The Stylised Facts of the Business Cycle Ref: Barro & Grilli Ch.1 Ryan (2002) Ryan & Mullineux (1997)

1. Output is growing over time But the rate of growth fluctuates.

However, the trend is upwards Can we identify the trend?

Q: Why does output fluctuate in this way

Q: What is is happening to other variables as output fluctuates

Three question: 1. Does XXXX go up when Output is up, or does it go down? O Real national income Time Output Called CORRELATION

Two types of question 1. Does XXXX go up when Output is up, or does it go down? O Real national income Time Output XXXX is PROCYCLICAL - positive correlation

Two types of question 1. Does XXXX go up when Output is up, or does it go down? O Real national income Time Output XXXX is COUNTER- CYCLICAL - Negative correlation

O Real national income Time Y Q.2 Does XXXX fluctuate by more or less than Output?

O Real national income Time Y Q.2 Does XXXX fluctuate by more or less than Output? Low- Standard Deviation

O Real national income Time Y High- Standard Deviation Q.2 Does XXXX fluctuate by more or less than Output?

Q.3 Does XXXX lead or lag Output? O Real national income Time Output XXXX is LEADING

Q.3 Does XXXX lead or lag Output? O Real national income Time Output XXXX is LAGING

How Do We Characterize the Business Cycle? What other Variables are we interested in? Are they up or down when Output (GNP/GDP) is up? Do they fluctuate more or less than Output? Do they lead or lag output? Make a List

The correlation between the cyclical component of real GDP and the cyclical component of selected macroeconomic variables in the UK, Source: Ryan (2002) (Data: ) Barro and Grilli (1994). (Data

Facts I Consumption and investment demand are highly procyclical. Government consumption is weakly procyclical. Employment is pro-cyclical- Unemployment is countercyclical. Output expands more than employment in a boom and falls more than employment in a recession.

The correlation between the cyclical component of real GDP and the cyclical component of selected macroeconomic variables in the UK, Source: Ryan (2002) (Data: ) Barro and Grilli (1994). (Data

Facts I (Cont) Real Interest rate is Acyclical The Price level is COUNTERCYCLICAL The real wage is acyclical or weakly procyclical.

The standard deviation of selected macroeconomic variables, %, UK, Source: Ryan (2002.

Facts I Consumer Durables and Gross investments are, by far, the most volatile component of real GDP. Non-durable consumption demand is relatively stable and fluctuate less that GDP

The correlation between the cyclical component of real GDP and monetary aggregates and the GDP deflator in the UK, Source: Barro and Grilli (1994).

fig Countercyclical and leading prices O Real national income Time Which turning point does A belong to? A Peak |Trough Prices Output

fig Countercyclical and leading prices O Real national income Time Output Inflation rising but prices are below trend A Peak Trough Prices

St DevCross-Correlation of Output with: Variable X(t+4)X(t+3)X(t+2)X(t+1)X(t)X(t-1)X(t-2)X(t-3)X(t-4) Output Non-Durable Cons Durable Cons Investment prices Real Interest Rates Unemployment Wages

1.Output is growing but fluctuates persistently and in an apparently systematic way; 2.Employment is procyclical, that is, it moves in the same direction as output. However, both the number of people employed and the number of hours worked fluctuates less than output (that is, firms are apparently reluctant to hire and fire). Hence productivity or output per worker is procyclical and varies considerably over the cycle; 3.Real Wages are procyclical, though the share of wages in GNP is countercyclical, that is, the share of labour in GNP falls as output rises. Thus real wages rise proportionally less than output in booms and fall proportionally less in recessions);

4.Non-durable consumption is procyclical but fluctuates less than output. It also leads the cycle slightly, that is, it rises or falls before output rises or falls in US data. 5.Consumption of consumer durables (henceforth durables) and investment are procyclical but fluctuate more than output; the former tends to lead the cycle while investment tends to rise or fall after (or lag) the change in output;

6.Both narrow money and broad money are procyclical. Narrow money is contemporaneous or slightly leading but broad money does not exhibit a consistent pattern of lags or leads across countries; 7.The price level is countercyclical and leading; 8.Interest rates are acyclical (there is no discernible pattern across business cycles).

Review of what you Do Know about Microeconomics FirmIndustry pxpx qxqx AC MC QxQx pxpx q x1 q x2 = s i S=  MC Q x1 Q x2 p x1 p x2 Perfect Competition Full Information Perfectly Flexible Prices D

Review of what you Don’t Know about Macroeconomics Microecomics MACROECONOMICS P Y Perfect Competition Full Information Perfectly Flexible Prices pxpx S=  MC Q x1 Q x2 D AD LRAS SRAS?

So in IS/LM-AD/AS LRAS – Vertical if have –Perfect Compt. –Rational Expectations –Flexible Prices SRAS – May be upward sloping if –Imperfect Competition –Non-Rational Expectations e.g. Adaptive –Rigid Prices

WRAP UP SO IS/LM-AD/AS is Macroeconomics with advanced Micro This module is easy It is Microeconomics with baby micro Will show that you can go a long way yo explaining fluctuations in the economy with just baby micro ITS EASY PEASY LEMON SQUEAZY