What is Economic Expansion?
Economic expansion happens when real GDP grows from a trough to a peak within two or more subsequent quarters. The expansion occurs during times of economic stimulation, where there is a rise in employment, followed by consumer confidence and discretionary spending. The phase is also known as economic recovery.
- Expansion is a phase within the business cycle where there the economy is stimulated, prosperous, and flourishing, resulting in an upward trend from a graphical perspective.
- On average, expansions can last for four to five years.
- Indicators to consider to determine whether the economy is entering a recession or expansion are interest rates, corporate profits, and capital expenditures.
Understanding Economic Expansion
Economic expansion exists within a process called the business cycle, where there are four phases – expansion, peak, contraction, and trough.
Within an expansion, the economy is known to be flourishing. The qualities of a flourishing economy include low interest rates where money is cheap to borrow, high business activity, as well as large discretionary spending. From a macro-perspective, GDP rises, disposable income per capita rises, and unemployment rates shrink due to a large number of job opportunities.
A peak occurs when expansion reaches its climax. With a large sum of demand for goods, inflation occurs where costs begin to increase. Gradually, consumers begin to buy less and macroeconomic indicators cease to increase.
After reaching the peak, economic growth begins to decline and contract. With the lack of cash flowing around the economy due to heightened prices of goods, companies are not receiving as much income to sustain or scale operations. Often, they stop hiring and begin to lay off staff to reduce their expenses and protect themselves from balance sheet risk.
The lowest point of the business cycle is known as the trough. The trough is the transitioning point between a contraction and a recession.
Expansions are known to typically last for approximately four to five years.
Indicators of an Economic Expansion
There are several primary indicators to determine if an expansion would be happening within the future. They are analyzing corporate profits, capital expenditures spent on sustaining and scaling operations, and interest rates. Other factors that would be considered are average weekly hours worked by manufacturers, unemployment claims, building permits, and more. This is also applicable to contractions.
Interest Rates and Their Effect on Economic Expansion
When the economy needs to be stimulated, the Federal Reserve will lower interest rates, which will decrease borrowing costs. By doing so, businesses and consumers are more inclined to spend their discretionary income, as issuing debt becomes very cheap. In such a situation, saving is not favorable; thereby, cash flow begins to circulate around the economy through spending activity.
Eventually, the cheap cash flow will increase the cost of spending, which would ultimately force central banks to increase interest rates, encouraging consumers to save instead. It would impact a company’s top line, which would be an indication of the economy contracting.
Defining the Federal Reserve System
The Federal Reserve System is the central bank of the United States. It is known to play an integral role in controlling recessions and expansions through regulatory actions such as monetary or fiscal policy.
- Monetary policy is when the Fed controls the country’s money supply by implementing higher or lower interest rates and taxes to ensure there isn’t too little or too much cash within the economy. This would then reduce the likelihood of experiencing excessive inflation or slow economic growth. Generally, the inflation rate is approximately 2%-3% per year, which is the Fed’s long-term target at the moment.
- Fiscal policy is when the Fed controls the country’s money supply by cutting taxes or implementing higher government spending to boost or lower cash accordingly.
CFI offers the Certified Banking & Credit Analyst (CBCA)™ certification program for those looking to take their careers to the next level. To keep learning and developing your knowledge base, please explore the additional relevant resources below: