Economic Trade Cycle

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

  1. 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.
  2. 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.
  3. Technology. Improvements in technology may cause a boost in economic growth. A lull in technological innovation may cause slower growth.
  4. 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.
  5. 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

  1. Are recessions avoidable?

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.

Output Gap

  • 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.