What are Business Cycles?

Transcription

1 Macroeconomics II Business Cycles What are Business Cycles? 12 United States - Gross Domestic Product Constant Prices - Trillions of US Dollars q1 196q1 197q1 198q1 199q1 2q1 Actual series Trend Real GDP: average annual growth rate of 3.4% 1

2 What are Business Cycles? (cont d) We divide real GDP into two components: Trend: Long-term and very persistent movements in GDP. Cycle: Transient (medium-term) fluctuations around the trend. The phenomenon of growth is characterized by the trend: In the US, pc GDP has grown at an annual rate of 1.75% for the period Today: consider the transient component of GDP. What are Business Cycles? (cont d) 4 United States - Real GDP Percentage Fluctuation around Trend q1 196q1 197q1 198q1 199q1 2q1 2

3 What are Business Cycles? (cont d) Today: Components, Definitions Properties of Business Cycles Co-movement Forecasting Are Business Cycles costly? Theories of Business Cycles Business Cycle Components Components of business cycles: Expansion Peak Recession Trough 3

4 Recession Definition Commonly used definition (media): Recession: two consecutive quarters of negative output growth. NBER s official definition: A recession is a significant decline in economic activity spread across the economy, lasting more than a few months, normally visible in real GDP, real income, employment, industrial production, and wholesale-retail sales. A recession begins just after the economy reaches a peak of activity and ends as the economy reaches its trough. Between trough and peak, the economy is in an expansion. Expansion is the normal state of the economy; most recessions are brief and they have been rare in recent decades. Business Cycle Components (cont d) 4

5 Recession Definition (cont d) On November 26, 21, the (bus. cycle dating) committee determined that the peak of economic activity had occurred in March of that year. The March 21 peak marked the end of the expansion that began in March 1991, an expansion that lasted exactly 1 years and was the longest in the NBER's chronology. On July 16, 23, the committee determined that a trough in economic activity had occurred in November 21. The trough marks the end of the recession that began in March 21. The 21 recession thus lasted eight months, which is somewhat less than the average duration of recessions since World War II. The postwar average, excluding the 21 recession, is eleven months. Properties of Business Cycles Expansions are longer than recessions Luxembourg Ireland Netherlands Belgium Spain Italy UK France Germany Japan Canada USA Recessions Expansions Duration in Months 5

6 Properties of Business Cycles (cont d) In industrialized countries, expansions last 3 to 4 times longer than recessions. Recessions last around 12 to 15 months Expansions last 4 to 7 years. Properties of Business Cycles (cont d) Recessions are sharper than expansions: Ireland Belgium Italy France Japan Decline in Contraction Growth in Expansion USA

7 Properties of Business Cycles (cont d) Cycles are correlated across regions and across countries. 1 Correlation Across US States, Wyoming Wisconsin West Virginia Washington Virginia Vermont Utah Texas Tennessee South Dakota South Carolina Rhodes Island Pennsylvania Oregon Oklahoma Ohio North Dakota North Carolina New York New Mexico New Jersey New Hampshire Nevada Nebraska Montana Missouri Mississippi Minneapolis Michigan Massachussets Maryland Maine Louisana Kentucky Kansas Iowa Indiana Illinois Idaho Hawaii Georgia Florida District of Delaware Connecticut Colorada California Arizona Alaska Alabama Properties of Business Cycles (cont d) GDP is less volatile in more industrialized countries. 25 Real GDP Germany and Peru 2 15 Annual Percentage Growth Q1 1982Q1 1984Q1 1986Q1 1988Q1 199Q1 1992Q1 1994Q1 1996Q1 1998Q1 2Q

8 Properties of Business Cycles (cont d) Is the business cycle changing? Properties of Business Cycles (cont d) Is the business cycle changing? 4 United States - Real GDP Percentage Fluctuation around Trend q1 196q1 197q1 198q1 199q1 2q1 8

9 Properties of Business Cycles (cont d) There has been a significant reduction in the volatility of output growth rates since Between , standard deviation of the annual output growth rate was 2.7%. It was only 1.6% in the period Culprits Improved monetary and fiscal policies (2-3%). Identifiable good luck in productivity and commodity price shocks (4-6%). Remainder: unidentifiable shocks. Co-Movement of Macro Variables Business cycles: co-movements in Macro variables. Rising Investment Rising GDP Rising Employment Rising Consumption 9

10 Co-Movement (cont d) Aggregate consumption 4 United States Percentage Fluctuation around Trend q1 196q1 197q1 198q1 199q1 2q1 GDP Consumption Co-Movement (cont d) Nondurable consumption 4 United States Percentage Fluctuation around Trend q1 196q1 197q1 198q1 199q1 2q1 GDP Nondurables 1

11 Co-Movement (cont d) 2 United States Percentage Fluctuation around Trend q1 196q1 197q1 198q1 199q1 2q1 GDP Gross Investment Co-Movement (cont d) 2 United States Percentage Fluctuation around Trend q1 196q1 197q1 198q1 199q1 2q1 GDP Consumption Gross Investment 11

12 Co-Movement (cont d) 1 United States Percentage Fluctuation around Trend q1 196q1 197q1 198q1 199q1 2q1 GDP Import Co-Movement (cont d) 2 United States Percentage Fluctuation around Trend q1 196q1 197q1 198q1 199q1 2q1 GDP Export 12

13 Co-Movement (cont d) Do Macro variables move in a synchronized way? (1) That is, do they all move in the same direction as GDP? Pro-cyclical variables: move in the same direction as GDP. Correlation (x t,y t ) is positive. Example: aggregate consumption. Counter-cyclical variables: move in opposite direction. Correlation(x t,y t ) is negative. Example: unemployment. Co-Movement (cont d) (2) Do they move at the same time? That is, when GDP peaks, does investment peak at the same time? Coincident series: Absolute (contemporaneous correlation with GDP) is highest. Leading series: Absolute (correlation (x t-j,y t )) is highest, for j=1,2, Lagging series: Absolute (correlation (x t+j,y t )) is highest, for j=1,2, 13

14 Co-Movement (cont d) Coincident series: exhibits change at the same time at GDP GDP Time Co-Movement (cont d) Leading series: precedes GDP GDP Time 14

15 Co-Movement (cont d) Lagging series: follows GDP GDP Time Co-Movement (cont d) Money supply: example of a leading indicator. 4 United States Percentage Fluctuation around Trend q1 1965q1 197q1 1975q1 198q1 1985q1 199q1 1995q1 2q1 25q1 GDP Money Supply - M2 15

16 Co-Movement (cont d) Contemporaneous correlation between monetary aggregates and GDP is.3: Money is procyclical. Monetary aggregates peak two quarters previous to the cycle. Correlation between GDP and two quarter lagged values of monetary aggregates are the highest, between.4-.6: Money is a leading indicator. Co-Movement (cont d) How could we forecast GDP?. Simple idea: use leading indicators. 16

17 Co-Movement (cont d) 4 United States Percentage Fluctuation around Trend q3 1967q1 1979q3 1992q1 24q3 GDP Term Spread - Actual Values Co-Movement (cont d) Forecasting GDP growth with the term spread q1 21q1 22q1 23q1 24q1 Actual Growth Rate of GDP Predicted value 17

18 Co-Movement (cont d) Examples of lagging indicators: Investment (+) Examples of coincident indicators: Retail sales (+), aggregate consumption (+) Leading Indicators Index Conference Board Average weekly hours, manufacturing Average weekly initial claims for unemployment insurance Manufacturers new orders, consumer goods and materials Vendor performance, slower deliveries diffusion index Manufacturers new orders, nondefense capital goods Building permits, new private housing units Stock prices, 5 common stocks Money supply, M2 Interest rate spread, 1-year Treasury bonds less federal funds rate Index of consumer expectations 18

19 Leading Indicators Index (cont d) 1 United States Percentage Fluctuation around Trend q1 197q1 198q1 199q1 2q1 GDP Leading Indicators Index Descriptive Statistics for US Cyclical Components Leading Quarters GDP Cons (ND) Inflation M Source: Cooley and Hansen, Money and the Business Cycle 19

20 Is it Bad to Have Business Cycles? What could the costs of business cycles be? Consumption smoothing Investment build up/run down Is it Bad to Have Business Cycles? (cont d) While 57.7% of the population see consumption fall by less than 2% in a recession,.9% see a fall of 1% or more. 2

21 What Causes Business Cycles? What causes output to move around its trend? Two main theories of business cycles: Real Business Cycle Theory Keynesian Models Real Business Cycle Theory Economic agents are smart and react to incentives Markets clear Shocks that lead to cycles are technological shocks, shocks in total factor productivity, the same source of trend growth. What Causes Business Cycles? (cont d) Economic agents react to incentives: Consumers maximize utility through their choice of consumption, saving and hours worked. Firms maximize profits through their hiring and investment choices. Markets clear: Labor, capital and output markets. The interaction between market participants puts pressure on prices to adjust so that supply always equals demand. Technology side of the economy: Aggregate production function. 21

22 Aggregate Production Function (remember?) Output = TFP Capital Stock α Labor Hours (1- α) Real GDP A parameter (α number, < α < 1) Total Factor Productivity What Causes Business Cycles? (cont d) Business cycles are caused by temporary shocks to the production function These shocks shift the production function, affecting the behavior of firms and consumers and, in turn, impacting markets and prices. 22

23 What Causes Business Cycles? (cont d) What Causes Business Cycles? (cont d) Temporary shifts in the production function caused by TFP shocks: Firms hire more labor Firms invest to expand their capital (machines, inventories) Consumers, shareholders to firms, benefit from a wealth effect: work less, consume more. Markets clear: Labor, capital and output markets The interaction between market participants puts pressure on prices to adjust so that supply always equals demand. 23

24 What Causes Business Cycles? (cont d) Can temporary TFP shocks, together with optimizing behavior, explain the main features of business cycles? Stated differently, are the simulated movements in prices and quantities that follow from TFP shocks consistent with real data? E.g., are consumption, hours worked and investment procyclical, according to the model? Answer: Yes. Does this mean TFP shocks are the exclusive cause of business cycles? NO! What Causes Business Cycles? (cont d) Simulation of models with only TFP shocks does not do a good job at explaining some of the features of the data: Actual correlations of inflation rate, price level, interest rate with GDP are counterfactual; persistence is sometimes a problem. What other candidate theories are there? There are frictions in the economy that allow for monetary variables to affect the time path of real ones. Example: sticky price/sticky wage theories: Firms do not adjust prices/wages every time their circumstances change; E.g. if they face changes in demand, adjust through quantities. 24

25 What Causes Business Cycles (cont d) Why are prices/wages not adjusted more frequently? Menu costs: it is costly to change prices. Labor contracts lock firms/workers into a fixed-wage relationship of a certain length. More generally, the starting point of Keynesian theories is the notion that markets do not always work! Coordination problems may lead markets to bad equilibria. From the theory, there is a role for governmental intervention. Keynesian models also differ with respect to real business cycle theory in the cause they attribute business cycles to: Nominal demand shocks due to variations in the money supply. What Causes Business Cycles (cont d) The true cause of business cycles is one of the hottest topics in current macroeconomics, as we speak. The two main candidates are technology shocks (TFP) and monetary shocks. 25

26 In the News NEW YORK, 16 Nov 27 (Reuters) U.S. stocks rose on Friday after a day of sharp price swings, helping the S&P 5 narrowly avert a third straight week of losses as bargain-hunting lifted the beaten-down technology sector while shares of oil companies advanced on buoyant crude prices. After see-sawing through most of the day as the market was buffeted by worries over the housing slump and the credit crisis, major indexes mounted a swift upturn in the last half hour of trade as investors bid up shares of technology companies such as BlackBerry maker Research In Motion Ltd and computer and printer maker Hewlett-Packard Co. In the News (cont d) Plans for an additional $1 billion share repurchase by network equipment maker Cisco Systems Inc. also buoyed sentiment in tech shares, helping the Nasdaq snap a two-day losing streak. Investors also bought up shares of companies seen as better positioned to withstand an economic slowdown, including consumer products maker Procter & Gamble Co, helping to underpin the broader market. 26

27 In the News (cont d) ZEW institute [Center for European Economic Research], ZEW Indicator of Economic Sentiment - Subprime crisis is extending The ZEW Indicator of Economic Sentiment for Germany decreased significantly in November 27 and now stands at minus 32.5 points after minus 18.1 points in the previous month. This is still well below its historical average of 31.8 points. Owing to the continuously extending subprime crisis the financial market experts have re-adjusted their economic expectations. They particularly expect a considerable economic downturn in the United States. The weak US-dollar has made business conditions for German exporting firms more difficult. Further risks arise from the high oil price and the development of consumer prices. In the News (cont d) "Risks are particularly important for the assessment of financial market experts. The financial crisis is not over yet, and the depreciation of the USdollar puts a burden on the German export industry. It is therefore to be expected that the economic development may lose considerable speed", said ZEW President Prof. Dr. Dr. h.c. mult. Wolfgang Franz. The assessment of the current economic situation in Germany stabilised in November. The corresponding indicator decreased by.2 points to 7. points. Economic expectations for the euro zone decreased in November. The indicator dropped by 11. points and now stands at minus 3. points. The corresponding indicator for the current economic situation in the euro zone decreased by 2.7 points to 6.2 points. 27