The theory of the Business Cycle states that national output, or GDP (Gross Domestic Product), does not grow smoothly at its expected trend rate. Rather, it fluctuates irregularly around its trend, showing recurring patterns from trough, through upturn, to peak and then from peak, through downturn and back to the trough. The cyclic movements themselves are not regular in timing or in size.

There are several policies related to the business cycle. Stabilization Policies are aimed at smoothing out the business cycles fluctuations, whilst Structural Policies are aimed at raising the growth trend. This distinction can also be applied to inflation and unemployment, both of which posses cyclical and structural facets.

The variations in the economy brought about by the business cycle are as a result of 4 combined influences:

  • The economic trend itself,

  • The Cyclical fluctuations around the trend,

  • Various Seasonal variations and

  • Irregular variations.

    Each of these components is studied by simply eliminating the others from the scope of the analysis.

    Many methods have been developed specifically for this purpose, largely by the NBER, the National Bureau of Economic Research.

    There are also many ways in which the turns in market activity can be dated.

    The Composite Series method, the Cluster of Turning Points method and the Diffusion Indices.

    Each one of the aforementioned methods has within itself, numerous variations and adaptations, dependant upon the market in which it is applied.

    The time series that evolve from this analysis are used as leading indicators of the fluctuations in the economy as a whole. Such composite indicators are published in quarterly form by most national reserve banks.

    South African Leading Indicators: (as published by the South African Reserve Bank.)

  • Net gold and other foreign reserves

  • Building plans passed

  • Physical volume of mining production

  • Net new companies registered
  • A Series of Unfortunate Bubbles

    First someone notices a small uptick in tulip bulb sales, so they pour a lot of money into buying tulip bulbs. This causes tulip bulb prices to edge upward some more. As more people notice this, more and more people jump on the tulip bulb bandwagon. Tulip bulb prices start to soar. People start thinking they'd be stupid not to invest in tulip bulbs at this point - it's sheep following sheep. Eventually, the people buying tulip bulbs for investment purposes far outnumber the people buying them to actually use - so it just becomes investors selling to more investors. The people who got in early make a killing - kind of like a pyramid scheme. Eventually the bubble pops and tulip bulb prices take a dive - suddenly there's mass unemployment in the tulip bulb industry - after all, during the bubble's hey-day, tons of people were being hired in the bulb industry.

    So now that investors (at least the ones that haven't been wiped out by the tulip bulb crash) have pulled out all their money, what's next? Do they learn their lesson? No, not really. They're just looking for the next "investment opportunity". In fact, bubbles are an essential part of making money in the investment business. The goal is to get in on the next bubble early, and get out before you are burned.

    So what's next? Well, how about the dot com bubble? The housing bubble? The rice bubble? The oil price bubble?

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