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Narsee Monjee Institute of Management Studies

NMIMS University

Introduction to Business Cycles

Dipankar De
Mumbai, August 2007

1
Business Cycles

• Business implication of an overall economic slowdown is harmful for any


economy

• Production and sales decline, impacting profits of the companies; in


extreme scenario may lead to bankruptcy

• Business cycles follow irregular patterns & predicting when an expansion


will end & recession will begin is often difficult

• Business cycle exhibits simultaneous upswings in output, employment,


sales, and income, followed by similarly general downswings. It is the co-
movement of the variables that generates the cycle

• Leading indicator approach may be used to predict ‘turning points’


and business cycles
2
Predicting Business Cycles

• Given the linkages in the economy, some variables must turn down before
others. To identify those series that consistently change well in advance of
changes in the major measures of any economic activity - leading indicator is
used.

• List of leading indicators for any particular variable is not constant overtime – few
may act as co-incident or lagging indicator over a period of time; also lead time
may undergo changes

Business respond
Consumers cut down by producing less + Lowers personal incomes
on spending cutting jobs

These activities fall together Hurting Consumers


during recession Reinforce the downturn
Spending further
+
Spread & Diffuse faster

COINCIDENT INDICATORS
3
Predicting Business Cycles

• How could one predict such a shift in production?


– If new orders fell, production would soon follow
– Impact on employment pattern (workers working overtime / layoffs)

Might indicate
Fall in production soon Future Downturn in
Fall in New Orders
production

LEADING INDICATORS
4
Business Cycles

• A broad spectrum of indicators are needed to represent the various drivers of the
economic cycle. The risk of falsely predicting a cyclical turn can be minimized only
by collecting diverse indicators in Composite Indexes

• Business cycles are common to all modern economies, but their frequency, timing
& severity differ across countries

• Because of the globalized world economies, development in one country are


affected by economic conditions in other economies. This is known as
international propagation of business cycles