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Peak Trough Recovery Recession Peak

The term business cycle refers to the recurrent ups and downs in the level of economic activity, which extend over several years. √ The term business cycle refers to the recurrent ups and downs in the level of economic activity, which extend over several years. √ Individual business cycles may vary greatly in duration and intensity. √ All display a set of phases. Business Cycles

THE BUSINESS CYCLE Phases of the Business Cycle PEAK Level of business activity Time RECESSION TROUGH RECOVERY GROWTHTREND

PEAK GROWTHTREND √ Peak or prosperity phase:  Real output in the economy is at a high level  Unemployment is low  Domestic output may be at its capacity  Inflation may be high. Level of business activity

√ Contraction or recession phase:  Real output is decreasing  Unemployment rate is rising.  As contraction continues, inflation pressure fades.  If the recession is prolonged, price may decline (deflation)  The government determinant for a recession is two consecutive quarters of declining output. Level of business activity Time RECESSION GROWTHTREND

Level of business activity TimeTROUGHGROWTHTREND √ Trough or depression phase:  Lowest point of real GDP  Output and unemployment “bottom out”  This phase may be short-lived or prolonged  There is no precise decline in output at which a serious recession becomes a depression.

Level of business activity Time RECOVERY GROWTHTREND √ Expansionary or recovery:  Real output in the economy is increasing  Unemployment rate is declining  The upswing part of the cycle.

Peak Trough One cycle Recovery Real GDP per year Recession Time Peak Business Cycle-one cycle through 4 phases

Recessions since 1950 show that duration and depth are varied: PeriodDuration in monthsDepth PeriodDuration in monthsDepth (decline in real GDP) — 3.0% — 3.5% — 1.0% — 1.1% — 4.3% — 3.4% — 2.6% — 2.6% app. —3.3%

The Leading Indicator System The Leading Indicator System … provides a basis for monitoring the tendency to move from one phase to the next. …assesses the strengths and weaknesses in the economy … gives clues to a quickening or slowing of future rates of economic growth … indicates the cyclical turning points in moving from the upward expansion to the downward recession, and from the recession to the upward recovery. How Indicators Monitor the Four Phases of the Business Cycle How Indicators Monitor the Four Phases of the Business Cycle

Leading indicators anticipate the direction in which the economy is headed. Leading indicators anticipate the direction in which the economy is headed. The coincident indicators provide information about the current status of the economy The coincident indicators provide information about the current status of the economy 1)changing as the economy moves from one phase of the business cycle to the next 2) telling economists that an upturn or downturn in the economy has arrived. Lagging indicators change months after a downturn or upturn in the economy has begun and help economists predict the duration of economic downturns or upturns. Lagging indicators change months after a downturn or upturn in the economy has begun and help economists predict the duration of economic downturns or upturns.

Based on the theory that expectations of future profits are the motivating force in the economy. Based on the theory that expectations of future profits are the motivating force in the economy. Companies may expand production of goods and services and investment in new structures and equipment,when business executives believe that their sales and profits will rise. Companies may expand production of goods and services and investment in new structures and equipment,when business executives believe that their sales and profits will rise. When they believe profits will decline, they reduce production and investment. When they believe profits will decline, they reduce production and investment. These actions generate the four phases of the business cycle.

Innovation Innovation Political events Political events Random events Random events Wars Wars Level of consumer spending Level of consumer spending Seasonal fluctuations Seasonal fluctuations Cyclical Impacts — durable and non durable Cyclical Impacts — durable and non durable Causes of Fluctuations

An Actual Business Cycle ($ billion, 1992 dollars) An Actual Business Cycle ($ billion, 1992 dollars) Real GDP Peak Peak Trough One Cycle ‘80‘85 ‘

The Great Depression

The Great Depression [continued]

Ave. Unemployment Rate, Ave. Unemployment Rate, Ave. Unemployment Rate, Percent Decrease in Prices, Percent Decrease in Prices, Global Depression,

Six Million “Rosie the Riveters” Six Million “Rosie the Riveters” World War II Production of these items brought us out of the Great Depression. 300,000 warplanes 300,000 warplanes 124,000 ships 124,000 ships 289,000 combat vehicles and tanks 289,000 combat vehicles and tanks 36 billion yards of cotton goods 36 billion yards of cotton goods 41 billion rounds of ammunition 41 billion rounds of ammunition 2.4 million military trucks 2.4 million military trucks 111,527 tank guns and howitzers 111,527 tank guns and howitzers $288 billion was spent on the war,$288 billion was spent on the war, $100 billion in the first six months.$100 billion in the first six months. Unemployment hit an all-time low of 1.2% and personal savings were 25.5%.