12 Business Cycles

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8-1

Business Cycles

Chapter 8



8-2

Business Cycle Terms

• Direction of movement – Pro-cyclical – tending to move in the same direction as GDP

– Countercyclical – tending to move in the opposite directionof GDP

• Timing of movement

– Peak – time when aggregate economic activity stops risingand begins falling

– Trough – time when aggregate economic activity stopsfalling 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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Business Cycle Facts

• Business cycles are not all alike, but they do have features incommon which our macro models should capture

• Variables like industrial production, consumption, investment,and employment are pro-cyclical. They are also coincident withthe cycle meaning that they have the same timing. Almost alleconomic 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 todiscriminate among models and among causes of businesscycles.

• To predict cycles, we want leading indicators, variables whichchange direction prior to the cycle – problems with false signals



Copyright © 2005 Pearson Addison-Wesley. All rights reserved. 8-5

Table 8.1 NBER Business Cycle Turning Points

and Durations of Post–1854 Business Cycles

Contractions are

shorter and further

apart as time hasprogressed.

Business cycles are

asymmetric.Expansions are much

longer than

contractions.



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Has the US business cycle become less

severe?Figure 8.2 GDP growth, 1960-2009



8-7

Figure 8.3 Standard deviation of GDP

growth, 1960-2009






8-9

Pro-Cyclical, Coincident Variables

• Industrial production

• Consumption

• Business fixed investment

• Employment• These are variables used to classify

periods as contractions or expansions.




Figure 8.4 Cyclical behavior of the index of

industrial production




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 pro-cyclical and

leading.




Figure 8.6 Cyclical behavior of civilian

employment




Figure 8.7 Cyclical behavior of the

unemployment rate

Unemployment is

counter-cyclical



8-14

The Job Finding Rate and the Job Loss

Rate

• The probability that someone finds or

loses a job in a given month changesover time

• The job finding rate is the probabilitythat someone who is unemployed will

find a job during the month, but that

probability declines in recessions andincreases in expansions



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Figure 8.10 The job finding rate, 1976–2009



8-16

Figure 8.11 The job loss rate




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 – inrecession

• Labor force utilization• Production function Y=AKα(uN)(1- α)

• Labor productivity is Y/N=A(K/N)αu(1- α)



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Real Wages = MPN

• A Classical model says that the cyclical

behavior of real wages should mirror thecyclical 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 don’t always seem to move with thecycle.




Figure 8.9 Cyclical behavior of nominal

money growth and inflationMoney

growth and

inflation are

bothprocyclical.

Money

growth leads

and inflation

lags, but not

always.




Figure 8.10 Cyclical behavior of the

nominal interest rate




Figure 8.11 Industrial production indexes

in six major countriesThere is some

co-movement

in industrial

production(and hence in

the business

cycle) acrosscountries.

S C



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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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12 Business Cycles