Transcript Chapter 8

Business Cycle Facts
Real Output of the U.S. economy
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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.
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Introduction
Aggregate Economic Activities
Long-run
Economic Growth
Business Cycles
Time
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Introduction

The observed changes in aggregate economic activity
can be decomposed into two parts:
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Long-run economic growth: the changes in economic
performance over a long period of time, say between 1870
and 2007.
Business cycles: fluctuations in economic activities about
the long-run trend.
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What is a business cycle?
What is a business cycle ?

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.
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Recessions

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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.
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Expansions

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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.
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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)
Business cycles are recurrent, not
predictable, and asymmetric
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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.
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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.
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Procyclical Variable
Real GDP
Procyclical
variable
Time
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Countercyclical Variable
Real GDP
Countercyclical
variable
Time
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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…!)
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Leading Variable
Real GDP
Leading
variable
Time
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Business Cycle Facts (1)
Variable
Direction
Timing
Consumption
Procyclical
Coincident
Business Fixed
Investment
Procyclical
Coincident
Residential
Investment
Procyclical
Leading
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Business Cycle Facts (2)
Variable
Direction
Timing
Employment
Procyclical
Coincident
Unemployment
Countercyclical
——
Inflation
Procyclical
Lagging
Stock Prices
Procyclical
Leading
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