Chapter 8
BUSINESS CYCLES.
Introduction.
§ Remember from Chapter 1 how the last 130 years of US economic history looked like in terms of GDP growth (see Figure 1.1):
- There has been an upward trend in GDP (approximately 1.9% growth per year.)
- For certain periods of time the economy has grown above and below that trend value.
§ Those oscillations of economic activity are called business cycles.
§ We have studied the basic determinants of long-run economic growth but we still have to describe the factors that produce short-run fluctuations of economic activity.
§ In fact, since that is a very difficult and elusive task we are just going to describe what we know about business cycles so that in later chapters we can attempt to prevent them.
8.1 What is a Business Cycle?
§ “A fluctuation found in the aggregate economic activity of nations.”
(but, what exactly is a “fluctuation” and how do we define “aggregate economic activity”?)
1. The term “aggregate activity” can be confusing because not all individual businesses are on the same phase of the business cycle (B-C) at the same time.
(e.g.: universities and private employers, hospitals and cemeteries)
§ We generally rely on the National Bureau of Economic Research (NBER) to produce the "official" determination of the current phase of the B-C.
§ As a rule of thumb a recession (expansion) is a period of time of at least six months of decreasing (increasing) Gross Domestic Product.
http://www.nber.org/
2. “Fluctuations” in the business cycle are defined as successions of expansions in economic activity followed by contractions. When the expansion is very fast we call it a boom and when the contraction is persistent we call it a depression.
§ The highest level of economic activity during the B-C is called a peak and the lowest point of the contraction is called a trough. Both are considered turning points because that is where the cycle changes its phase.
(See Figure 8.1)
Additionally, we must remark the following points about business cycles:
3. Economic activity in different sectors tends to move together in each phase of the cycle, a phenomenon known as co-movement.
(e.g.: if residential house sales fall, kitchen appliances fall too)
§ Different economic indicators (e.g.: output, prices, interest rates) also move together, while some others (e.g.: unemployment, government deficits) do change in the opposite direction.
4. Business cycles are recurrent (occur an expected number of times during any given period of time) but not periodic (they have proved to be -so far- impossible to predict.)
(e.g.: we expect a certain average snowfall during winter but we don't know when)
§ Business cycles have variable lengths and strengths and, once again, those qualities are impossible -so far- to predict.
(e.g.: we know that spring follows winter but we don't know how cold winter is going to be or when the last snowfall will occur)
5. Sometimes, regular short-run business cycle may have permanent effects on the long-run growth rate. This type of phenomenon is known as persistence (or hysteresis.)
8.2 The American Business Cycle: The Historical Record.
(See Table 8.1 and, additionally, Figure 1.1)
- Prior to WWI, economic growth was brisk but the number of recessionary months was par to the number of expansionary months.
- The worst recession in US economic history occurred in 1929. It was so bad that it has been known since as the "Great Depression." Output drops (30%) and unemployment (25%) had never been worse. It expanded internationally and lasted almost a decade.
- WWII took the US out of the recession by virtue of general military mobilization and government-directed war production.
- The post-war demobilization brought with it a small-scale recession but overall between 1945 and 1971 the US experienced long expansionary periods and very brief recessionary periods.
- The oil shocks of the 70s, high inflation rates and growing government deficits ended the -so far- longest (and also fastest-paced) period of economic prosperity of this country.
- Even as we recovered from the short-run effects of all these imbalances, some permanent effects remained (e.g: lower productivity, relatively high unemployment...)
- The expansion during the mid 80s ended up in a brief recession in 1991 (the Gulf War recession) and after that the economy grew for what has been the longest period of economic expansion without wars.
- The 1991-2001 expansion ended for what appear to be demand factors (e.g.: overinvestment.)
§ While the economy grows “economic gurus” like to think that business cycles have finally been overcome and no recession will follow. The historical record is full of disappointments.
§ What may be happening, though, is that recessions have been shortening and expansions lengthening, but that issue is the object of a great debate between economists and historians.
§ Do the rest of the world experience business cycles? Of course, and some of them are more pronounced than those of the US.
§ Some countries have contemporaneous business cycles and some other countries don't.
(See Figure 8.9)
§ Why is that important? Because in a global economy setting, what happens to your neighbor affects your own interests. Besides, in the case of trade and economic unions, the present phase of the B-C in each country has critical implications for macroeconomic coordination.
8.3 Business Cycle Stylized Facts.
§ Even though there are no patterns in periodicity and length of business cycles, there are patterns in their evolution, what are called stylized facts.
- Some variables are procyclical (output, prices, interest rates) while others are countercyclical (unemployment.) The variable that does not change with the business cycle is called acyclical.
- Some variables lead the business cycle if they peak or trough ahead of the B-C's turning point (number of new houses under construction) and some others lag behind the B-C (unemployment insurance claims.) The variable that moves with the cycle is called coincident.
§ The Conference Board puts together a composite index of these facts to indicate the possible change in the phase of the business cycle.
http://www.conference-board.org/ and http://www.tcb-indicators.org/
§ For a summary of the cyclical and timing qualities of the key economic variables see Summary 10 and Figures 8.3 through Figure 8.8.