Transcript Business Cycles - KsuWeb Home Page

Macroeconomics
Macroeconomics
• Macroeconomics is the study of the
economy in the aggregate.
• The “Big Three” Macroeconomic Concepts:
– Unemployment
– Inflation
– Productivity
Unemployment
• The unemployment rate is the number of
unemployed persons who are actively
looking for work or are on temporary layoff
divided by the total labor force.
– Labor Force = Civilian non-institutional
population over age 16 minus people not in the
labor force (students, homemakers, retirees,
discouraged workers).
• The current unemployment rate is 5.7%.
Definitions
Labor Force = Number of Employed + Number of Unemployed
Unemployment Rate = Number of Unemployed
Labor Force
X 100
Labor Force Participation Rate = Labor Force
Adult Population X 100
Types of Unemployment
• Frictional Unemployment
– Occurs due to normal turnover in the labor
market. People changing jobs.
• Structural Unemployment
– Refers to workers who are not employed
because their skills are not in demand.
• Cyclical Unemployment
– Occurs due to changes in the business cycle.
Natural Rate of Unemployment
• The natural rate of unemployment is the
percentage of the labor force that can normally
be expected to be unemployed for reasons
other than cyclical fluctuations in real GDP.
– The natural rate of unemployment is related to
the willingness of workers to voluntarily separate
from their jobs, job loss, the duration of
unemployment periods, the rate of change in the
pattern of demand, and changes in technology.
Costs of Unemployment
• Loss in productivity is measured by the gap
between potential GDP and actual GDP.
– A conservative estimate of the cumulative gap
between actual and potential GDP over the years
1974-1992 (evaluated in 1987 prices) is
approximately $1300 billion.
– At 1993 levels, this loss in output would be about 3
months’ worth of production.
– It cannot be made up.
Inflation
• The inflation rate is the percentage rate of
increase in the economy’s average level of
prices.
• Inflation refers to a sustained rise in the
average level of prices.
– Inflation does not mean that all prices are
rising. Some prices may be falling, but on
average the overall level of prices is rising.
Inflation
• Creeping inflation is an inflation that
proceeds for a long time at a moderate and
fairly steady pace.
• Galloping inflation is an inflation that
proceeds at an exceptionally high rate, often
for only a brief period.
– In 1993, Brazil experienced inflation rates of
2,700%
The Costs of Inflation
• The main cost of inflation is the loss of
efficiency that results because inflation
distorts price signals. For example…
– People invest in assets designed to protect
them against inflation, such as real estate,
rather than in productive investments that
enhance the growth and efficiency of the
economy.
The Costs of Inflation
– Business collect bills more promptly, using
resources that could otherwise have been
used to produce goods and services.
– Individuals reduce money holdings, which
is inconvenient and misallocates the
individual’s personal resources of time,
energy , and leisure.
– In the case of hyperinflation, inflation over
100%, the currency system breaks down
and the economy reverts to barter.
Purchasing Power and Inflation
• Inflation erodes the purchasing power of a given
sum of money.
– Assume you have $10,000 and the price level is 1.
• In current dollars, you have $10,000, and in constant dollars
you have $10,000.
– Now let the price level rise to 2.
• In current dollars, you still have $10,000, but in
constant dollars you now have ??? ?
– The rise in the price level has decreased the purchasing
power of your money.
Productivity
• Productivity is the average output produced
per employee or per hour.
– In 2002, productivity was about $44 per
worker-hour in the United States.
• Growth in productivity is one way to
measure economic progress.
– If productivity grows by 3% per year, by 2022
U.S. productivity would rise to $80 per workerhour.
Productivity and Economic Growth
• Increases in productivity are one source of
economic growth.
• Other sources of economic growth are
increases in capital and labor.
Sources of Economic Growth in the
USA
Sources
/\L/L
/\K/K
Total Input
Growth
Productivity
Growth
Output
Growth
1929-48
1948-73
1973-82
1929-82
1.42
0.11
1.40
0.77
1.13
0.69
1.34
0.56
1.53
2.17
1.82
1.90
1.01
1.53
-0.27
1.02
2.54
3.70
1.55
2.92
Economic Growth: 1870-1989
Level of Real GDP/Population
Growth/Year
Country
1870
1913
1950
1989
1870-1989
Australia
Canada
France
Germany
Japan
U.K.
U.S.A.
3123
1347
1571
1300
618
2610
2247
4523
3560
2734
2606
1114
4024
4854
5931
6113
4149
3339
1563
5651
8611
13584
17576
13837
13989
15101
13468
18317
1.2%
2.2%
1.8%
2.0%
2.7%
1.4%
1.8%
Business Cycles
Business Cycles
• Business cycles are fluctuations in the level
of economic activity, alternating between
periods of recession and prosperity.
Business Cycles
• Business cycles are comprised of four phases:
– Recession
• Rate of growth in GDP falls, unemployment
increases, excess capacity increases, inflationary
pressures decrease, and profits fall.
– Trough/Bottom
– Expansion
• Rate of growth in GDP rises, unemployment
decreases, excess capacity decreases, inflationary
pressures build, and profits rise.
– Peak
Natural
GDP
GDP
Natural
GDP
GDP
Actual Real
GDP
Recession
Actual Real
GDP
Expansion
0
Time
Infl
Rate
0
Time
Unemp
Rate
Inflation
Rises
Actual
Unemp
Inflation
Rate
Natural
Rate of Un
Inflation Slows
0
t0
t1
t2 Time
0
t0
t1
t2 Time
Graphs: Description
• Left Graphs:
– In the upper frame, the black line shows the
steady growth of natural real GDP or the
amount the economy can produce at a constant
rate of inflation.
– The red line shows the actual growth of GDP.
– When actual GDP is below (above) natural
GDP, inflation falls (rises).
Graphs: Description
• Right Graphs:
– In the upper frame, the black line shows the
steady growth of natural real GDP or the
amount the economy can produce at a constant
rate of inflation.
– The red line shows the actual growth of GDP.
– When actual GDP is below (above) natural
GDP, unemployment rises (falls).
A Brief History of Business
Cycles: The USA
Expansions
1945:4-1948:4
1950:1-1953:2
1954:3-1957:3
1958:2-1960:1
1961:1-1969:3
1971:1-1973:4
1975:2-1980:1
1980:3-1981:3
1982:4-1990:3
1991:3-2001:1
Recessions
13
14
13
8
35
12
20
5
32
38
1949:1-1949:4
1953:3-1954:2
1957:4-1959:1
1960:2-1960:4
1969:4-1970:4
1974:1-1975:1
1980:2-1980:2
1981:4-1982:3
1990:3-1991:2
2001:1-2001:4
4
4
2
3
5
5
1
4
4
3
Business Cycles: Selected Facts
• In the period from 1854 to 2004, there have been 32
full cycles, averaging 53 months in length (from
trough to trough).
• Expansions averaged 35 months
• Contractions averaged 18 months
• In the period from 1945 to the present, there have
been 10 full cycles, averaging 61 months in length.
– Since WWII, expansions have been 43% longer while
contractions have been 39% shorter.
• Expansions averaged 53 months
• Contractions averaged 10.5 months
Business Cycles: Selected Facts
• Consumer spending cycles are not as extreme as
those of GDP.
• People realize that recessions are temporary so
declines in income are offset by increased use of
savings.
• In nine of the ten recessions since World War II,
consumer spending either rose or declined by
smaller percentages than GDP.
– The one exception was the recession of 1990-91, when
consumer spending declined slightly more than GDP.
Business Cycles: Selected Facts
• Investment has the most extreme cyclical
movements of all the components of GDP.
– This is due to the fact that investment spending
is determined in part by the availability of
profits, which have extreme cyclical swings.
– It is also because capital investment can be
deferred.
Taming Business Cycles
Stabilization Policy
Business Cycles and Government
• The government’s response to the cyclical
nature of business is to engage in economic
stabilization measures.
– Monetary policy
• Change in the rate of growth in the money supply.
– Fiscal policy
• Change government spending and taxes.
Economic Stabilization: Goals
• Price Stability
– Maintenance of an unchanged general level of
prices over time.
• Full Employment
– Full utilization of all available labor and capital.
• Economic Growth
– Growth of real output over time.
Economic Stabilization: Laws
• The Federal Reserve Act (1913)
– Establish a central bank, furnish elastic
currency, provide a lender of last resort,
supervise the banking system.
• The 1946 Employment Act
– Formulate and execute policy to promote
maximum employment, production and
purchasing power.
Economic Stabilization: Laws
• The 1978 Humphrey-Hawkins Act
– Provide employment and price objectives as
well as money growth targets.
• The 1980 Monetary Control Act
– Deregulate the banking system.
THE
PRESIDENT
CONGRESS
FEDERAL
RESERVE
BUDGET
TAXES
MONETARY
POLICY
FEDERAL
AGENCIES
SPENDING
FISCAL
POLICY
REGULATORY
POLICY
Economic Stabilization: The
Authorities
• The Congress
– House of Representatives
• Elected every 2 years: 435 Members
– Senate
• Elected every 6 years: 50 Members
• The President of the United States
• Elected every 4 years
• The Federal Reserve
Stabilization Authorities:
Congress
• Congress implements the nation’s fiscal
policy.
• Congress produces the government’s annual
budget.
– Congress determines spending levels for the
government.
– Congress enacts tax laws for the nation.
Stabilization Authorities:
President
• The President and his staff prepare an
annual economic report that reviews the
state of the economy.
• The President submits an annual budget, but
Congress has fiscal authority.
• The President must influence members of
Congress to adopt his budget priorities.
THE FEDERAL RESERVE SYSTEM
Board of Governors
(7 appointed members)
Determines reserve
requirements and
approves changes in the
discount rate.
Supervisory and regulatory responsibilities
over member banks and
holding companies.
Oversight of Federal
Reserve Banks.
Reserve
Requirements
Federal Reserve Banks
(12 District Banks)
Handle reserve balances
for banks.
Furnish currency.
Collect, clear , & transfer
funds.
Handle U.S. government
debt and cash balances.
Federal Open Market
Committee
(12 members)
Meets 8 times a year in
Washington, D.C.
Formulates monetary
policy directives
implemented through
open market operations.
Establish discount rate
and furnish loans at
discount window.
Discount
Rates
Open Market
Operations
ORGANIZATION OF THE FEDERAL RESERVE SYSTEM
Board of Governors
Supervise (7 members appointed by
the President)
12 Federal Reserve Banks
and 25 Branch Banks
(Reserve Bank Presidents
appointed by Board of
Directors)
State-Chartered Member
Banks and Bank
Holding Companies
Serve
Serve
Federal Open Market
Committee
(12 voting members: BOG,
President of NY Fed, & 4
other Fed Bank Presidents)
Open Market Operations
Economic Stabilization: Policies
• Economic policies used by the federal government
to counter the cyclical fluctuations in economic
activity.
– Monetary policy
• Conducted by the Federal Reserve
• Uses changes in the rate of growth of the money supply to
cause changes in the level of economic activity.
– Fiscal policy
• Implemented by the Congress and the President
• Uses changes in taxes and spending to cause changes in the
level of economic activity
Control of the Money Supply
• The Fed controls the money supply with...
– Open Market Operations
• Purchases and sales of government securities by the
Fed on the open market.
– Discount Window Operations
• Loans made by the Fed to banks.
– Changes in the reserve requirement on bank
deposits.
Thinking Like an Economist
A Guide to Business Cycle
Theories
• Questions to be Answered:
– What is the primary source of economic
disturbance in the macroeconomy?
– How fast do expectations adjust to changing
circumstances?
– Are other frictions in the market clearing
process important?
– Are policy lags highly variable and
unpredictable?
Early Keynesian Model
• The main source of economic disturbance is
thought to come from fluctuations in aggregate
demand.
– Changes in autonomous consumption
– Changes in investment spending
– Changes in liquidity preference/money demand
• Expectations adjust relatively slowly.
• Policy lags can be anticipated and taken into
account in advance of policy responses.
• No additional frictions included in the model.
Monetarist Model
• The main source of disturbance is from the
demand side, specifically from erratic stop-and-go
policies of the central bank (Fed) as it changes the
rate of growth in the money supply.
• Expectations adjust relatively slowly.
• Policy lags are thought to be “long and variable”
and, most importantly, unpredictable.
– As a result, policies that are intended to be
countercyclical can end up being procyclical.
• No additional frictions are considered important.
New Classical Model
• Fluctuations in the macroeconomy are primarily
from unexpected changes in the money supply.
• Expectations adjust very quickly. Expectations are
said to be rational.
– People use all the information available including
educated guesses about the future when making
decisions.
• Policy lags are not thought to be important
• No other frictions are important.
New Keynesian Model
• The main source of disturbances comes from
fluctuations in aggregate demand.
– Changes in autonomous consumption
– Changes in investment spending
– Changes in liquidity preference
• Expectations adjust rapidly.
• Policy lags are not a major problem.
• The market-clearing process is characterized by a
number of frictions that result in an observed
“stickiness” in wages and prices that slow down
the economy’s return to full employment.
Real Business Cycle Model
• Fluctuations from the demand side are relatively
unimportant in their impact on output and
unemployment. The main source of business
cycles comes from the “real” side of the economy,
the supply side.
– Random fluctuations in capital, primarily from
uneven technological change, cause business
cycles.
• Expectations adjust rapidly.
• Policy lags are not significant.
• No other frictions are important.
Modeling the Aggregate
Economy
• Aggregate Demand
– Aggregate demand is a schedule relating the
total demand for all goods and services in an
economy to the general price level in that
economy.
• Aggregate Supply
– Aggregate supply is a schedule relating the total
supply of all goods and services in an economy
to the general price level.
Aggregate Demand
Determinants
Consumption
Investment
Government
Net Exports
Nonfinancial
Markets
Money
Financial
Assets
Financial
Markets
Aggregate
Demand
Aggregate Supply: Determinants
Labor Costs
Capital Costs
Materials Cost
Productivity
Capacity
Expectations
Profit Margins
Aggregate
Supply
Production
Costs
Aggregate Demand and Supply:
Determinants
Consumption
Investment
Government
Net Exports
Nonfinancial
Markets
Money
Financial Assets
Financial
Markets
Aggregate
Demand
Price Level
Real Output
Labor Costs
Capital Costs
Materials Cost
Productivity
Capacity
Expectations
Profit Margins
Aggregate
Supply
Production Costs