Transcript Macroeconomic Forces Chapter 2

Macroeconomic Forces
Chapter 2
Characteristics of the Business
Cycle
1. Fluctuations in aggregate business activity
2. Characteristic of a market driven economy
3. Regular sequence of changes from expansion,
downturn, contraction, recovery
4. Not periodic in duration, intensity, or scope.
5. Expansion and contraction occur in many
phases of economic activity in both the real and
financial sectors.
6. Cycles cannot be further subdivided into
shorter cycles with similar characteristics
Duration of expansion,
contraction, and full cycle
• NBER reference dates:
http://www.nber.org/cycles.html/
• Macroeconomic data:
http://rfe.wustl.edu/Data/USMacro/index.ht
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• Diffusion of industrial production
Past Business Cycles
• The 1970-75 Cycle (The Great Recession)
– Longest and most severe post-WWII recession (16 months,
3.6% decline in real GDP, and 13% decline in industrial
production)
– Causes of recession included both demand factors and supply
factors:
a. Inflation due to relatively easy monetary policy prior to 1973
b. Poor crop that drove up food prices
c. Rapid increase in energy prices due to OPEC cartel
d. Excessive inventory buildup and real estate speculation
– Endogenous forces set the stage for recovery as inflation
slowed and inventories were “worked down.” Consumer debt
was repaid and adjustments were made to higher energy prices.
• The 1980 and 1981-82 Recessions:
– Higher rates of inflation and lower “real” interest rates had
maintained spending for housing and consumer durables until
1979. In late 1979 the Fed switched to monetary aggregates
as a monetary policy target with resulting overnight increases in
nominal interest rates. Private borrowing fell over 50% during
the second quarter of 1980.
– In early July the Fed eased credit and interest rates fell resulting
in renewed expansion over the 12 months from August 1980.
Inflation remained in double-digit levels.
– The Fed again turned restrictive in and, together with high
rates of inflation, pushed nominal interest rates upward to about
20 percent. Housing and consumer durable demand fell by
over 10 percent.
– Cooling inflation and tax cuts enacted in 1981 led to economic
recovery that continued from 1982 to 1990 (92 months).
• The 1990-91 Recession:
– The official business cycle peak of July 1990 was not
recognized until 9 months later and, in fact, real GDP did not fall
until the fourth quarter of 1990. Iraq’s invasion of Kuwait
occurred August 1990 and public debate centered upon the
impact of US involvement on domestic economic conditions.
– Higher debt loads by households and business and financial
industry imbalances were a fundamental reason for the
economic downturn. The invasion of Kuwait was probably a
contributing factor.
– The economic recovery was slow relative to prior periods and,
in fact, the unemployment rate increased because economic
growth in the last three quarters of 1991 was 1.4, 1.8, and 0.3
percent, respectively.
• The 2001 recession
– Probably began in the second half of 2000 as
industrial production declined in response to
overinvestment in late 1990s
– Business investment in capital spending
decreased and remained soft during recovery
– A relatively mild recession due to the
resiliency of household spending and
relatively strong housing demand.
– Labor markets reflect slow employment
demand relative to output (“jobless recovery’)
Five Lessons from 2001 Cycle
• Structural imbalances take time to resolve, especially in
the capital goods sector.
• Uncertainty matters for economic decisions by business
and households.
– September 11, 2001 terrorist attack
– Corporate financial reporting scandal
– Iraq war
• Aggregate monetary policy can mitigate recession
• Tax cuts and government spending boost economic
activity
• Strong productivity growth raises standards of living but
require much faster growth in order to raise employment
Indicator forecasting
• Strengths and weaknesses of indicator
method
– Useful in identifying reference dates with
composite measures
– May confirm strength of recovery or downturn
– May give false signals
Econometric models
• Structural equations in early models did not link
sufficiently to the financial sector (simple
Keynesian with lags)
• Financial sector added in second generation
models with greater disaggregated detail.
• Aggregate supply added after Great Recession.
• Macro models serve as a “driver” for industry
and firm level projections that may be purchased
from commercial vendors.