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Economic expansion, a period of economic prosperity marked by rising production, employment, and consumer confidence, is a welcome phase in any business cycle. Businesses flourish, job markets tighten, and a general sense of optimism permeates the economy. Understanding the characteristics of economic expansion empowers individuals across various backgrounds – from students of economics to investors and anyone curious about economic trends – to make informed decisions during these times of plenty. Let’s delve deeper into the hallmarks of an expanding economy and explore the key factors that contribute to this growth phase.
What is economic expansion?
Economic expansion is a period when economic activity increases. Real GDP and other output indicators, such as industrial production, grew positively. In a business cycle, it occurs after the trough phase and before the peak phase.
After exiting the lowest point, the economy began to recover and strengthen. The final phase of economic expansion is a boom.
During the expansion phase, real GDP, which measures the total value of goods and services produced in an economy, experiences positive growth during expansion. This signifies an increase in overall economic output.
Businesses ramp up production to meet rising demand for goods and services. Factories operate at higher capacity, and new production lines might be added to keep pace with consumer spending.
As businesses expand production, they require more workers. This translates to a rise in job creation and a decline in the unemployment rate. A thriving job market empowers workers and boosts overall economic confidence.
In essence, economic expansion signifies a period of economic health and growth, with increased production, job opportunities, and a generally optimistic outlook.
Characteristics of economic expansion
During economic expansion, real GDP grows, production of goods and services increases, and inflation and interest rates usually also tend to increase.
Increased production activities create more jobs, resulting in a low unemployment rate. However, the supply of qualified labor began to diminish, prompting workers to demand higher wages to compensate for purchasing power lost due to inflation.
Economists usually distinguish the expansion phase into two periods, recovery and boom. Both periods have different characteristics.
Phases of economic expansion
Economists sometimes categorize expansion into two phases:
- Recovery: It is the initial stage when the economy heals from a recession. Job growth picks up, but unemployment might remain elevated as businesses cautiously rehire. Inflation is typically moderate.
- Boom: The economy accelerates, with rapid growth in production, job creation, and consumer spending. While a boom signifies prosperity, potential risks like asset bubbles can emerge.
Economic recovery
Economic recovery is the first period of expansion after the economy exits the trough phase. During this period, interest rates were still low in line with the implementation of the central bank’s expansionary policies.
Economic activities start to rise. Growth of real GDP and production indicators change from negative to positive.
The unemployment rate usually remains high. Although layoffs decline, businesses yet hire new full-time workers. As an alternative, they increase overtime hours and recruit temporary workers to meet growing demand.
Demand for goods and services has begun to grow in the household sector. With low interest rates, consumers usually increase their purchases of durable goods, which are mostly financed by loans.
Meanwhile, businesses have not ordered heavy equipment or built new factories. Instead, they prefer to order some lightweight equipment. They are not optimistic enough and are waiting for stronger demands before investing more.
Because demand growth is relatively low. Inflation remains moderate.
Boom
During this period, economic activity showed a faster rate of growth. Demand for goods and services grew solidly. Inflationary pressures on the economy are also getting higher.
Businesses are optimistic and see positive future profit prospects. They then expand output and hire full-time labor. They start to order heavy equipment and build a new factory to meet the high demand. As a result, the unemployment rate has decreased.
When the economy approaches its potential level, inflation begins to surge. The unemployment rate is also close to its natural level.
When trying to increase production, businesses face a reduced supply of qualified labor. To attract new workers, they begin raising salaries. On the other hand, workers also renegotiate for higher wages to offset the decreased purchasing power of wages due to high inflation.
Businesses pass higher production costs on selling prices to maintain profitability margins. Because demand remains strong, they are not worried about falling demand due to rising selling prices.
The increase in selling prices will eventually bring the inflation rate to go faster. As a result, the economy is overheated. To prevent the fall in the purchasing power of money due to high inflation, the government adopted a contractionary policy.
Key characteristics of economic expansion
Economic expansion isn’t just a single indicator; it’s a symphony of positive economic forces working in tandem. Let’s delve into the key characteristics that define this prosperous phase:
- Rising real GDP and production: The engine of economic growth, real GDP, accelerates during expansion. This signifies a rise in the total value of goods and services produced in the economy. Factories hum with increased activity, and businesses might even expand production lines to keep up with consumer demand.
- Increasing employment and lower unemployment: As businesses ramp up production, they require more manpower. This translates into a surge in job creation. The unemployment rate dips as more people find work, boosting overall economic confidence and purchasing power.
- Rising wages (separate from inflation): A thriving job market empowers workers. Due to increased demand for their skills and a tightening labor market, workers may experience rising wages. This rise in wages is separate from inflation and reflects the growing value employees bring to businesses.
- Booming consumer confidence and spending: A sense of optimism pervades the economy during expansion. Consumers feel secure in their jobs and have more money in their pockets due to rising wages. This fuels a surge in consumer spending, which further stimulates economic activity and creates a positive feedback loop.
- Business investment and expansion: Fueled by economic optimism and rising profits, businesses become more willing to invest. They might invest in new equipment or technology or even expand their operations by opening new factories or stores. This investment creates jobs, increases production capacity, and propels further economic growth.
Potential risks of expansion and government intervention
Economic expansion, while a desirable phase, isn’t without its potential pitfalls. Here are some key risks to be aware of:
- Asset bubbles and market crashes: Rapid economic growth can sometimes lead to the formation of asset bubbles. This occurs when the price of assets, such as stocks, real estate, or commodities, inflates significantly beyond their intrinsic value. This inflation is often fueled by speculation and easy access to credit. If these bubbles burst, they can trigger financial crises, with asset prices plummeting and causing economic instability.
- Overheating economy and inflation: As the expansion matures, economic activity can become excessive, leading to an “overheating” economy. This can manifest in several ways, including:
- Rapidly rising prices (inflation): Demand for goods and services outpaces production capacity, leading to a significant rise in prices. This inflation can erode consumer purchasing power and ultimately dampen economic activity.
- Shortage of skilled labor: a booming job market can deplete the pool of available skilled workers. This can lead to wage pressures, further fueling inflation.
Government intervention to avoid excessive risks
Governments are not passive observers during economic expansion. They use various tools to try to mitigate potential risks and ensure a sustainable expansion:
- Monetary policy: Central banks can raise interest rates to slow down borrowing and investment. This can help curb inflation and prevent the economy from overheating.
- Fiscal policy: Governments might implement tighter fiscal policies, such as reducing spending or raising taxes. This can help cool down a rapidly growing economy and prevent excessive inflation.
