Phases of the business cycle
The timing of a cycle is not predictable, but its phases seem to be. Many economists cite four phases—prosperity, liquidation, depression, and recovery—using the terms originally developed by the American economist Wesley Mitchell, who devoted his career to studying business cycles.
During a period of prosperity a rise in production becomes evident. Employment, wages, and profits increase correspondingly. Business executives express their optimism through investment to expand production. As the upswing continues, however, obstacles begin to occur that impede further expansion. For example, production costs increase; shortages of raw materials may further hamper production; interest rates rise; prices rise; and consumers react to increased prices by buying less. As consumption starts to lag behind production, inventories accumulate, causing a price decline. Manufacturers begin to retrench; workers are laid off. Such factors lead to a period of liquidation. Business executives become pessimistic as prices and profits drop. Money is hoarded, not invested. Production cutbacks and factory shutdowns occur. Unemployment becomes widespread. A depression is in progress.
Recovery from a depression may be initiated by several factors, including a resurgence in consumer demand, the exhaustion of inventories, or government action to stimulate the economy. Although generally slow and uneven at the start, recovery soon gathers momentum. Prices rise more rapidly than costs. Employment increases, providing some additional purchasing power. Investment in capital-goods industries expands. As optimism pervades the economy, the desire to speculate on new business ventures returns. A new cycle is under way.
In fact, business cycles do not always behave as neatly as the model just given, and no two cycles are alike. Business cycles vary considerably in severity and duration. Major and minor cycles can occur, with varying spans.
The most severe and widespread of all economic depressions occurred in the 1930s. The Great Depression affected the United States first but quickly spread to Western Europe. From 1933 to 1937 the United States began to recover from the depression, but the economy declined again from 1937 to 1938, before regaining its normal level. This decline was called a recession, a term that is now used in preference to liquidation. Real economic recovery was not evident until early 1941.