Given the recent news reports, as a business owner, you may feel rather apprehensive about the possibility of an upcoming recession.
Gloom and doom reverberate everywhere one turns, and anyone would think that economic turmoil had never happened before.
Well, unfortunately, it has and will continue to occur. This is known as a business cycle (or economic cycle), and nothing we are experiencing today is new or unprecedented.
For business owners, preparing for a recession is essential as you will face one at least once in the lifetime of your business. And when the economic activity gets tough, it is essential to remember that recovery always occurs and, when it does, presents a wave of opportunities.
In this article, explain what a business cycle is and how it works to help you develop your recession plan.
What is meant by a business cycle?
A business cycle is a term economists use to describe how the economy grows and shrinks over time. A period of expansion is followed by recession, then expansion and so on and so on.
Although this explanation makes the concept of business cycles seem simple, some of the greatest economic minds in history have built careers on studying these events.
The French economist Clément Juglar was the first to recognise that economic cycles are approximately seven to ten years long. However, he was careful to state that these intervals were not rigid, and his theory became known as the Juglar cycle.
What are the four stages of the business cycle?
Austrian economist, Joseph Schumpeter, stated that the Juglar cycle has four stages, namely:
- Expansion – interest rates are low, making it easier for businesses to borrow, and production and prices increase. GDP rises
- Crisis – involves banking panics, stock market crashes, and the bursting of financial bubbles such as sub-prime mortgages in 2007/08
- Recession – negative economic growth over two consecutive quarters. Caused by a widespread drop in spending resulting from the crisis. Unemployment rises, and there may be civil unrest
- Recovery – the economy adapts to new circumstances, including the policies and regulations by governments and central banks in reaction to the recession.
Displaced workers find new employment, and the capital goods, labour, and other economic resources from failed businesses are hoovered up by other firms, leading to their growth and expansion
How does inflation affect a business cycle?
Inflation is linked to the expansion stage of the business cycle. As the economy strengthens, prices naturally increase (after all, businesses will charge as much as the market will pay for their goods and services).
However, like all economic theories, this explanation is too simplistic because high inflation can also occur when the economy is contracting. This happens because employees demand higher wages to compensate as prices increase.
The only way a business can meet such demands, along with increases in supplier costs and interest rates, is to raise the price of the goods and services it supplies.
Inflation also impacts export businesses. If UK inflation is higher than inflation in the country a business exports to, the cost of the UK goods will be higher, making them uncompetitive.
What happens during the recovery phase of a business cycle?
In most cases, the stock market is the first indicator of a business cycle recovery because investment in stocks and shares is based on potential hopes and optimism.
A return to a regular unemployment rate (4-6%) is one of the last features of economic recovery as employers want to ensure that consumer demand, inflation, and interest rates (which are raised to counter rising inflation) have stabilised before taking on new talent.
What happens in between is mainly affected by government policy.
British economist John Maynard Keynes, one of the most influential minds of the 20th century and the founder of Keynesian economics, argued that unless the government engaged in fiscal stimulus, for example, public spending projects and bailouts to prevent mass layoffs, business and consumer optimism would struggle to return.
Although his theories fell out of favour during the 1970s, they were adopted during the 2008 financial crisis and again by Chancellor Rishi Sunak and other world leaders during the Coronavirus pandemic, the latter being in the form of the furlough scheme.
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Creating and updating a business budget plan from day one will ensure you have enough money to pay for marketing, operations and hiring new talent to meet your commercial ambitions.
It puts you in charge of your destiny and will allow you to run your business with confidence.