Session 7. Business Cycles. Labor Markets. - Search …faculty.insead.edu/fatas/mge/Session 7.pdfSession 7. Business Cycles. Labor Markets. v Introduction to Business Cycles v What

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Macroeconomics in the Global Economy Antonio Fatás

Session 7. Business Cycles. Labor Markets.

v  Introduction to Business Cycles

v What causes recessions?

v Labor markets

v Unemployment


What is the Business Cycle?

v The business cycle describes medium term fluctuations in the level of economic activity (GDP) around a long term trend

v  The business cycle can only be understood starting from a

measure of the long-term trend of the economy (Session 4).

v The business cycle is an aggregate phenomenon. Most sectors, most variable are well described by the business cycle.

2


600

700

800

900

1000

1100

1200

1300

1400

1500

1600

1980 1982 1984 1986 1988 1990 1992 1994 1996 1998 2000 2002 2004 2006 2008 2010 2012

UK GDP Potential

The Business Cycle


How do we measure potential output?

1.  Using statistical analysis and measuring the trend of real GDP.

2.  Using a model that combines factors of production (labor, capital) and productivity to measure the potential of the economy if all factors are employed.

In both cases, actual output is seen as fluctuating around potential output (not just below). The difference between the two is what we call the output gap.

3


Output Gap

-9

-6

-3

0

3

6

1980 1982 1984 1986 1988 1990 1992 1994 1996 1998 2000 2002 2004 2006 2008 2010 2012

Germany Japan United Kingdom United States

% Difference between GDP and Potential (Trend) GDP 100*(Actual – Potential)/Potential


Measurement and Definitions

0

3

0

Recession

Peak

Trough

Expansion

Eco

nom

ic a

ctiv

ity

4


-15

-10

-5

0

5

10

15

1870 1880 1890 1900 1910 1920 1930 1940 1950 1960 1970 1980 1990 2000 2010

US Business Cycles Growth rate GDP

Industrialization

Railroads

The Depression of the 1890s

World War I

World War II

The Great Depression

Oil Shocks

“New Economy”

Historical Record: The US Business Cycles

Great Recession



Exp

ansi

ons

Rec

essi

ons

Average duration of recessions

1870 1890 1910 1930 1950 1990 2009 1970

Average duration of expansions 29 months 50 months

21 months 11 months

5


-4

-2

0

2

4

6

8

1960 1966 1972 1978 1984 1990 1996 2002 2008

US GDP Growth



-4.5

-2.5

-0.5

1.5

3.5

5.5

1961 1967 1973 1979 1985 1991 1997 2003 2009

Euro Area GDP Growth

Historical Record: The Euro Business Cycles

6


-7

-5

-3

-1

1

3

5

7

9

11

1971 1974 1977 1980 1983 1986 1989 1992 1995 1998 2001 2004 2007 2010

Korea GDP Growth

Historical Record: The Korean Business Cycles


The “Great Recession”: 2008-2009

-1

0

1

2

3

4

5

6

1980 1982 1984 1986 1988 1990 1992 1994 1996 1998 2000 2002 2004 2006 2008 2010

World GDP Growth

7


-6

-4

-2

0

2

4

6

8

10

1980 1982 1984 1986 1988 1990 1992 1994 1996 1998 2000 2002 2004 2006 2008 2010 2012

GDP Growth

Advanced Emerging

Advanced Economies Led the World into a Recession


Expansions always end because of an unexpected event (good luck forecasting them!) or because of accumulation of imbalances (or a combination of both).

In the post-war period recessions have been relatively short

and mild – from 6 to 16 months (in advanced economies).

Their length and frequency has been going down over time

(“The Great Moderation”).

Why do recessions occur?

8


2200

3200

4200

5200

6200

7200

8200

9200

10200

11200

Oct

-90

Mar

-91

Aug

-91

Jan-

92

Jun-

92

Nov

-92

Ap

r-93

Se

p-9

3 Fe

b-9

4 Ju

l-94

D

ec-9

4 M

ay-9

5 O

ct-9

5 M

ar-9

6 A

ug-9

6

Dow Jones Index (US) “How do we know when irrational exuberance has unduly escalated asset values?”

Alan Greenspan (Chairman US Federal Reserve)

December 6, 1996

How long can imbalances persist?


0

2000

4000

6000

8000

10000

12000

Oct

-90

Ap

r-91

O

ct-9

1 A

pr-

92

Oct

-92

Ap

r-93

O

ct-9

3 A

pr-

94

Oct

-94

Ap

r-95

O

ct-9

5 A

pr-

96

Oct

-96

Ap

r-97

O

ct-9

7 A

pr-

98

Oct

-98

Ap

r-99

Dow Jones Index


9


2200

3700

5200

6700

8200

9700

11200

12700

Oct

-90

Jun-

91

Feb

-92

Oct

-92

Jun-

93

Feb

-94

Oct

-94

Jun-

95

Feb

-96

Oct

-96

Jun-

97

Feb

-98

Oct

-98

Jun-

99

Feb

-00

Oct

-00

Jun-

01

Feb

-02

Oct

-02

Jun-

03

Feb

-04

Oct

-04

Jun-

05

Feb

-06

Oct

-06

Jun-

07

Feb

-08

Oct

-08

Jun-

09

Feb

-10

Oct

-10

Jun-

11

Feb

-12

Dow Jones Index



0

5

10

15

20

25

30

35

40

45

50

1860 1880 1900 1920 1940 1960 1980 2000 2020

Pric

e-E

arni

ngs

Rat

io (

CA

PE)

Year

US Stock Market Price-Earnings Ratio

1901 1966

2000

1981

1921

1929

22.02

Source: Robert Shiller


10


50

70

90

110

130

150

170

190

210

1880 1900 1920 1940 1960 1980 2000 2020

Ind

ex 1

890=

100

Year

House Prices (US) adjusted for Inflation

Source: Robert Shiller



November 17th 2009, CNBC:

“While not being comfortable with the current gold trade, Dennis Gartman, founder of The Gartman Letter, told CNBC Monday that the price of the precious metal will “continue to go up until it stops …It is a gold bubble,” Gartman told CNBC. He called the trade on gold “mind boggling,” but also said he is currently long — or betting gold will go higher.”

The difficulty of predicting how long imbalances can persist

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Summary of Business Cycles

v Business cycles are characterized by co-movements of a large number of macroeconomic series.

v On the basis of these movements we determine the state of the cycle – recessions, expansions, and the turning points.

v The nature of the business cycle has changed over time – in the 1980-2007 period recessions were shorter and milder and expansions are longer than fifty years ago.

v A possible candidate to explain business cycles isexogenous shocks. These shocks are transmitted throughout the economy by various propagation mechanisms.

v An alternative view is that we build imbalances over time until a correction is needed.


Characterizing Labor Markets

v The utilization of labor resources can be summarized with the following variables: –  Participation rate: It measures how active the working-age

population is. Some times discouraged unemployed will not appear in the statistics on unemployment but will show up as out of the labor force

–  Unemployment rate (=100-Employment rate). It measures the % of active workers who do not have a job

–  Number of hours worked. A measure of the intensity of effort for those who have a job (also reflects the part-time/full-time choices)

12


Labor Market Statistics: France (2010)

Working Age 65%

Not working

age 35%

Labor force 70%

Not in Labor force 30%

Employed 90.8%

Population: 64.9m

Working age (15-64): 42.1m

Labor force: 29.9m

Unemployed 9.2%


Assignment

68

68

69

69

72

63

65

67

64

64

68

65

67

74

65

58 60 62 64 66 68 70 72 74 76

Australia Brazil

Bulgaria Canada

China Egypt

France Greece

India Japan

Lebanon Mexico

New Zealand Singapore

South Africa

Working-Age Population as % of Total

2010

13


Assignment

66

70

54

67

74

49

56

55

56

60

46

62

68

67

52

0 10 20 30 40 50 60 70 80

Australia Brazil

Bulgaria Canada

China Egypt

France Greece

India Japan

Lebanon Mexico


South Africa

Labor Force Participation

2008


Assignment

5.6 8.3

6.8 8.3

4.3 9.4

9.1 9.5

4.4 5.0

9.0 5.2

6.1 5.9

23.8

0 5 10 15 20 25

Australia Brazil

Bulgaria Canada

China Egypt

France Greece

India Japan

Lebanon Mexico


South Africa

Unemployment

2008 (India for 2004)

14


Male Female

1973 2008 1973 2010

USA 89.7 83.3 52.9 71.4

EU15 82.5 80.8 38.3 66.9

0 20 40 60 80 100

15-24

25-54

55-64

65-69

Employment to Population (2010)

EU15 USA

30

40

50

60

70

80

US France

1975 2010

Age 55-64 Employment (to Population) Rate

A detailed analysis of labor force participation rates in Europe reveals very different patterns. Some European countries display lower participation rates especially for older and younger workers.

Labor Force Participation

Differences in Labor Markets


Differences in Labor Markets: Europe versus the US

1,400

1,500

1,600

1,700

1,800

1,900

2,000

2,100

1970 1972 1974 1976 1978 1980 1982 1984 1986 1988 1990 1992 1994 1996 1998 2000 2002 2004 2006 2008

France Germany USA

Average Number of Hours per Year

15


59 61 63 65 67 69 71 73 75

1990

19

91

1992

19

93

1994

19

95

1996

19

97

1998

19

99

2000

20

01

2002

20

03

2004

20

05

2006

20

07

2008

20

09

2010

Ages 15-64

USA EU15

73

75

77

79

81

83

1990

19

91

1992

19

93

1994

19

95

1996

19

97

1998

19

99

2000

20

01

2002

20

03

2004

20

05

2006

20

07

2008

20

09

2010

Age 35-44

USA EU15

3

5

7

9

11

13

15

17

1990

1991

1992

1993

1994

1995

1996

1997

1998

1999

2000

2001

2002

2003

2004

2005

2006

2007

2008

2009

2010

Age 65+

USA EU15

The US Labor Market and the Current Crisis Employment to Population Ratio

The destruction of employment in the US during the current crisis has been much larger than in previous. As a result Europe has caught up with the US along some labor market dimensions.


Differences in Labor Markets

Total Male Female

United States 70.9 76.4 65.5

Japan 70.7 81.6 59.7

France 64.6 69.2 60.1

Poland 59.2 66.3 52.4

Mexico 59.9 80.7 41.4

Korea 63.8 74.4 53.2

Sweden 75.7 78.1 73.2

Turkey 44.9 66.6 23.5

Employment to Working-Age Population Ratio (2008)

There are large differences in the level of activity in labor markets across countries. Emerging markets tend to have lower employment to population ratios, more so for female workers.

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Unemployment

v Unemployment is the most common definition of the slack in the labor market. It is measured as the number of unemployed divided by the labor force. From a conceptual point of view, it is useful to distinguish between:

–  Cyclical unemployment: Unemployment that responds to changes in the business cycle. Unemployment increases during recessions and decreases during booms.

–  Natural Rate of Unemployment (structural unemployment): This is the unemployment that originates in the fact that “full employment” is impossible. There are always workers in a transition from one job to another. This unemployment is related to the structure and functioning of the labor market, the search process.


What is the Natural Rate of Unemployment?

v There are flows out of employment –  Sectoral or geographical shifts

  Changes in the composition of demand   Technological changes

–  Bad matches between companies and workers

v  It takes time to find a job once unemployed because of –  Search – Frictional unemployment –  Rigidities (for example, wage rigidities, minimum wages, taxes on

labor) – Structural unemployment

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0

2

4

6

8

10

12

% o

f lab

or fo

rce

Unemployment Rate

Natural Rate of Unemployment

Cyclical Unemployment

The Natural Rate of Unemployment (U.S.)

?


0

2

4

6

8

10

12

1960 1964 1968 1972 1976 1980 1984 1988 1992 1996 2000 2004 2008 2012

Unemployment Rate (% of Labor force)

Euro Countries

United States

Japan

A comparison between Europe, Japan and the US illustrates how different labor market institutions can lead to differences in performance: Since early 80’s, the EU has suffered from high rates of unemployment. Some of it has been labelled as structural.

Labor Markets: Unemployment

18


Summary of Labor Markets

v  In the absence of rigidities, real wage and employment in the economy is determined by labor supply factors and labor demand.

v  Labor demand is determined by the real wage, productivity and the

availability of capital. v  The supply of labor is affected by the real wage, demographics,

participation rate, wealth, taxes, and the expected future wage. v  The natural rate of unemployment characterizes the long-run

equilibrium rate of unemployment and is affected by the job search process and structural rigidities.

v  Cyclical unemployment is the result of Business cycles.


J63-70 J71-80

J81-90

J91-00

US63-70

US71-80

US81-90

US91-00

EU63-70

EU71-80

EU81-90

EU91-00

J01-05 US01-05

EU01-05

0

1

2

3

4

5

6

7

8

9

10

0 1 2 3 4 5 6 7 8 9 10

Une

mp

loym

ent R

ate

Productivity Growth

(*) Productivity is measured as labor productivity of the business sector. All data are averages over the years indicated in the labels. J stands for Japan, US for the United States and EU for European Union

There is no reason why technological progress should lead to unemployment (in fact the evidence shows the opposite correlation). This is only true under the (false) assumption that the number of jobs is limited or that there is a limit to how fast GDP can grow. Both of these variables (number of jobs and GDP growth) are endogenous!

Appendix: Does Technological Progress Lead to Unemployment?

19


Appendix: Great Moderation

v  After inflation was brought down in the early 80s, we entered a period of stability in both inflation and growth rates known as “The Great Moderation”.

v  The Great Moderation was the result of improved policies and an element of luck (absence of major economic shocks).


0

2

4

6

8

10

12

14

16

0

0.5

1

1.5

2

2.5

3

3.5

4

4.5

1965 1970 1974 1978 1982 1987 1991 1995 1999 2004 2008

Inflation Volatility Growth Volatility Inflation

Appendix: The Great Moderation, US

Vol

atili

ty Inflation

20


0

2

4

6

8

10

12

14

16

0

0.5

1

1.5

2

2.5

3

3.5

4

1965 1969 1974 1978 1982 1986 1991 1995 1999 2003 2008


Appendix: The Great Moderation, France V

olat

ility

Inflation


-2

0

2

4

6

8

10

12

14

16

18

20

0

1

2

3

4

5

6

7

8

9

10

1965 1970 1974 1978 1982 1987 1991 1995 1999 2004 2008


Appendix: The Great Moderation, New Zealand

Vol

atili

ty Inflation

Documents

Session 7. Business Cycles. Labor Markets. - Search …faculty.insead.edu/fatas/mge/Session 7.pdfSession 7. Business Cycles. Labor Markets. v Introduction to Business Cycles v What