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The alternation between economic downturns and upturns in the macroeconomy is known as the business cycle. A depression is a very deep and prolonged downturn; fortunately, the United States hasn’t had one since the Great Depression of the 1930s. Instead, we have experienced less prolonged economic downturns known as recessions, periods in which output and employment are falling. These are followed by economic upturns—periods in which output and employment are rising—known as expansions (sometimes called recoveries). According to the National Bureau of Economic Research there have been 11 recessions in the United States since World War II. During that period the average recession lasted 11 months, and the average expansion lasted 58 months. The average length of a business cycle, from the beginning of a recession to the beginning of the next recession, has been 5 years and 8 months. The shortest business cycle was 18 months, and the longest was 10 years and 8 months. The most recent economic downturn started in December 2007 and ended in June 2009. Figure 2.1 shows the history of the U.S. unemployment rate since 1989 and the timing of business cycles. Recessions are indicated in the figure by the shaded areas.

The business cycle is an enduring feature of the economy. But even though ups and downs seem to be inevitable, most people believe that macroeconomic analysis has guided policies that help smooth out the business cycle and stabilize the economy.

What happens during a business cycle, and how can macroeconomic policies address the downturns? Let’s look at three issues: employment and unemployment, aggregate output, and inflation and deflation.

Although not as severe as a depression, a recession is clearly an undesirable event. Like a depression, a recession leads to joblessness, reduced production, reduced incomes, and lower living standards.

To understand how job loss relates to the adverse effects of recessions, we need to understand something about how the labor force is structured. Employment is the total number of people who are currently working for pay, and unemployment is the total number of people who are actively looking for work but aren’t currently employed. A country’s labor force is the sum of employment and unemployment.

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The unemployment rate—the percentage of the labor force that is unemployed—is usually a good indicator of what conditions are like in the job market: a high unemployment rate signals a poor job market in which jobs are hard to find; a low unemployment rate indicates a good job market in which jobs are relatively easy to find. In general, during recessions the unemployment rate is rising, and during expansions it is falling. Look again at Figure 2.1, which shows the unemployment rate from 1989 through 2013. The graph shows significant changes in the unemployment rate. Note that even in the most prosperous times there is some unemployment. A booming economy, like that of the late 1990s, can push the unemployment rate down to 4% or even lower. But a severe recession, like the one that began in 2007, can push the unemployment rate into double digits.

Rising unemployment is the most painful consequence of a recession, and falling unemployment the most urgently desired feature of an expansion. But the business cycle isn’t just about jobs—it’s also about output: the quantity of goods and services produced. During the business cycle, the economy’s level of output and its unemployment rate move in opposite directions. At lower levels of output, fewer workers are needed, and the unemployment rate is relatively high. Growth in output requires the efforts of more workers, which lowers the unemployment rate. To measure the rise and fall of an economy’s output, we look at aggregate output—the economy’s total production of goods and services for a given time period, usually a year. Aggregate output normally falls during recessions and rises during expansions.

In 1970 the average production worker in the United States was paid $3.40 an hour. By October 2013 the average hourly earnings for such a worker had risen to $19.65. Three cheers for economic progress!

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But wait—American workers were paid much more in 2013, but they also faced a much higher cost of living. In 1970 a dozen eggs cost only about $0.58; by October 2013 that was up to $1.93. The price of a loaf of white bread went from about $0.20 to $1.36. And the price of a gallon of gasoline rose from just $0.33 to $3.43. If we compare the percentage increase in hourly earnings between 1970 and October 2013 with the increases in the prices of some standard items, we see that the average worker’s paycheck goes just about as far today as it did in 1970. In other words, the increase in the cost of living wiped out many, if not all, of the wage gains of the typical worker from 1970 to 2013. What caused this situation?

Between 1970 and 2013, the economy experienced substantial inflation, a rise in the overall price level. The opposite of inflation is deflation, a fall in the overall price level. A change in the prices of a few goods changes the opportunity cost of purchasing those goods but does not constitute inflation or deflation. These terms are reserved for more general changes in the prices of goods and services throughout the economy.

Both inflation and deflation can pose problems for the economy. Inflation discourages people from holding on to cash, because if the price level is rising, cash loses value. That is, if the price level rises, a dollar will buy less than it would before. As we will see later in our more detailed discussion of inflation, in periods of rapidly rising prices, people stop holding cash altogether and instead trade goods for goods.

Deflation can cause the opposite problem. That is, if the overall price level falls, a dollar will buy more than it would before. In this situation it can be more attractive for people with cash to hold on to it rather than to invest in new factories and other productive assets. This can deepen a recession.

In later modules we will look at other costs of inflation and deflation. For now, note that economists have a general goal of price stability—meaning that the overall price level is changing only slowly if at all—because it avoids uncertainty about prices and helps to keep the economy stable.