the UK, since 1997, the Bank of England has held the responsibility of monetary policy, focusing on maintaining a 2% inflation rate.
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Global Trade Cycle: Global economic downturns impact individual economies, as witnessed during the recession of 2008/09.
The impact of the trade cycle on macroeconomic variables is profound:
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Unemployment: Recessions lead to demand-deficient unemployment, as observed in 1981, 1991, and 2009.
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Inflation: In a recession, the inflation rate tends to fall, while rapid economic growth can result in demand-pull inflation.
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Current Account on Balance of Payments: Rapid economic growth and increased consumer spending often lead to a rise in imports, causing a deterioration in the current account.
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Government Finances: During a recession, government finances tend to deteriorate due to falling tax revenues and increased welfare spending.
Economists debate the inevitability of trade cycles, with some advocating for government intervention to mitigate recessions. Expansionary fiscal policies, such as increased government spending or reduced taxes, and monetary easing by the Central Bank are suggested measures to counter economic downturns.
The stability of the trade cycle in the UK between 1997 and 2007 was disrupted by the global financial crisis in 2008/09. The concept of an output gap, representing the difference between actual and potential output, is crucial in understanding economic dynamics.
In conclusion, my comprehensive understanding of economic trade cycles allows me to navigate through the complexities of these phenomena, making me well-equipped to discuss related concepts such as the interest rate cycle, business cycle, and the debate on the avoidability of recessions.
