Transcript Phases of the Business Cycle

Phases of the Business Cycle
Business Cycle
• Definition: alternating increases and
decreases in the level of business activity
of varying amplitude and length
• How do we measure “increases and
decreases in business activity?”
– Percent change in real GDP!
Business Cycle
• Why do we say “varying amplitude and
length?”
– Some downturns are mild and some are
severe
– Some are short (a few months) and some are
long (over a year)
• Do not confuse with seasonal fluctuations!
The Classical Business Cycle
“Business cycles are a type of fluctuation found in the
aggregate economic activity of nations that organize their work
mainly in business enterprises.
A cycle consists of expansions occurring at about the same
time in many economic activities, followed by similarly general
recessions, contractions, and revivals which merge into the
expansion phase of the next cycle.
This sequence of changes is recurrent but not periodic.
In duration business cycles vary from more than one year to
ten or twelve years; they are not divisible into shorter cycles of
similar character with amplitudes approximating their own.”
-- Burns and Mitchell, 1946
Recessions and Expansions
A recession is the phase of the business cycle
marked by pronounced, pervasive and persistent
declines in the key measures of aggregate economic
activity, i.e., output, employment, income and sales.
An expansion is the phase of the business cycle
marked by pronounced, pervasive and persistent
increases in the key measures of aggregate
economic activity, i.e., output, employment, income
and sales.
Alternating expansions and recessions make up the
business cycle.
Real GDP 1958-2007, in 2000 dollars
• Note: “Years” is on horizontal axis and “real GDP”
is on vertical axis.
• General trend of economic growth
• Recession years are shaded blue: note downward
slope on graph indicating that GDP is decreasing.
Note: Shaded areas indicate recessions.
U.S. real gross domestic product per person
from 1900 to 2004
The Phases of the Business Cycle
Expansion
Recession
Expansion
Total Output
Peak
0
McGraw-Hill/Irwin
Trough
Secular
growth
trend
Jan.- Apr.- July- Oct.- Jan.- Apr.- July- Oct.- Jan.- Apr.Mar June Sept. Dec. Mar June Sept. Dec. Mar June
© 2004 The McGraw-Hill Companies, Inc., All Rights Reserved.
Stages of the Business Cycle
Long-Run Economic Growth
Secular long-run growth, or long-run growth, is the
sustained upward trend in aggregate output per person
over several decades.
A country can achieve a permanent increase in the
standard of living of its citizens only through long-run
growth. So a central concern of macroeconomics is what
determines long-run growth.
The Conventional ThreePhase Business Cycle
Peak
Peak
Peak
Prosperity
Trough
Trough
2005
2010
2015
Year
Copyright 2002 by The McGraw-Hill Companies, Inc. All rights reserved.
10-4
Recession
• What is a recession?
– Generally, 2 or more quarters of declining real
GDP
– Implication: it’s not officially a called a
recession until the economy has already been
declining for 6 months!
• Who decides when we’re in a recession?
– National Bureau of Economic Research
traditionally declares recessions
• Recession dates from peak of business
The Recession as a Vicious
Cycle
A recession occurs when a decline in some measure of
aggregate economic activity sets off cascading declines in the
other coincident measures of activity.
Thus, when a dip in sales causes a drop in production,
triggering declines in employment and income, which in turn
feed back into a further fall in sales, a vicious cycle results and
a recession ensues.
This domino effect of the transmission of economic weakness
from sales to output to employment to income, feeding back
into further weakness in all of these measures in turn, is what
marks a recessionary downturn.
This effect spreads from industry to industry, region to region,
and indicator to indicator.
The Expansion as a Virtuous
Cycle
At some point, the vicious cycle is broken and an
analogous self-reinforcing virtuous cycle begins, with
increases in output, employment, income and sales
feeding into each other – the hallmark of a business
cycle expansion.
How the Virtuous Cycle Works
Stages of the Business Cycle
• There are expansions and contractions
• Aggregate economic activity declines in a contraction or
recession until it reaches a trough
– Informal recession definition: 2 consecutive quarters or
negative GDP growth
• Then activity increases in an expansion or boom until it
reaches a peak
• A particularly severe recession is called a depression
• The sequence from one peak to the next, or from one
trough to the next, is a business cycle
• Peaks and troughs are turning points
Popular saying: “Recession is when someone you know
becomes unemployed; a depression is when you
become unemployed.”
Post-World War II Recessions*
*The February 1945–October 1945 recession began before the war ended in August 1945.
Note: These recessions were of varying duration and severity.
Another Look at Expansions
and Recessions
Can you find a pattern? Neither can economists! That’s why
recessions are hard to predict.
Business Cycle Theories
• Endogenous theories:
– Innovation theory: innovation leads to saturation.
– Psychological theory: alternating optimism and
pessimism
– Inventory cycle theory: inventory and demand not
in sync
– Monetary theory: changes in money supply by
Federal Reserve
– Underconsumption theory: or overproduction
Business Cycle Theories
• Exogenous theories:
– The external demand shock theory: effect of
foreign economies
– War theory: war stimulates economy; peace
leads to recession
– The price shock theory: fluctuations in oil
prices
Endogenous
• Starts from within the model
• Endo- inside, source
• Genous- born
Exogenous
• From outside of the model
• Exo- outside
• Genous- born, source
Business Cycle Theories
• Endogenous theories
– Innovation theory
– Psychological theory
– Inventory cycle theory
– Monetary theory
– Under-consumption theory
• Exogenous theories
– Sunspot theory
– War theory
Copyright 2002 by The McGraw-Hill Companies, Inc. All rights reserved.
10-5
Business Cycle Forecasting
• The Ten Leading Economic Indicators
– 1. Average workweek of production workers in
manufacturing
– 2. Average initial weekly claims for state
unemployment insurance
– 3. New orders for consumer goods and materials
– 4. Vendors performance (companies receiving
slower deliveries from suppliers)
– 5. New orders for capital goods
Copyright 2002 by The McGraw-Hill Companies, Inc. All rights reserved.
10-6
Business Cycle Forecasting
(Continued)
• The Ten Leading Economic Indicators
– 6. New building permits issued
– 7. Index of stock prices
– 8. Money supply
– 10. Index of consumer expectations
Copyright 2002 by The McGraw-Hill Companies, Inc. All rights reserved.
10-7
Three Key Aspects of the Economy
Economic Growth
Employment
Inflation
The State of the Art
Inflation
Non-Financial
Imports
Manufacturing
Trade
Balance
Construction
Economic Growth
Mfg
Non-Mfg
Exports
Employment
Financial
Long Leading, Weekly Leading,
Short Leading & Coincident
Domestic
Services
Foreign
Trade
Employment
Future Inflation Gauge
Home Prices
Crack of the Bullwhip
• Around the globe, recession is being transmitted
in amplified form to the more export-oriented
economies
• Ruth Mack, a colleague of ECRI founder Dr.
Geoffrey H. Moore, uncovered this link in a study
of shoe, leather and hides
• When Mack did her study, shoes were not
impulse buys but expensive products that
consumers would buy in good times
• In not so good times, consumers would get their
shoes repaired and postpone the purchase,
implying that shoe demand was moderately
cyclical
Crack of the Bullwhip
• An increase in inventories of shoes and shoe leather due
to a drop in demand resulted in shoemakers reducing
production and orders for leather
• Thus slowdown in shoe demand would result in an
actual decline in the demand for leather, which is made
from cattle hides
• This would trigger a sharp plunge in the demand for
hides
• Thus small shifts in demand growth at the consumer
level are amplified through the supply chain into big
swings in demand as we move up the supply chain away
from the consumer
• This is the BULLWHIP EFFECT because a little flick of
the wrist produces a big arc at the end of the whip
Bullwhip Effect Bottom Line
• Contractions in the global economy are
concentrated in the developed countries
• Economies that are heavily involved in the
exports of manufactured goods will be
lashed by the Bullwhip Effect and their
suppliers – especially the producers of
industrial commodities, including oil – will
be in even worse predicaments
Keynesian View
• Prices and wages may be sticky … may
not adjust to equilibrate markets
• Conduct countercyclical aggregate
demand management
– Business cycle largely the result of
destabilizing movement in aggregate demand
– New Keynesians also acknowledge aggregate
supply shocks matter
• Government must step in to shore up
aggregate demand … policy can alter the
business cycle.