1. Economic Cycles

2. The economic cycle The economic cycle A term used to describe the tendency of economic activity to cycle along its trend path A term used to describe the tendency of economic activity to cycle along its trend path Real GDP shows a series of peaks and troughs along trend, characterising booms, slowdowns, recessions and recoveries Real GDP shows a series of peaks and troughs along trend, characterising booms, slowdowns, recessions and recoveries All countries experience economic cycles All countries experience economic cycles Key Concepts

3. Cycles vary in terms of Cycles vary in terms of (i) Their volatility (i) Their volatility (ii) Their duration (ii) Their duration There are several models of the cycle There are several models of the cycle Cycles caused by internal changes in output and prices Cycles caused by internal changes in output and prices Cycles affected by external economic shocks Cycles affected by external economic shocks

4. The UK Economic Cycle

5. The recession of the early 1990s

6. Data on the last recession (1)

7. Data on the last recession (2)

8. Data on the last recession (3)

9. The Need for Macroeconomic Stability Large fluctuations in output, employment and inflation add to uncertainty for businesses and consumers, and can reduce the economy's long- term growth potential Large fluctuations in output, employment and inflation add to uncertainty for businesses and consumers, and can reduce the economy's long- term growth potential Stability allows businesses, individuals and the Government to plan more effectively for the long term, improving the quality and quantity of investment in physical and human capital and helping to raise productivity Stability allows businesses, individuals and the Government to plan more effectively for the long term, improving the quality and quantity of investment in physical and human capital and helping to raise productivity Adapted from the Budget Statement, April 2003 Adapted from the Budget Statement, April 2003

10. UK and Global Economic Fluctuations Demand-side shocks Demand-side shocks Growth of income & demand in OECD economies Growth of income & demand in OECD economies E.g. an recession in the United States E.g. an recession in the United States Asian economic downturn / financial turbulence Asian economic downturn / financial turbulence Interest rates decisions in Europe and in the USA Interest rates decisions in Europe and in the USA Performance of global stock markets - particularly in the USA Performance of global stock markets - particularly in the USA Foreign capital investment decisions of global multinationals Foreign capital investment decisions of global multinationals Supply-side shocks Supply-side shocks Fluctuations in international commodity prices such as oil, copper and other essential raw materials Fluctuations in international commodity prices such as oil, copper and other essential raw materials

11. Demand-side shocks General Price Level National Income AD1 SRAS Pe Ye LRAS Yfc AD2 Y2 P2

12. Supply-side Shocks General Price Level National Income AD SRAS1 P1 Y1 LRAS Yfc SRAS2 P2 Y2 SRAS3 Y3

13. Characteristics of an Economic Boom Strong and rising level of AD Strong and rising level of AD Often driven by fast growth of consumption Often driven by fast growth of consumption Rising employment and real wages Rising employment and real wages High demand for imported goods & services High demand for imported goods & services Government tax revenues will be rising quickly Government tax revenues will be rising quickly Company profits and investment increase Company profits and investment increase Increased utilisation rate of existing resources Increased utilisation rate of existing resources Danger of demand-pull and cost-push inflation if the economy overheats Danger of demand-pull and cost-push inflation if the economy overheats

14. Characteristics of an Economic Recession Declining aggregate demand for UK output Declining aggregate demand for UK output Contracting employment / rising unemployment Contracting employment / rising unemployment Sharp fall in business confidence & profits Sharp fall in business confidence & profits Decrease in fixed capital investment spending Decrease in fixed capital investment spending Reduced inflationary pressure Reduced inflationary pressure Falling demand for imports Falling demand for imports Increased government borrowing Increased government borrowing Lower interest rates from central bank Lower interest rates from central bank

15. The Multiplier Effect An initial change in aggregate demand / output can have a much greater final impact on equilibrium national income An initial change in aggregate demand / output can have a much greater final impact on equilibrium national income Injections of demand stimulate further rounds of spending Injections of demand stimulate further rounds of spending The key to the final size of the multiplier effect is the propensity to consume (demand) out of extra income The key to the final size of the multiplier effect is the propensity to consume (demand) out of extra income

16. Construction projects and the multiplier effect Major construction projects such as the new Terminal 5 building at Heathrow can have big multiplier effects Major construction projects such as the new Terminal 5 building at Heathrow can have big multiplier effects Thousands of people are employed within the project Thousands of people are employed within the project Their incomes are re-injected into the circular flow Their incomes are re-injected into the circular flow Companies supplying to the project will also increase their own spending Companies supplying to the project will also increase their own spending

17. Accelerator Effect Planned capital investment spending is linked to the growth of demand for goods and services Planned capital investment spending is linked to the growth of demand for goods and services When demand is rising strongly, businesses may increase investment to expand their production capacity When demand is rising strongly, businesses may increase investment to expand their production capacity But a slowdown in demand creates excess capacity and may lead to a fall in planned investment demand But a slowdown in demand creates excess capacity and may lead to a fall in planned investment demand

18. Consider the links between the UK and the USA economy Consider the links between the UK and the USA economy 15% of UK exports go to the USA 15% of UK exports go to the USA There are large flows of foreign investment between the two countries There are large flows of foreign investment between the two countries Many international commodities are priced in US dollars – so movements in the dollar exchange rate can be important Many international commodities are priced in US dollars – so movements in the dollar exchange rate can be important What would happen if there was a recession in the USA? What would happen if there was a recession in the USA? Inter-relationships between countries

19. US Economic Growth in recent years

20. The UK and the Euro Zone Over half of our trade in goods and services is with countries inside the Euro Zone Over half of our trade in goods and services is with countries inside the Euro Zone It represents our biggest export market It represents our biggest export market In recent years the Euro Zone countries have experienced fairly slow growth of GDP In recent years the Euro Zone countries have experienced fairly slow growth of GDP This has made it harder for UK exporters to sell into European markets This has made it harder for UK exporters to sell into European markets

21. Euro Zone GDP growth in recent years