Understanding Economic Contraction

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Friday, September 09, 2016 5.59AM / Investopedia

A subscriber asked for this information and made us realise we could help by directing other users attention to the understanding behind the nations’s current economic cycle.

It is trite to state the obvious that you need to try to figure out a way to make the economic contraction work for you so that you can improve from it. Even though you are passionate about your work and country, you should bear in mind that growing a new business is difficult in times of economic contraction.

Here are some definitions that can help your understanding:

What is a 'Contraction'

A contraction is a phase of the business cycle in which the economy as a whole is in decline. More specifically, contraction occurs after the business cycle peaks but before it becomes a trough. According to most economists, a contraction is said to occur when a country's real GDP has declined for two or more consecutive quarters.

BREAKING DOWN 'Contraction'

For most people, a contraction in the economy can be a source of economic hardship; as the economy plunges into a contraction, people start losing their jobs. While no economic contraction lasts forever, it is very difficult to assess just how long a downtrend will continue before it reverses. History has shown that a contraction can last for many years, such as during the Great Depression.

The Business Cycle
Four discrete phases comprise the business cycle, and the economy moves through them in a specific order: expansion, peak, contraction and trough. During economic expansion, gross domestic product (GDP) rises, per capita income grows, unemployment declines and equity markets tend to perform well. The peak phase represents the end of an expansionary period, after which contraction takes hold. GDP and per capita income decline, unemployment ticks up and stock market indices trend downward.

The most-watched indicator of economic contraction is GDP; when it contracts for two consecutive quarters in the United States, a recession is officially signaled. The end of a contractionary phase is marked by the trough. This is the nadir of a recession or downturn, what many refer to as "rock bottom." A new period of expansion begins after a trough.

Effects of Contraction
While GDP is the primary measure used to assess the health of the economy and the phase of the business cycle, the ancillary effects of contraction are what the public feels the most. Decreased productivity almost always precipitates higher unemployment and lower wages, as less work is available when production is low. When more people are unemployed or have their incomes cut, less money gets spent and put into the economy, which can further exacerbate contraction.

Famous Periods of Contraction
The longest and most painful period of contraction in modern American history was the Great Depression, which lasted for a full decade, from 1929 to 1939. More recently, deep contraction occurred during the early 1980s when the Federal Reserve sent interest rates soaring to squelch inflation. This contractionary period, however, was short-lived and followed by a robust and sustained period of expansion. The Great Recession of 2007-2009 was a period of substantial contraction spurred by an unsustainable asset bubble in the real estate and financial markets.

Trough
A trough is the stage of the economy's business cycle that marks the end of a period of declining business activity and the transition to expansion. In general, the business cycle is said to go through expansion, then a peak, followed by contraction and then finally bottoming out with the trough.

Description: Trough


BREAKING DOWN 'Trough'
Economists use several metrics to track the economic cycle throughout its four phases. The most recognizable of these is gross domestic product (GDP), which is the value of all goods and services that a country produces.

Related Terminologies from Investopedia

1.       Contraction

2.      Trough

3.      Expansion

4.      Peak

5.      Cyclical Industry

6.      Economic Recovery

7.      Economic Cycle

8.     Business Cycle

9.      Continuous Contract

10.  Contract Unit

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