1. Short-Term Fluctuations: An Introduction Chapter 12

2. Chapter 12 Learning Objectives. You should be able to: Identify the phases of the business cycle. Explain how the dates of a business cycle are established. Indicate the relationship between business cycles and inflation. Define potential output, recessionary gap, inflationary gap and the natural rate of unemployment.

3. Fluctuations in U.S. Real GDP, 1920-2001

4. Expansion Recession The Phases of the Business Cycle Boom Secular growth trend Downturn Upturn Trough Peak 0 Jan.- Mar Total Output Apr.- June July- Sept. Oct.- Dec. Jan.- Mar Apr.- June July- Sept. Oct.- Dec. Jan.- Mar Apr.- June McGraw-Hill/Irwin © 2004 The McGraw-Hill Companies, Inc., All Rights Reserved.

5. U. S. Business Cycles McGraw-Hill/Irwin © 2004 The McGraw-Hill Companies, Inc., All Rights Reserved. Civil War Recovery of 1895 World War I Panic of 1893 Panic of 1907 Great Depression Korean War Vietnam War World War II

6. Recessions shorter … …than booms. Recessions usually last 6 to 16 months. Durable goods industries and housing affected most.

7. Longest expansion March 1991 to March 2001 “The new economy.”

8. NBER Dating Committee http://www.nber.org/cycles/main.html

9. Q: Isn't a recession a period of diminished economic activity? A: It's more accurate to say that a recession-the way we use the word-is a period of diminishing activity rather than diminished activity. We identify a month when the economy reached a peak of activity and a later month when the economy reached a trough. The time in between is a recession, a period when the economy is contracting. The following period is an expansion. Economic activity is below normal or diminished for some part of the recession and for some part of the following expansion as well. Some call the period of diminished activity a slump.

10. Real GDP Growth in Five Major Countries, 1999-2002

11. Business Cycles and Inflation Recessions are usually followed by a decline in inflation and many have been preceded by an increase in inflation.

12. U.S. Inflation, 1960-2001

13. Potential Output, Y* Potential output is the level of real GDP produced when factors of production are fully employed at normal rates. If Y > Y*, there’s an inflationary gap. If Y < Y*, there’s a recessionary gap.

14. Natural Rate of Unemployment Rate of unemployment that exists when there is no output gap, that is, when Y = Y*. The level of the natural rate of unemployment is determined by the levels of frictional and structural unemployment.