The economic trade cycle shows how economic growth can fluctuate within different phases, for example:
- i) Boom (which is high growth causing inflation)
- ii) Peak (top of trade cycle)
- iii) Downturn or Recession ( fall in economic output)
- iv) Recovery (upturn of economic growth)
Quarterly Economic Growth in the UK
Causes of Trade Cycle
- Momentum effect. When there is positive economic growth, this tends to cause:
- A rise in consumer and business confidence
- Rising asset prices such as houses; this causes a rise in wealth and consumer spending.
- 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.
- 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.
- Global Trade Cycle. A global economic downturn will tend to affect individual economies.
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.
See: Fiscal Policy
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.
- If potential output grows faster than actual output there will be an increase in spare capacity, the shortfall between actual and potential output increase.
- With fast economic growth and increases in AD then the output gap gets smaller
The Long Run Trend Rate of Economic Growth:
This 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.