Making it Official

Expansions last, on average, about 3-4 years, but this is by no means guaranteed. One expansion in the early 1980s lasted a mere 12 months. The next expansion then lasted over 8 years. Much of the 1990s was dedicated to a 120-month, 10-year expansion.

Newspeople, political leaders, and economists are prone to call the early part of an expansion a recovery. During this period, the economy is picking up the pace after a contraction, but it has not yet returned to the pre-contraction level of economic activity.

While expansions are frequently indicated by an increase of real gross domestic product, they also show up in many aggregate measures of economic activity. A big one is the unemployment rate, which typically declines, approaching the full employment level of about 5%, if not lower. The inflation rate also tends to rise, especially during the latter stages of an expansion. Aggregate expenditures on gross domestic product, especially investment and to a lesser degree consumption, also increase.

A Graphical Upturn

A Shaded Expansion

Click the [Expansion] button to highlight the expansion phase of this business cycle. The shaded segment of the real GDP line between points B and C is the expansion. Clearly real GDP rises over this segment. An expansion generally takes the economy from below the long-run trend to at or above the long-run trend. The early part of an expansion is usually termed a recovery because the economy is "recovering" from a contraction.

Because the long-run trend represents full employment, when real GDP reaches the long-run trend, when actual real GDP is equal to potential real GDP, then the economy has full employment. Inflation problems, however, arise when actual real GDP exceeds potential real GDP, as is the case in this diagram near point C. In addition, the more real GDP rises above the long-run trend, then the greater inflation problems are likely to be.

The Bad with the Good

• First, inflation tends to worsen during an expansion. When the economy rises too much too quickly, production capabilities are stretched to their limits. The four macroeconomic sectors try to buy more than the economy can produce and the result is inflation. Inflation tends to hit some members of society more than most. People on fixed incomes, like retirees, or those owning a great deal of financial assets, like banks, are most adversely affected by inflation.


• Second, inefficiency tends to worsen in an expansion. During an expansion, everything is great. Everyone works. Every business is profitable. In fact, a business or worker needs to be completely incompetent or extremely unlucky not to enjoy higher profits or a rising living standard. This widespread, almost assured prosperity, reduces the incentive to be efficient and to get the most out of your productive abilities. If a worker is more or less guaranteed a rising living standard without putting forth extra effort, why put forth extra effort? As such, increased inefficiency results.

Contractionary Policies

• Contractionary fiscal policy is higher taxes or fewer government purchases. Inflation worsens during an expansion when buyers try to buy more than the economy can produce. This excessive spending, and the inflationary pressure that results, can be reduced directly by decreasing government purchases or indirectly by increasing taxes and diverting household income away from consumption expenditures.


• Contractionary monetary policy reduces the amount of money in the economy and increases interest rates. If people have less money, then they buy less output, the business-cycle expansion flattens, and inflationary pressures are reduced. Along with the decrease in the money supply, interest rates rise, which discourages expenditures made by borrowing.