Transcript Frank & Bernanke - Hiram Reads! — Where Hiram College

Frank & Bernanke
4th edition, 2009
Ch. 10: Short-Term
Economic Fluctuations
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Definitions

Recession (or contraction): A period in which the economy is
growing at a rate significantly below normal.


Depression: A particularly severe or protracted recession.
Peak: The beginning of a recession, the high point of economic
activity prior to a downturn.

Trough: The end of a recession, the low point of economic activity
prior to a recovery.

Expansion: A period in which the economy is growing at
a rate significantly above normal.

Boom: A particularly strong and protracted expansion.
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http://www.dallasfed.org/research/swe/2005/swe0502.pdf
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http://www.
nber.org/cy
cles/cycles
main.html
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5
http://research.stlouisfed.org/publications/net/page4.pdf
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Fluctuations in U.S. Real GDP,
1920-2004
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Recessions and Expansions

Growth rates of GDP show peaks and
troughs.
A peak is the onset of slowdown, perhaps
the beginning of a recession.
 A trough is the end of a slowdown or a
recession.


Expansions and slowdowns are irregular,
though they are called business cycles.
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Calling the 2001 recession
 Indicators
of the business cycle
 Industrial
production
 Total sales in manufacturing, wholesale
trade, and retail trade
 Nonfarm employment
 Real after-tax income of households
excluding transfers
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U.S. Recessions Since 1929
Peak date
(beginning)
Trough date
(end)
Duration
(months)
Highest
unemployment
rate (%)
Change in real
GDP (%)
Duration of
subsequent
expansion (months)
Aug. 1929
Mar. 1933
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24.9
-28.8
50
May 1937
June 1938
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19.0
-5.5
80
Feb. 1945
Oct. 1945
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3.9
-8.5
37
Nov. 1948
Oct. 1949
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5.9
-1.4
45
July 1953
May 1954
10
5.5
-1.2
39
Aug. 1957
Apr. 1958
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6.8
-1.7
24
Apr. 1960
Feb. 1961
10
6.7
2.3
106
Dec. 1969
Nov. 1970
11
5.9
0.1
36
Nov. 1973
Mar. 1975
16
8.5
-1.1
58
Jan. 1980
July 1980
6
7.6
-0.3
12
July 1981
Nov. 1982
16
9.7
-2.1
92
July 1990
Mar. 1991
8
7.5
-0.9
120
Mar. 2001
Nov. 2001
8
5.8
0.8
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Unemployment
During recessions unemployment rate
rises sharply.
 Usually unemployment rates are lagging
indicators: they start to rise after the
economy has passed the peak.
 During expansions unemployment rate
falls, rather slowly.

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Durable Industries

During recessions, durable industries,
like construction, cars, machines are
more affected by recessions than
service and non-durable industries
because basic consumption
expenditures continue.
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Inflation




Inflation rate drops during recessions.
Usually, inflation rates would be rising before
recessions.
In late nineties many East Asian, Latin
American and European newly industrializing
countries experienced recessions because of
exchange rate crisis.
US is a relatively closed economy, somewhat
insulated from global shocks compared to
others.
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U.S. Inflation, 1960-2004
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CPI
http://data.bls.gov/PDQ/servlet/SurveyOutputServlet
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Measuring Fluctuations
In order to claim a recession is big or
small, an unemployment rate is too high
or too low, one needs to have a
standard to measure against.
 The “normal” or “trend” or “potential” or
“full employment” output is the standard
to compare expansions or recessions.
 Long run average unemployment rate is
the “natural” or “full employment” rate of
unemployment.

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Output Gaps and
Cyclical Unemployment

Potential Output and the Output Gap
 Changes
in the rate at which the
country’s potential output is increasing
 Actual output does not always equal
potential output
 Y (actual output) - Y* (potential output)
 The difference between the economy’s
actual output and its potential output at a
point in time
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Output Gaps

Recessionary Gap: Y-Y* < 0
Y* > Y
 A negative output gap, which occurs when
potential output exceeds actual output
 Capital and labor resources are not fully
utilized
 Output and employment are below normal
levels

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Output Gaps

Expansionary Gap: Y-Y* > 0
Y > Y*
 A positive output gap, which occurs when
actual output is higher than potential output
 Higher output and employment than normal
 Demand for goods exceed the capacity to
produce them and prices rise
 High inflation reduces economic efficiency

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Natural rate of unemployment, u*
 U*
is attributable to frictional and
structural unemployment
 Cyclical unemployment equals zero
 No recessionary or expansionary gap
 Cyclical unemployment : u - u* > 0
 If u<u*, there is negative cyclical
unemployment, labor is being used
more intensively than normal.
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What Can Cause Slow Growth?

If the potential growth of the economy slows, the
society would experience a recession.





Capital
Technology
Labor
The experience of US in the second half of the
nineties was an acceleration of the potential
growth rate of the economy.
The experience of Japan was that the rate of
growth of potential output slowed from 3.6% in the
eighties to 2.2% in the nineties.
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What Can Cause Slow Growth?
If the economy produces less than its
potential amount, the “negative output
gap” will also be responsible for slow
growth and recession.
 If the economy produces more than its
potential amount because labor and/or
capital is overworked, the “positive
output gap” will be responsible for fast
growth.

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Natural Rate of Unemployment

Why has the natural rate of unemployment in
the United States apparently declined in the
nineties?
 Aging
labor force
 More efficient labor market
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Okun’s Law
Arthur Okun in the sixties observed that
every time unemployment rate in the US
rose one percentage point above the
natural rate, GDP fell 3 percentage
points below the potential GDP.
 Recent data indicate that the
relationship is now one percent
deviation of unemployment rate implies
two percentage point deviation in GDP.

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Okun’s Law
Year
u
u*
Y*
1982
9.7%
6.1%
5,584
1991
6.8
5.8
7,305
1998
4.5
5.2
8,950
2002
5.8
5.2
10,342
1982
• u - u* = cyclical unemployment
• 9.7 - 6.1 = 3.6%
• Output gap = 2 x 3.6 = 7.2%
• Output gap = 5,584 x .072
= $402 billion
1998
4.5 - 5.2 = -0.7
Output gap = 8,563 x -.014
= -$120 billion
1991
• 6.8 - 5.8 = 1%
• Output gap = 7,305 x .02 = $146 billion
2002
u - u* = 5.8 - 5.2 = 0.6
Output gap = 2 x .06 = .12
Y* - Y = 10,342 x .12
= $124 billion
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http://www.econ.yale.edu/alumni/conf2011/shiller-presentation.pdf
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Significance of Output Gaps
 The
1982 output gap per capita
$402
billion/230 million = $1,748 for a
family of four
In 2000 dollars it equals $7,000 for a
family of four
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Problem #5, p. 341
Year
1
2
3
4
Y
7840
8100
8415
Y*
8000
8200
8250
u*
5%
4.5%
5%
u
6%
5%
4%
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Why Do Output Gaps Occur?
If prices in every market adjusted
immediately to demand shifts, there would
not have been any output gaps. Firms do
not change their prices every day: contracts,
menu costs keep prices constant for a
period of time.
 Show a partial equilibrium, market supply
and demand case to indicate the above.
 Coke example.

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Why Do Output Gaps Occur?
If some markets are experiencing positive
output gaps and others negative output
gaps, the net outcome might be no
change.
 For the economy as whole to experience
positive or negative output gaps, total
spending in the economy has to be below
or above the total output produced.

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Why Do Output Gaps Occur?
It is the total spending (aggregate
demand) that determines the gaps in the
short run.
 Total spending is C+I+G+NX.

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GDP
HOUSEHOLDS
FIRMS
Y=wages+salaries+rent+profits+inter
est
C
IM
EX
FINANCIAL SYSTEM
I
T
TR+INT
GOVERNMENT
REST OF THE WORLD
G
Why Output Gaps Don’t Last?




In the long run firms will adjust prices upward
if total spending is more than the potential
output, eliminating the gap.
Likewise, if total spending is less than the
potential output, firms will reduce prices.
In the long run, the economy settles at the
potential output.
Chronic excess total spending will create
chronic inflation but not an increase in output.
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