Ups and Downs of Economic Activity Peak Trough Recovery Recession

Fear the Boom & the Bust Read over lyrics and then enjoy the music video: Fear the Boom & the Bust

Business Cycles √ 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. √ Tracked by NBER (National Bureau of Economic Research)

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

PEAK √ Peak or prosperity phase: Time GROWTH TREND Level of business activity √ 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.

RECESSION SECULAR TREND Time Level of business activity Time RECESSION SECULAR TREND √ Contraction/recession phase ((> 2 quarters of declining GDP): 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.

TROUGH √ Trough or depression phase: Lowest point of real GDP Level of business activity Time TROUGH SECULAR TREND √ 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.

RECOVERY √ Expansionary (> 2 quarters of ↑ rGDP): SECULAR TREND Level of business activity Time √ Expansionary (> 2 quarters of ↑ rGDP): Real output in the economy is increasing Unemployment rate is declining The upswing part of the cycle.

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

MORE BUSINESS CYCLE NOTES: GDP Quarterly Reports: 3 months of real GDP data + or – QI = Jan – Mar, QII = Apr – June, QIII = July – Sep, QIV = Oct -- Dec Depressions ~Traditionally measured as a recession that loses at least 10%, or more, of the value of real GDP Stagflation ~ A time of increasing inflation (associated with expansions) and increasing unemployment (associated with recessions) A Full Cycle ~ The time of one trough to the next trough (or peak to peak) Historic Cycles ~ Since the founding of the US, cycles have averaged approximately 6 years from trough to trough Historic Recessions ~ Since the early 1900’s, US recessions have averaged 14 months in length. Long Run Growth Assumptions ~ This is known as the Secular Trend. Market Systems have shown long run growth in real GDP/Standard of Living as the PPF moves outward over time Misery Index ~ The number created when the Inflation Rate is added to the Unemployment Rate

Recessions since 1950 show that duration and depth are varied: Period Duration in months Depth (decline in real GDP) 1953-54 10 — 3.0% 1957-58 8 — 3.5% 1960-61 10 — 1.0% 1969-70 11 — 1.1% 1973-75 16 — 4.3% 1980 6 — 3.4% 1981-82 16 — 2.6% 1990-91 8 — 2.6% 2001 8 app. —3.3%

How Indicators Monitor the Four Phases of the Business Cycle • 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.

Leading indicators anticipate the direction in which the economy is headed. The coincident indicators provide information about the current status of the economy 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.

These actions generate the four phases of the business cycle. 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. When they believe profits will decline, they reduce production and investment. These actions generate the four phases of the business cycle.

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

An Actual Business Cycle 1981 - 1990 ($ billion, 1992 dollars) Real GDP ‘80 ‘85 ‘90 4600 5200 6000 Peak Peak Trough 82 One Cycle 3 3 3

The Great Depression

The Great Depression [continued]

Great Depression Stats

Global Depression, 1929-1932 Ave. Unemployment Rate, 1925-1928 Percent Decrease in Prices, 1929-1932

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

3 Theories of Economics John Maynard Keynes David Ricardo Milton Friedman

5 CLASSICAL ECONOMICS BASICS (Neo-Classical, Supply Side, Trickle Down, Free Trade, Monetarism) In the long run, competition forces companies to be efficient and develop new technologies. If a company doesn’t, it will lose market shares to those that do. In the long run, competition encourages companies to reduce prices. If a company doesn’t, it will lose market shares to those that do. In the long run, competition encourages companies to create better wages and working conditions. If a company doesn’t, workers will move to companies that do. In the long run, competition will create self correcting stability and prosperity. If stability is lost, suppliers can correct the surpluses and shortages with new prices, production goals, and wage rates. For shortages: raise prices, produce more, pay more to extra workers. For surpluses: lower prices, produce less, pay less to fewer workers.

What is the Role of Government in Classical Economics? Protect private property rights that allow the incentive to profit. Protect economic law and order to allow competition without cheating. Defend the nation to allow open competitive markets. Promote free trade to allow competitive forces to benefit all nations. Lower taxes to restrict governmental interference and encourage industrial development.

5 Keynesian Basics (Protective Tariffs, Neo-Keynesian) In the long run, competition can create better standards of living for market economies. However, societies don’t live in the long run. The immediate, short run is critical for making a living, taking care of families, putting food on the table. In the short run, all competitive markets have flaws that create one crisis after another. Businesses often are not efficient and many fail, therefore they always under-employ the workforce. Say’s Law of suppliers balancing the economy is mythical. Businesses can’t always jettison workers, cut salaries, reduce prices because resources didn’t get more plentiful and society will reject these “solutions”. Wages are usually “sticky” when forced downward. This all is known as the “Ratchet Effect”.

5 Keynesian Basics (Protective Tariffs, Neo-Keynesian) Consumers will fear both inflation and unemployment. When they fear inflation, they will panic buy to beat the price increases, thus causing worse inflation. When they fear unemployment, they quit buying and cause surpluses, thus creating more unemployment.

What is the Role of Government in Keynesian Economics? Focus on the short run. In the short run there will be flaws. “In the long run, we are all dead.” Forget the Supply solutions to problems, create the correct amount of demand. During the inevitable recessions, lower taxes to boost consumption spending and raise government spending to create jobs. Run deficits as needed (and assumed). During the occasional inflation spirals, raise taxes to dampen consumption spending and decrease government spending to slow job growth. Run surpluses to pay off older debts and then get ready for the next recession. Create stabilizers to dampen the effects of the next crisis. Protect the elderly with social security programs and slow the panic of the unemployed with compensation. Give subsidies to key industries to keep technology developing and keep jobs plentiful.

5 Monetary Policy Basics (Central Bank, Federal Reserve, Fine Tuning) Competitive markets can flourish but need goals of stable growth and low inflation rates. Keynesians policies fail to work quickly enough to help with tax cuts and job programs. By the time the “stimulus” plan is debated and passed by any legislative body, the recession that caused the policy debate has probably ended on its own. Keynesian policies really collapse during times of inflation because legislative bodies won’t raise taxes and cut government job programs. The tax increases get leaders removed from office and the job programs are usually entrenched in fiercely protective bureaucracies and lobby groups. Stagflation creates a crisis that no elected government can easily solve. Fight the excessive unemployment and increase the inflation even more. Fight the inflation and increase the excessive unemployment even more.

5 Monetary Policy Basics (Central Bank, Federal Reserve, Fine Tuning) Inflation is always more damaging to any economy than unemployment. Unemployment hurts the jobless; inflation hurts everyone in the society.