Contraction

A contraction begins after the economy reaches its peak and continues until it hits a trough. During this phase, businesses sell less, cut production, reduce investment and may lay off workers. Consumers often become more cautious and spend less, which can deepen the slowdown.

A contraction that is significant and lasts for a sustained period is called a recession. A common informal rule defines a recession as two consecutive quarters of falling real GDP, although official bodies in some countries use broader judgments that look at employment, income and other indicators. An extremely severe and prolonged contraction is called a depression.

For example, a sudden rise in energy prices might squeeze consumers' budgets and business profits, causing spending and output to fall over several quarters.

Governments and central banks often respond to contractions by cutting interest rates, increasing government spending or reducing taxes, aiming to support demand and shorten the downturn. Contractions eventually end, and the economy moves into recovery and expansion.