What is 'Expansion'

Expansion is the phase of the business cycle when the economy moves from a trough to a peak. It is a period when the level of business activity surges and gross domestic product (GDP) expands until it reaches a peak. A period of expansion is also known as an economic recovery.

BREAKING DOWN 'Expansion'

An expansion is one of two basic business cycle phases; the other is contraction. The transition from expansion to contraction is a peak, and the changeover from contraction to expansion is a trough. Expansions last on average about three to four years, but they have been known to last anywhere from 12 months to more than 10 years. Much of the 1960s was a time of expansion, which lasted almost nine years.

Economists and policy makers closely study business cycles. Learning about economic expansion and contraction patterns of the past can help forecast potential trends in the future. Whether cash is available or scarce, interest rates are low or high, and companies and consumers can borrow money to spend on goods and services affects how businesses and consumers react.

Examples of Expansion and Contraction

Expansion, or a boom, occurs when the Federal Reserve lowers interest rates and buys back bonds in the open market to add money to the financial system. The bondholders put their cash in the bank, which lends out money to companies that purchase buildings and equipment and hire workers. The employees produce more products and services to meet consumer demand as the economy improves. Unemployment is low while productivity and consumer spending are high. Money flows freely through the economy.

When the economy contracts, or busts, productivity declines, business revenues go down and companies lay off workers to decrease expenses. Unemployment rises, and consumers spend less. When the GDP declines over two consecutive quarters, a recession occurs. When productivity and revenue slowly begin increasing, economic recovery begins. The unemployment rate decreases as consumers spend more and the economy begins expanding.

Since 1945, the U.S. economy has gone through 10 expansion and contraction phases. Expansion periods included 1975 to 1980 and 106 months in the 1960s. Durable manufactured goods were more affected than services, as were wholesale and industrial prices more than retail prices.

Leading indicators such as average weekly hours worked by manufacturing employees, unemployment claims, new orders for consumer goods and building permits all give clues as to whether an expansion or contraction is occurring in the near future. While not completely accurate, knowledge about a certain industry or company can help prepare for changes in the economy before they occur.

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