Copyright © 2011 Pearson Education. All rights reserved. Business Cycles Chapter 8

Copyright © 2011 Pearson Education. All rights reserved.

Business Cycles

Chapter 8

Copyright © 2011 Pearson Education. All rights reserved.8-2

Fig 8.1 A business cycle


Business Cycle Facts

All business cycles have features in common.

But no two business cycles are identical.

Features in common:

The business cycle is recurrent, but not periodic.

The business cycle is persistent.



• All business cycles have features in common

– Comovements among economic variables

(1) direction

– Procyclical: in the same direction

– Countercyclical: in the opposite direction

– Acyclical: with no clear pattern

(2) timing

– Leading: in advance

– Coincident: at the same time

– Lagging: after


Summary 10


Fig 8.6 Cyclical behavior of the index of industrial production

Source: Federal Reserve Bank of St. Louis FRED database at research.stlouisfed.org/fred2/series/INDPRO.


Fig 8.9 Cyclical behavior of the unemployment rate

Source: Federal Reserve Bank of St. Louis FRED database at research.stlouisfed.org/fred2/series/UNRATE.



(3) volatility

• A plot of the standard deviation (Fig8.3) confirms the decline in volatility.

• The reduction in output’s volatility remains unexplained.


Fig 8.3 Standard deviation of GDP growth, 1960-2009

Source: Authors’ calculations from data on real GDP from the Federal Reserve Bank of St. Louis FRED database, research.stlouisfed.org/fred2/GDPC1.


Fig 8.10 The job finding rate, 1976–2009

Source: Shigeru Fujita and Garey Ramey, “The Cyclicality of Separation and Job Finding Rates,” International Economic Review, May 2009, pp. 415–430; data updated by Shigeru Fujita.


Fig 8.11 The job loss rate

Source: Shigeru Fujita and Garey Ramey, “The Cyclicality of Separation and Job Finding Rates,” International Economic Review, May 2009, pp. 415–430; data updated by Shigeru Fujita.


Flow in/ flow out

• the job finding rate: f

• the job loss rate: ℓ

1

1

t t t

t t t

t t t t

t t t t

E fU E

U E fU

U U E fU

E E E fU


Table 8.2 Jobs Lost and Gained In an Expansion and a Recession



• Table 10.2

the job finding rate declines substantially more than the job loss rate rises during recessions

• Since the job loss rate applies to many more people, job loss is the main force in increased unemployment rates during recessions


Fig 8.12 Cyclical behavior of average labor productivity and the real wage

Source: Federal Reserve Bank of St. Louis FRED database at research.stlouisfed.org/fred2 series OPHNFB (productivity) and COMPRNFB (real wage).


Fig 8.13 Cyclical behavior of nominal money growth and inflation

Source: Federal Reserve Bank of St. Louis FRED database at research.stlouisfed.org/fred2 series M2SL and CPIAUCSL.


Fig 8.14 Cyclical behavior of the nominal interest rate, 1947–2009

Source: Federal Reserve Bank of St. Louis FRED database at research.stlouisfed.org/fred2/series/TB3MS.


International aspects of the business cycle

The cyclical behavior of key economic variables in other countries is similar to that in the United States

– Major industrial countries frequently have recessions and expansions at about the same time

– each economy faces small fluctuations that aren't shared with other countries


Business Cycle Analysis: A Preview

• What explains business cycle fluctuations?

– 2 major components of business cycle theories

• A description of the shocks

• A model of how the economy responds to shocks

– 2 major business cycle theories

• classical theory

• Keynesian theory

– Study both theories in aggregate demand-aggregate supply (AD-AS) framework


AD-AS model

• Aggregate demand and aggregate supply: a brief introduction

– The model (along with the building block IS-LM model) will be developed in chapters 9-11

– The model has 3 main components:

all plotted in (P, Y) space

• aggregate demand curve (AD)

• short-run aggregate supply curve (SRAS)

• long-run aggregate supply curve (LRAS)


Aggregate demand curve (AD)

• AD shows quantity of goods and services demanded (Yd) for any price level (P)

• Higher P means less aggregate demand (lower Yd),

so the aggregate demand curve slopes downward; reasons why discussed in chapter 9

• An increase in AD for a given P

shifts AD curve up and to the right

– eg: a rise in the stock market increases consumption, shifting AD curve up and to the right

– eg: a decline in government purchases shifts AD curve down and to the left


Aggregate supply curve (AS)

• AS curve shows how much output producers are willing to supply (Ys) at any given price level (P)

• The short-run aggregate supply curve (SRAS) is horizontal; prices are fixed in the short run.

• The long-run aggregate supply curve (LRAS) is vertical at the full-employment level of output

• Equilibrium

– SR equilibrium: AD curve intersects SRAS curve

– LR equilibrium: AD curve intersects LRAS curve


Fig 8.16 The AD–AS model


AD shocks

• An AD shock is a change that shifts AD curve

– eg: a negative AD shock (Fig. 8.17)

• The AD curve shifts down and to the left

• SR equilibrium occurs where AD curve intersects SRAS curve

output falls, price level is unchanged

• LR equilibrium occurs where AD curve intersects LRAS curve

output returns to its original level, price level has fallen.


Fig 8.17 An adverse aggregate demand shock


AD shocks

• How long does it take to get to the long run?

• Classical theory: prices adjust rapidly

– So recessions are short-lived

– No need for government intervention

• Keynesian theory: prices (and wages) adjust slowly

– Adjustment may take several years

– So the government can fight recessions by taking action to shift the AD curve


AS shocks

• Classicals view AS shocks as the main cause of fluctuations in output.

• An AS shock is a shift of the LRAS curve.

– eg, things like changes in productivity or labor supply.

– eg: a negative AS shock (Fig. 8.18)

• AS shock reduces full-employment output, causing LRAS curve to shift left

• New equilibrium has lower output and higher price level

• So recession is accompanied by higher price level

– Keynesians also recognize the importance of supply shocks; their views are discussed in Ch11.


Fig 8.18 An adverse AS shock

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Copyright © 2011 Pearson Education. All rights reserved. Business Cycles Chapter 8