Business cycle

What it means

The business cycle is the recurring alternation of expansion, peak, contraction and trough in the economy. During expansion GDP, employment and demand rise; at the peak the economy hits capacity limits; in contraction demand weakens; and at the trough conditions form for a new recovery.

Cycles have no regular length, and their causes vary: interest rate changes, energy prices, financial crises, technological change or global events. A marked fall in GDP is called a recession, usually accompanied by rising unemployment and falling investment.

Sectors respond to the cycle with different intensity. Cyclical sectors such as construction, automotive or luxury goods rise and fall sharply with the economy, while defensive sectors such as food, energy or healthcare are more stable.

How it works in practice

Understanding the cycle helps plan investment, inventory and financing. In expansion it pays to add capacity and hire, while still building reserves. In a slowdown, liquidity, cost control and caution with new commitments matter most.

Financing is cheaper and easier to obtain when rates are low and sentiment is good, while in a crisis banks tighten their terms. Companies that secure a long-term loan or credit line in good times have more room to manoeuvre in bad times.

The state tries to smooth the cycle with fiscal policy, supporting the economy in a crisis and, ideally, saving during expansion. The central bank responds with interest rates to inflation, which tends to be higher at the peak of the cycle and lower in contraction.

What to watch out for

Nobody can predict precisely when the cycle will turn. Businesses should therefore not build plans on a single scenario but prepare for different outcomes, for example through sensitivity analysis of revenue and costs.

In expansion it is easy to underestimate risk and take on too much debt or build up inventory that is hard to sell in a downturn. Discipline in good times, meaning reserves, sensible borrowing and a diversified customer base, decides survival in bad times.