Employment, capital spending, inventories, housing and trade over the cycle

How do firms adjust their workforce?

Firms change hours before headcount, so employment lags output.

Resource use and activityfirms change hours and orders before people and buildings

• Employment Memorize lags: overtime and hours first, headcount last
• Capital spending Memorize highly cyclical: light equipment moves first both ways
• Inventories Memorize swing fast; the ratio rises as sales slow, falls in early recovery
• Housing Use it rate and credit sensitive; permits turn early (leads)
• External trade Know the idea exports follow foreign growth and the exchange rate; imports follow domestic demand

Going into a contraction, firms cut overtime and hours, freeze hiring and only then lay people off. They hold on to staff longer than demand alone would justify (labor hoarding ) because finding and training new workers is costly. In prolonged downturns the cuts deepen: consultants, advertising and workers beyond the strict minimum go.

Coming out of a contraction the sequence reverses. Firms add overtime and temporary staff first and hire permanently only once the upturn looks durable. The result is that the unemployment rate turns after output does.

How does capital spending move?

Use it

Capital spending (spending on property, plant and equipment) follows profits, cash flow, expectations and capacity utilization , the share of productive capacity in use. Because all of these swing with activity, investment is among the most procyclical and volatile parts of GDP.

Phase	Capital spending pattern
Recovery	Low but rising. Spare capacity, so the focus is on efficiency. Software, systems and light equipment (fast obsolescence) are reordered first.
Expansion	Utilization rises, so spending shifts to capacity: heavy equipment, warehouses, plants. Orders run ahead of shipments.
Slowdown	Firms near capacity still place orders. Capacity-adding orders are a late-cycle sign.
Contraction	Orders halted or canceled. Light equipment with short lead times is cut first, heavy projects later. Maintenance is deferred.

Exam tip Short lead time means first out and first in. Light equipment leads, heavy projects follow.

Go deeper Reading orders correctly: lumpy orders and 'core' series

Orders include deliveries spread over years. A single contract for a fleet of jets or a batch of naval vessels, delivered over several years, lands in one month and makes the series jump. Analysts therefore watch “core” capital goods orders, which exclude defense and aircraft, to see the underlying trend. Orders also precede shipments, so orders are a widely watched signal of future capital spending.

Go deeper Lean production at the end of a contraction

By the end of a contraction firms run lean: the fewest workers needed for the output they produce. That is why output can start rising before much hiring happens, one more reason employment lags.

How do inventories behave?

Inventories are small relative to GDP, but firms build and run them down quickly, so they can move measured growth a lot. The key gauge is the inventory–sales ratio .

$$R = \frac{\text{inventory}}{\text{sales}}$$

Inventory–sales ratioinventory divided by sales

• Recovery: falls Memorize sales recover faster than production
• Expansion: stable Memorize production races to restock
• Slowdown: rises Memorize sales slow before production is cut; a warning sign
• Contraction: falls back to normal Memorize production set below sales to clear stock

Phase	Sales vs production	Inventory–sales ratio
Recovery	Sales recover faster than production	Falls
Expansion	Production races to restock	Stable
Slowdown	Sales slow before production is cut	Rises (warning sign)
Contraction	Production set below sales to clear stock	Falls back toward normal

What about consumers, housing and trade?

Know the idea

• Consumer spending. It follows income and confidence. Durable goods such as cars and appliances swing the most; services and staples the least.
• Housing activity . Very sensitive to interest rates and credit availability. Building permits and starts turn early, so housing tends to lead the cycle.
• External trade . Exports depend on foreign growth and the exchange rate. Imports rise with domestic demand, so a domestic boom often widens a trade deficit.

Go deeper Why inventory build-ups matter beyond the cycle

A growing pile of unsold goods is a warning for analysts of single companies too: it can force price cuts, write-downs and lower margins. The financial statement lessons on inventories show how the accounting method changes what that pile does to reported profit.