Business cycles are recurring expansions and contractions in real economic activity. The exam wants you to name the phases, explain credit cycles, and identify which sectors lead, lag, or coincide with the cycle.
A business cycle is the fluctuation of real GDP and broader activity around its long-run trend. Modern CFA framing uses four phases bounded by two turning points.
- Recovery. Activity rises off a trough. Output gap is large and negative. Confidence is fragile but improving. Inflation is subdued. Unemployment is still high but stops rising.
- Expansion. Growth runs above trend. Capacity utilization climbs. Hiring is broad. Inflation pressure builds late in this phase as slack disappears.
- Slowdown. Growth decelerates and runs below trend, but the level of output may still rise. Profit margins compress. Inventories swell. Central banks often tighten here.
- Contraction (recession). Activity falls outright. Two consecutive quarters of negative real GDP is the textbook shorthand, though dating committees use a broader set of measures.
Peak is the top turning point between expansion and slowdown. Trough is the bottom turning point between contraction and recovery. Neither is a phase. They are single dates.
Common mistakes
- Calling slowdown a recession. Slowdown is below-trend growth. Contraction is negative growth. Trap answer: labeling any deceleration a "recession."
- Reversing the inventory-to-sales signal. Falling ratio is bullish (demand strong); rising ratio late cycle is bearish (goods piling up). Trap: assuming a falling ratio means weak sales.
- Treating unemployment rate as leading. The unemployment rate is lagging. Initial jobless claims are leading. Trap: using the unemployment rate to forecast a turning point.
Bottom line
- Four phases: recovery, expansion, slowdown, contraction. Peak and trough are turning points (single dates), not phases
- Credit cycles last 15 to 20 years and amplify business cycles (5 to 10 years) through leverage and asset prices
- Inventory-to-sales ratio FALLS in early recovery (sales outpace stock) and RISES near a peak (sales fade, bearish)
- Consumer durables and business equipment capex are highly cyclical; services and structures are smoother or lag
Exam shortcut
Match the indicator to its timing class first, then read the question. Permits, yield curve, ISM new orders, and M2 are leading; payrolls and industrial production are coincident; unemployment rate, CPI, and prime rate are lagging. When asked to identify a phase from a data table, weight leading indicators most for "where are we headed" questions and coincident indicators most for "where are we now" questions.
The full lesson (about 2,323 words, 15 min read) adds 2 worked examples, all 6 common mistakes, a self-check, free in the app.
Learning objectives
- business cycles
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