Business Cycle Facts

1 Real Output of the U.S. economy

3 Introduction  Since the Industrial Revolution, the economies of the US, like many other countries, have grown tremendously.  This long-term economic expansion has been periodically interrupted by temporary declines in economic activities and then followed by recovery.

4 Introduction Aggregate Economic Activities Time Long-run Economic Growth Business Cycles

5 Introduction  The observed changes in aggregate economic activity can be decomposed into two parts: Long-run economic growth: the changes in economic performance over a long period of time, say between 1870 and Business cycles: fluctuations in economic activities about the long-run trend.

What is a business cycle?

6  Lucas defines the business cycle as the recurrent fluctuations of output about trend and the co-movements among other aggregate time series.  Other, important, “aggregate time series” include employment, aggregate investment, inflation rate etc.

8 Recessions  The period of time during which aggregate economic activity falls below trend is a contraction or recession.  If the recession is particularly severe, it becomes a depression.  During a recession, many sectors of the economy experience declining sales and production, and workers are laid off or forced to work only part-time.

9 Expansions  After reaching the low point of the contraction (the trough), aggregate economic activity begins to increase.  The period of time during which aggregate economic activity grows above trend is an expansion or a boom.  The high point of the expansion is called a peak.  A complete cycle is measured from peak to peak or trough to trough.

Key business cycle facts (which any successful theory is supposed to explain)

Persistent deviations from trend in GDP; High correlation between hours worked and GDP. Source: Prescott’s Nobel lecture

Consumption is relatively smooth while investment is more volatile than output (deviations in both variables are positively correlated with output deviations)

10 Business cycles are recurrent, not predictable, and asymmetric they do not occur at regular, predictable intervals of time (in fact no one knows for sure when they will happen) they do not last for a fixed or predetermined length of time (once a cycle begins no one knows for sure when it will end). Business cycles are often asymmetric: the contraction period is short and sudden, the expansion period is long and slow.

14 Cyclical Behavior of Economic Variables  An economic variable that moves in the same direction as real GDP is called procyclical.  An economic variable that moves in the opposite direction to real GDP is called countercyclical.

15 Procyclical Variable Time Real GDP Procyclical variable

16 Countercyclical Variable Time Real GDP Countercyclical variable

18 Cyclical Behavior of Economic Variables  An economic variable is a leading variable if it tends to move in advance of real GDP.  This means the peaks and troughs in a leading variable occur before the corresponding peaks and troughs in real GDP.  Economic observers are interested in economic variables that consistently lead the business cycle because they use such variables to forecast the future course of the economy (of course consistent relations can suddenly break down…!)

19 Leading Variable Time Real GDP Leading variable

21 Business Cycle Facts (1) VariableDirectionTiming ConsumptionProcyclicalCoincident Business Fixed Investment ProcyclicalCoincident Residential Investment ProcyclicalLeading

22 Business Cycle Facts (2) VariableDirectionTiming EmploymentProcyclicalCoincident UnemploymentCountercyclical—— InflationProcyclicalLagging Stock PricesProcyclicalLeading