Last time, we started a discussion on a few phases of the business cycle. Specifically, we had a look at those parts of the business cycles that could be described as prosperity. This time around, we are having a look at the phases of a depression.
The recession phase
The demand for products continues to decline because prices are high and wages are not increasing. If there is a sudden decline in demand, it triggers a recession.
Producers are still not yet aware of the oncoming change. Their input prices still remain high, and they believe demand is still high. Very few people are buying their products though, and supply exceeds demand. Thus input costs eventually overtake profits, leading to problems in many companies.
Prices, investment, and production take a nose-dive. As people invest less, people invest less, and a self-perpetuating cycle of decline ensues.
The trough phase
The economy has now fallen to a low level. Lower than what an economy normally expects. Income and spending also fall. As people have less money, they are less able to pay debts. Therefore, interest rates fall and some people even default on their debts.
There’s no more investment in stock markets as economic output is lower. Unemployment rises higher as a result. This is as low as the economy will get in this cycle.
The recovery phase
Usually, a very low trough is followed by a time of recovery. People start viewing the future brightly and seeking to improve things. Investment picks up, and, therefore, so does employment (usually in the labour market first) and production. Businesses start recovering and hiring, slowly.
With more people in employment, more people have money to spend. Therefore, demand increases, encouraging more economic growth.
Banks lower the rates and their investments in bonds and securities. The stock market itself starts picking up, encouraging corporate growth.
As businesses earn more and more people are in employment, we are back to an expansion phase. The business cycle can start again.