2 Business CycleDefinition: alternating increases and decreases in the level of business activity of varying amplitude and lengthHow do we measure “increases and decreases in business activity?”Percent change in real GDP!
3 Business Cycle Why do we say “varying amplitude and length?” Some downturns are mild and some are severeSome are short (a few months) and some are long (over a year)Do not confuse with seasonal fluctuations!
4 Note: Shaded areas indicate recessions. Real GDP , in 2000 dollarsNote: “Years” is on horizontal axis and “real GDP” is on vertical axis.General trend of economic growthRecession years are shaded blue: note downward slope on graph indicating that GDP is decreasing.Note: Shaded areas indicate recessions.
5 U.S. real gross domestic product per person from 1900 to 2004 As a result of this long-run growth, the U.S. economy’s aggregate output per person was about 7.5 times as large in 2004 as it was in 1900.(Note that there was a 7.5-fold increase in real GDP per capita over the same period in which there was a 20-fold increase in real GDP; the difference in these two numbers is due to a much larger U.S. population in 2004 compared to 1900.)
7 Long-Run Economic Growth Secular long-run growth, or long-run growth, is the sustained upward trend in aggregate output per person over several decades.A country can achieve a permanent increase in the standard of living of its citizens only through long-run growth. So a central concern of macroeconomics is what determines long-run growth.The word “secular”, in this context, is used to distinguish long-run growth from the expansion phase of business cycles, which lasts less than 5 years on average. Secular long-run growth refers to the growth of the economy over several decades.
8 The Conventional Three-Phase Business Cycle 10-4Copyright 2002 by The McGraw-Hill Companies, Inc. All rights reserved.
9 Recession What is a recession? Generally, 2 or more quarters of declining real GDPImplication: it’s not officially a called a recession until the economy has already been declining for 6 months!
10 Who decides when we’re in a recession? National Bureau of Economic Research traditionally declares recessionsPrivate research organization, not a federal agencyRecession dates from peak of business
11 Post-World War II Recessions* *The February 1945–October 1945 recession began before the war ended in August 1945.Note: These recessions were of varying duration and severity.
12 Another Look at Expansions and Recessions Can you find a pattern? Neither can economists! That’s whyrecessions are hard to predict.
13 Business Cycle Theories Endogenous theories:Innovation theory: innovation leads to saturation.Psychological theory: alternating optimism and pessimismInventory cycle theory: inventory and demand not in syncMonetary theory: changes in money supply by Federal ReserveUnderconsumption theory: or overproduction
14 Business Cycle Theories Exogenous theories:The external demand shock theory: effect of foreign economiesWar theory: war stimulates economy; peace leads to recessionThe price shock theory: fluctuations in oil prices
15 Endogenous Starts from within the model Endo- inside, source Genous- born
16 ExogenousFrom outside of the modelExo- outsideGenous- born, source
17 Business Cycle Theories Endogenous theoriesInnovation theoryPsychological theoryInventory cycle theoryMonetary theoryUnder-consumption theoryExogenous theoriesSunspot theoryWar theory10-5Copyright 2002 by The McGraw-Hill Companies, Inc. All rights reserved.
18 Business Cycle Forecasting The Ten Leading Economic Indicators1. Average workweek of production workers in manufacturing2. Average initial weekly claims for state unemployment insurance3. New orders for consumer goods and materials4. Vendors performance (companies receiving slower deliveries from suppliers)5. New orders for capital goods10-6Copyright 2002 by The McGraw-Hill Companies, Inc. All rights reserved.
19 Business Cycle Forecasting (Continued) The Ten Leading Economic Indicators6. New building permits issued7. Index of stock prices8. Money supply9. Spread between rates on 10-year Treasury bonds and Federal funds10. Index of consumer expectations10-7Copyright 2002 by The McGraw-Hill Companies, Inc. All rights reserved.
20 The Index of Leading Indicators, 1958-2001 Note that the index has turned down well before recessions begin and turned upward before recovery set in10-8Copyright 2002 by The McGraw-Hill Companies, Inc. All rights reserved.
21 The GDP Gap,Since potential GDP has exceeded actual GDP for most years since World War II, we have had a GDP gap. However in some periods, most recently from 1996 through 2000, actual GDP has been greater than potential GDPThe GDP gap is the amount of production by which potential GDP exceeds actual GDP10-9