Business Cycles Chapter 8

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Business Cycle Terms

Direction of movement
Pro-cyclical tending to move in the same direction as GDP Countercyclical tending to move in the opposite direction of GDP

Timing of movement
Peak time when aggregate economic activity stops rising and begins falling Trough time when aggregate economic activity stops falling and begins rising Boom or expansion period when economic activity is rising Recession period when economic activity is falling (at least two consecutive quarters) Turning point - peaks or troughs

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Figure 8.1 A business cycle

Contraction is not defined here as output below potential.

Copyright 2005 Pearson Addison-Wesley. All rights reserved.

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Business Cycle Facts

Business cycles are not all alike, but they do have features in common which our macro models should capture Variables like industrial production, consumption, investment, and employment are pro-cyclical. They are also coincident with the cycle meaning that they have the same timing. Almost all economic models imply these variables are pro-cyclical. Other variables like inflation, real wages, and money growth also tend to be pro-cyclical. This behavior allows us to discriminate among models and among causes of business cycles. To predict cycles, we want leading indicators, variables which change direction prior to the cycle problems with false signals

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Table 8.1 NBER Business Cycle Turning Points and Durations of Post1854 Business Cycles
Contractions are shorter and further apart as time has progressed. Business cycles are asymmetric. Expansions are much longer than contractions.

Copyright 2005 Pearson Addison-Wesley. All rights reserved.

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Has the US business cycle become less severe? Figure 8.2 GDP growth, 1960-2009

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Figure 8.3 Standard deviation of GDP growth, 1960-2009

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Pro-Cyclical, Coincident Variables Industrial production Consumption Business fixed investment Employment These are variables used to classify periods as contractions or expansions.

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Figure 8.4 Cyclical behavior of the index of industrial production

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Figure 8.5 Cyclical behavior of consumption and investment

Expenditures on durable goods are much more cyclical than other expenditures. Why? Inventory investment is also highly procyclical and leading.
Copyright 2005 Pearson Addison-Wesley. All rights reserved.

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Figure 8.6 Cyclical behavior of civilian employment

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Figure 8.7 Cyclical behavior of the unemployment rate

Unemployment is counter-cyclical

Copyright 2005 Pearson Addison-Wesley. All rights reserved.

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The Job Finding Rate and the Job Loss Rate The probability that someone finds or loses a job in a given month changes over time The job finding rate is the probability that someone who is unemployed will find a job during the month, but that probability declines in recessions and increases in expansions
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Figure 8.10 The job finding rate, 1976 2009

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Figure 8.11 The job loss rate

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Figure 8.8 Cyclical behavior of average labor productivity and the real wage

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Labor productivity is pro-cyclical Does labor really become less productive technological regress in recession Labor force utilization Production function Y=AK(uN)(1- ) Labor productivity is Y/N=A(K/N)u(1- )

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Real Wages = MPN A Classical model says that the cyclical behavior of real wages should mirror the cyclical behavior of the marginal product of labor (not average product of labor but they tend to move together) Real wages are slightly pro-cyclical but dont always seem to move with the cycle.
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Figure 8.9 Cyclical behavior of nominal money growth and inflation

Money growth and inflation are both procyclical. Money growth leads and inflation lags, but not always.

Copyright 2005 Pearson Addison-Wesley. All rights reserved.

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Figure 8.10 Cyclical behavior of the nominal interest rate

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Figure 8.11 Industrial production indexes in six major countries

There is some co-movement in industrial production (and hence in the business cycle) across countries.

Copyright 2005 Pearson Addison-Wesley. All rights reserved.

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Summary and Conclusion Business cycles are not regular and are not all alike. Cycles have different lengths and turning points are hard to predict. All variables do not behave exactly the same over each cycle. However, there are regularities we want our models to capture.
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