The Effect of the Business Cycle on Your Finances
A business cycle is the economic fluctuations that an economy experiences over a period of time. These fluctuations are defined by the periods of economic growth and periods of contraction or recession. The business cycle is also known as the economic cycle.
The fundamental stages of a business cycle are:
Expansion: A period where the economy is expanding, as seen by higher output, employment, and income. Consumer and business confidence are high during an expansion, and spending and investment are robust.
Peak: When the economy experiences its highest rate of expansion, a business cycle reaches its peak. Interest rates may start to climb at this point, and inflationary pressures may start to increase.
Recession: Economic contraction, often known as a recession, is a time of declining output, employment, and income. Spending and investment fall when consumer and business confidence declines.
Trough: This is the time in the business cycle when growth in the economy is at its slowest. Interest rates are typically low and the unemployment rate is high at this time.
Recovery: The period of economic growth that comes after a recession is known as a “recovery,” and it is defined by an increase in output, employment, and income.
How does the business cycle impact your finances?
Now that you understand the stages of a business cycle, you can better understand how it affects your finances.
During the first stage, expansion, the economy expands and unemployment is low, this is also commonly referred to as a boom. This may result in higher salaries, more employment options, and higher stock values. Stocks, real estate, and other assets that tend to appreciate in value during a boom may be ideal investments at this time.
During the recessionary stage of the business cycle, commonly referred to as a bust, the economy contracts and unemployment is high. This also leads to lower salaries, fewer employment options, and lower stock values. Focusing on debt reduction and money savings at this time may be wise. Other than that, during this period, businesses may also be struggling which can lead to lower profits and decreased stock prices. Because of this, it is more difficult to grow your wealth through investments and harder to obtain credit.
Once the recession has stopped and the economy enters the expansion stage, jobs will be easier to find and wages tend to be higher. Generally, businesses will also be more profitable and stock prices will rise.
Business cycles are not predictable and difficult to pinpoint the exact point when the economy enters a recession or a boom. Adding to that, duration and severity of a business cycle is also difficult to forecast. However, by managing your money wisely and by understanding business cycles, you are well equipped to face whatever business cycle is ahead.