Identify the phases of the business cycle and classify economic indicators.
Economies grow around a rising trend in irregular waves.
| Phase | Activity | Inflation | Typical policy |
|---|---|---|---|
| Early expansion (recovery) | Rebounding from a trough; unemployment high but falling | Low | Rates low; stimulus still in place |
| Mid expansion | Steady growth; profits rising; credit expanding | Moderate | Rates moving toward neutral |
| Late expansion | Capacity tight; labour scarce | Rising | Rates restrictive; curve flat or inverted |
| Contraction (recession) | Output and employment fall; defaults rise | Falling | Rates cut; fiscal support |
Expansions last years; recessions are usually shorter, often under a year. No two cycles are alike and expansions do not die of old age: they end because of a shock, a policy tightening or the unwinding of a financial excess.
In the US, the Business Cycle Dating Committee of the National Bureau of Economic Research, which looks at a broad set of data. In Canada, the C.D. Howe Institute's Business Cycle Council. The popular rule of two consecutive quarters of falling real GDP is a shorthand, not the official definition.
| Type | Meaning | Examples |
|---|---|---|
| Leading | Turn before the economy | Yield curve slope, purchasing managers' indexes (PMI) new orders, building permits and housing starts, initial jobless claims, consumer confidence, stock prices, credit spreads |
| Coincident | Move with the economy | Employment, industrial production, real retail sales, real personal income |
| Lagging | Turn after the economy | Unemployment rate, inflation, wage growth, bank loan delinquencies |
A purchasing managers' index is a survey scaled so that 50 divides expansion from contraction. A manufacturing PMI of 53 means more firms report growth than decline; 47 means the opposite. The direction of change matters as much as the level.
Lending conditions move in their own cycle that amplifies the business cycle. In the upswing, lenders compete, standards loosen, leverage builds and spreads narrow. Something then triggers losses, lenders retreat, spreads widen and even sound borrowers struggle to refinance. The economist Hyman Minsky argued that long periods of stability breed the risk-taking that ends them. Watch debt growth relative to income, lending standards, credit spreads and default rates.
Residential investment is highly rate-sensitive and often leads the cycle. In Canada, with high household debt relative to income and short mortgage terms, housing is an especially important channel.
Pandemics, wars, commodity price spikes and financial crises can start or end a cycle abruptly. Forecasts work best at describing where the economy is and worst at predicting turning points.
Stock markets are themselves a leading indicator: they tend to peak before a recession starts and bottom before it ends. An investor who waits for recession news to sell, and for recovery news to buy, will usually be late on both.
Economist Claudia Sahm proposed a simple real-time recession signal: a recession has likely started when the three-month average unemployment rate rises 0.5 percentage points or more above its lowest three-month average of the previous 12 months.
The lowest three-month average in the past year was 3.6%; the latest three-month average is 4.2%. The indicator reads 0.6, above 0.5, so the rule is triggered. The rule has a strong record in US history, but in 2024 it triggered without a recession following, partly because the rise in unemployment came from a fast-growing labour force rather than layoffs. Every rule of thumb has exceptions.
Since the Second World War, US recessions have lasted about 10 months on average and expansions about five years, though the range is wide: the 2020 recession lasted two months and the expansion before it more than ten years. Canada's recessions broadly coincide with those in the US, though not always in timing or depth.
The Conference Board publishes a leading economic index for the US that combines ten indicators, including the yield curve, claims, building permits, new orders and stock prices. Composite indexes smooth out the noise in individual series, but they too have given false signals.
A services PMI falling from 54 to 51 means activity is still expanding, at a slower pace. The level tells you expansion or contraction; the direction tells you momentum. Readings below 50 for several months in manufacturing have often preceded slowdowns, though manufacturing is a smaller share of the economy than in the past.
Corporate profits are far more cyclical than GDP because of operating leverage: in a recession, company earnings often fall by double digits while GDP falls only a few percent. Analysts' forecasts tend to lag, cutting estimates after the downturn is underway.
Rather than predicting turning points, track the balance of evidence each month: how many leading indicators are improving, how many deteriorating, and whether the change is broad or narrow. A slow shift in that balance is more informative than any single reading.
Build a one-page dashboard for Canada or the US with the latest value and three-month direction of ten indicators: four leading, three coincident, three lagging. Decide which phase of the cycle the economy is in and write three sentences of justification.
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