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1. Definitions and Fundamentals
Business cycle = cyclical change in business activities
length of phase
amplitude
t
KuB 1.1U. van Suntum 1U van Suntum, Vorlesung KuB 1
Cycle-types (Josef Schumpeter, Business Cycles, 1939)
• Kitchins (3 years storage-cycles)
• Juglars (10 years investment-cycles)
• Kondratieffs (50 – 60 years construction and innovation-cycles)
GDPreal
time t
GDPreal
time t
Reality: Cycle-types overlap
KuB 1.1U. van Suntum 2
Theory: ideal types
U van Suntum, Vorlesung KuB 2
Previous classification of cycle-phases(Gottfried Haberler, Prosperity and Depression, 1937)
GDPreal
GDPtrend
time t
1. boom 2. recession
3. crisis 4. recovery
• today: rising trend => growth rates of GDP are relevant
KuB 1.1U. van Suntum 3U van Suntum, Vorlesung KuB 3
Business Cycle vs. Economic Growth
Definition I: • growth = trend of GDP• cycles = cyclical deviations from trend
Definition II:• growth = rise in potential output• cycles = cyclical change of capacity utilization
t
ln BIPPP
ln BIP
t
Trend
KuB 1.1U. van Suntum 4U van Suntum, Vorlesung KuB 4
Definitions
KuB 1.1
Capacity utilization:
Output-Gap:
(PO = potential output)
U. van Suntum 5U van Suntum, Vorlesung KuB 5
KuB 1.1U. van Suntum 6U van Suntum, Vorlesung KuB 6
Alternative definitions of a recession (cf. SVR JG 2008, S. 78)
• Common definition: recession = real GDP (seasonally adjusted) declines for several (mostly: three) quarters
shortcomings: lagged publication of GDP, frequent revisions
• National Bureau of Economic Research: recession = substantial decline in several indicators (GDP, industrial production, sales…) for more than a few months
shortcomings: lagged publication, not very precise
• SVR: recession = decline of a (negative) relative output-gap of at least 2/3 of potential growth rate
shortcomings: different calculations of potential output, definition sophisticated
U. van Suntum, KuB 7U van Suntum, Vorlesung KuB 7
Example for SVR-definition of a recession(cf. JG 2008/09, S. 80)
• Relative Output-gap 2008: + 0,9%
• Relative Output-gap 2009: - 0,5%
=>decline of output-gap -1,4 percentage points
• potential output growth 2008: 1,6%
• Two thirds from that: 1,1%
• Difference > 0? 1,4 > 1,1
• Output-gap 2009 <0? -0,5 < 0recession
U. van Suntum, KuB 8U van Suntum, Vorlesung KuB 8
KuB 1.1
Cycle phases according to German Council of Economic Advisors
(capacity utilization)
GDPreal/PO
Upper turning point
lower turning point
Normal level of CU
timeupswing downswing
U. van Suntum 9U van Suntum, Vorlesung KuB 9
Concept of anticyclical business cycle policy (Keynes 1936)
• General Idea: Smoothing of cycles
• upswing: Budget-surplus, contractionary policy
• downswing/recession: Budget-deficits, expansionary policy
• on average (long run): balanced budget
KuB 1.1U. van Suntum 10U van Suntum, Vorlesung KuB 10
KuB 1.1
Classification of cycle indicators
• leading (e.g. orders)• coinciding (e.g. industrial production)• lagging (e.g. employment)
• „hard“(e.g. retail sales)• „weak“ (e.g. consumer confidence)
• single (e.g. quantity of money)• composite (e.g. FAZ-Indikator)
• real (e.g. orders, production)• monetary (e.g. interest rates, prices)
U. van Suntum 11U van Suntum, Vorlesung KuB 11
gGDP
t
(leading indicators) (coinciding indicators) (lagging indicators)
KuB 1.1U. van Suntum 12U van Suntum, Vorlesung KuB 12
• orders• business climate• consumer confidence• stocks• monetary growth• interest rate spread
Leading indicators
KuB 1.1U. van Suntum 13U van Suntum, Vorlesung KuB 13
• industrial production• GDP • capacity utilization• output gap• retail sales
Coinciding indicators
KuB 1.1U. van Suntum 14U van Suntum, Vorlesung KuB 14
• inflation rate• unemployment rate• employment growth• interest rates
Lagging indicators
KuB 1.1U. van Suntum 15U van Suntum, Vorlesung KuB 15
KuB 1.1
Confidence indicators in Germany
Ifo-business expectations industrieZEW-business cycle expectations
U. van Suntum 16U van Suntum, Vorlesung KuB 16
KuB 1.1U. van Suntum 17U van Suntum, Vorlesung KuB 17
U. van Suntum KuB 1.1U van Suntum, Vorlesung KuB 18
GDP
gBIP
t
t
0
Turning points: Level vs. Growth rate
=> Turning points of growth are leadingKuB 1.1U. van Suntum 19
U van Suntum, Vorlesung KuB 19
Why cycle forecast is principally limited*)
*) Source: S. Klein, Alles Zufall, Hamburg 2004, S. 50 f.
KuB 3.1 20KuB 4 20
U van Suntum, Vorlesung KuB 20
Small inexactness...
KuB 3.1 21KuB 4 21
U van Suntum, Vorlesung KuB 21
...amounts to total ignorance!
KuB 3.1 22KuB 4 22
U van Suntum, Vorlesung KuB 22
GDP-forecast and reality
2001 2002 2003 2004
reality in year t
1,0% 0,2% -0,1% 1,8%
SVR in autumn t-1
2,8% 0,7% 1,0% 1,5%
Institutesin spring t
0,7% 0,9% 0,5% 1,5%
KuB 3.1 23KuB 4 23
U van Suntum, Vorlesung KuB 23
%
KuB 3.1 24KuB 4 24
U van Suntum, Vorlesung KuB 24
SVR-forecast vs naive forecast
KuB 3.1 25KuB 4 25
U van Suntum, Vorlesung KuB 25
Digression: continuous vs. discrete growth
KuB 1.1U. van Suntum 26
discrete:
continuous:
• discrete rates are both better applicable in empirical research and more easily accessible• continuous rates are both better applicable in theoretical research and more elegant
U van Suntum, Vorlesung KuB 26
KuB 1.1U. van Suntum 27
Digression (continued): calculus using growth rates
discrete:
continuous:
Only with small growth rates are the differences negligible!
U van Suntum, Vorlesung KuB 27
KuB 1.1
Exercise (I)
U. van Suntum 28U van Suntum, Vorlesung KuB 28
KuB 1.1
Exercise (II)
U. van Suntum 29U van Suntum, Vorlesung KuB 29
Learning goals / review questions
• How do we classify the business cycle?
• How do we define capacity utilization and the output gap
• Which indicators are leading, lagging, coincident?
• What are the differences and comparative advantages of discrete vs. continuous growth rates?
• How do we calculate them?
U. van Suntum KuB 1.1U van Suntum, Vorlesung KuB 30
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