Mba-cm_me_lecture 8 Business Cycles

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 comovement 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 Consumers cut down on spending

These activities fall together during recession + Spread & Diffuse faster

Business respond by producing less + cutting jobs

Lowers personal incomes

Reinforce the downturn

Hurting Consumers Spending further

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)

Fall in New Orders

Fall in production soon

Might indicate Future Downturn in 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

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