econ 202: macroeconomics i lecture 9 - business cycle...

ECON 202: Macroeconomics ILecture 9 - Business Cycle Facts and Introduction

John Grigsby

February 2, 2017

Grigsby Lecture 9 - Business Cycle Facts February 2, 2017 1 / 28

So far, we’ve been concerned with growth – long run trends

8.5

9

9.5

10

10.5

11

11.5Lo

g G

DP

per

Cap

ita

(Ch

ain

ed 2

00

9 U

SD)


Now we will study fluctuations around trend

What is a business cycle?

Business Cycles are a type of fluctuation found in the aggregate economic activityof nations that organize their work mainly in business enterprises. A cycle consistsof expansions occurring at about the same time in many economic activities,followed by similarly general recessions, contractions and revivals which mergeinto the expansion phase of the next cycle

Burns and Mitchell (1946)


What do business cycles look like?

P indicates peak, T shows trough. Taken fromhttp://www.fperri.net/TEACHING/bocconi/20205/LEC10.pdf


http://www.fperri.net/TEACHING/bocconi/20205/LEC10.pdf

We see this in GDP growth rates

myf.red/g/cxNC

-15

-10

-5

0

5

10

15

20

1950 1955 1960 1965 1970 1975 1980 1985 1990 1995 2000 2005 2010 2015

fred.stlouisfed.orgSource:U.S.BureauofEconomicAnalysis

RealGrossDomesticProduct

PercentChangefrom

PrecedingPeriod

Long periods of positive growth followed by negative growth.


Observations regarding GDP cycle

myf.red/g/cxNC

-15

-10

-5

0

5

10

15

20

1950 1955 1960 1965 1970 1975 1980 1985 1990 1995 2000 2005 2010 2015

fred.stlouisfed.orgSource:U.S.BureauofEconomicAnalysis

RealGrossDomesticProduct

PercentChangefrom

PrecedingPeriod

1 Cycles recurrent but not periodic

2 Less volatile today than pre-80s.

3 Cycle length varies from 1.5 years to ≈ 20 years


Some key definitions (1)

Definition: Recession

A recession is defined as a period with 2+ consecutive quarters ofnegative growth in output (Okun).

NBER defines recussion to be recurring period of substantial declinein output, income, employment, and trade across a variety of sectors.See http://www.nber.org/cycles/main.html for more.

Definition: Cyclicality

A variable is said to be Pro-Cyclical, Counter-Cyclical, orA-cyclical if it moves together with, opposite to, or independently ofGDP, respectively.


http://www.nber.org/cycles/main.html

Some key definitions (2)

Definition: Lags, Leads, and Coincidence

A variable is said to be Lagging, Leading, or Coincident if it movesafter, before, or at the same time as GDP, respectively.

Definition: Durable Goods

A good is durable if it is not meant for immediate consumption andmay be consumed over time. Non-durable goods are the opposite.

Durable examples: cars, household appliances; things that depreciateslowly

Non-durable examples: Food, Gasoline; things that depreciate quickly


Quiz: what do you think is pro-, counter-, and a-cyclical?

Direction TimingConsumption Pro-Cyclical CoincidentIndustrial Production Pro-Cyclical Coincident

Business Fixed Investment Pro-Cyclical CoincidentResidential Investment Pro-Cyclical LeadingInventories Pro-Cyclical Leading

Government Spending Pro-Cyclical VariesImports Pro-Cyclical LeadingExports Pro-Cyclical LaggingNet Exports Counter-Cyclical Leading


Round 2: Labor market, stock prices, inflation

Direction TimingEmployment Pro-Cyclical CoincidentUnemployment Rate Counter-Cyclical LaggingLabor Productivity Pro-Cyclical LeadingReal Wage Pro-Cyclical Varies

Money growth Pro-Cyclical LeadingInflation Pro-Cyclical Lagging

Stock prices Pro-Cyclical LeadingNominal Interest rates Pro-Cyclical LaggingReal interest rates Acyclical –


What is least cyclical? Non-Durable Consumption Growth

-15.0

-10.0

-5.0

0.0

5.0

10.0

15.0

20.0

25.0

1947 1952 1957 1962 1967 1972 1977 1982 1987 1992 1997 2002 2007 2012

Perc

ent

Ch

ange

Non-Durable Consumption not too volatile


Durable Consumption Much More Volatile

-15.0

-10.0

-5.0

0.0

5.0

10.0

15.0

20.0

25.0

1947 1952 1957 1962 1967 1972 1977 1982 1987 1992 1997 2002 2007 2012

Perc

ent

Ch

ange


And Residential Investment Even More Volatile

-15.0

-10.0

-5.0

0.0

5.0

10.0

15.0

20.0

25.0

1947 1952 1957 1962 1967 1972 1977 1982 1987 1992 1997 2002 2007 2012

Perc

ent

Ch

ange

Note that recessions are different: 2001 had small drop in residentialinvestment, but 2008 had a huge drop.


While Non-Residential Investment Also Volatile

-10.0

-5.0

0.0

5.0

10.0

15.0

1947 1952 1957 1962 1967 1972 1977 1982 1987 1992 1997 2002 2007 2012

Perc

ent

Ch

ange


To Summarize (All Series Detrended by HP Filter)

Source: http://www3.nd.edu/~esims1/stylized_facts.pdf

Investment 2.76 times as volatile as GDP

Hours worked, consumption, investment, and TFP very cyclical

All variables above highly persistent


http://www3.nd.edu/~esims1/stylized_facts.pdf

Lower Income Countries more Volatile

Source: http://www.fperri.net/TEACHING/bocconi/20205/LEC10.pdf


http://www.fperri.net/TEACHING/bocconi/20205/LEC10.pdf

Causes and Consequences of Country Differences

Why?

Still under debate

Institutions/Corruption/Conflict?

Climate? (What is economic cost of global warming?)

Less ability to save and smooth?

More commodity-driven/less diversified economy, so more subject tosector-specific global shocks (Thanks Michael!)

Consequences

Poor individuals less able to save

⇒ If bad shock hits, no way to consumption smooth

⇒ May lead to abject poverty

⇒ Which in turn can lead to populist governments and bad politics


Major Questions of Business Cycle Theory

1 What causes business cycles?

Is it persistent shocks?Or is it from our response to temporary shocks?

2 Why do different goods categories have different responses?

3 What kinds of policies can smooth cycles?


A brief note on prediction

Economists at policy institutions and banks often try to predict onset ofbusiness cycles with leading indicators

Logic

If falls in labor productivity always preceed falls in output, we can predictthat output will fall, say, 2 quarters after an observed drop in laborproductivity.

Common leading indicators include

1 Weekly hours

2 Initial claims for unemployment insurance

3 Manufacturer new orders

4 Housing permits/starts

5 Index of Consumer Expectations


A word of caution

Lucas Critique

Without knowing the underlying mechanisms behind these statisticalrelationships, subject to mistakes if rules of the game change.

For example, residential investment fell a lot in 2008, but did not in 2001.

We need theory of business cycles


The predictive power of the yield curve

-4.00

-3.00

-2.00

-1.00

0.00

1.00

2.00

3.00

4.00

1953 1958 1963 1968 1973 1978 1983 1988 1993 1998 2003 2008 2013

Spre

ad b

etw

een

10

yea

r an

d 1

yea

r Tr

easu

ry Y

ield

s

“Yield on t-year Treasury Bond” means interest rate demanded to lend $1to the government for t years


Why might the yield curve be predictive?

Let iLt be the interest rate (yield) on a 10-year treasury in period t, andlet iSt be the yield on a 1-year treasury in period t. Then

iLT ≈1

10iSt +

1

10Et [iSt+1] + . . .+ Et [iSt+10]

Why? If iLt were much larger than the above, then should buy long-termbond and sell short-term bond because get higher return for it(no-arbitrage).

Suppose that above holds and iLt >> iSt . Then

Investors must expect future rates to be higher.

Rates tend to be higher in good times because Fed raises rates tocool inflation (more on this later/in ECON 203)

So must expect good times in future.

But if reverse is true iLt < iSt , then expect bad times in future. This iscalled an “inverted yield curve”


How to think about differences in Cyclicalilty?

Differences in Income Elasticities

Definition: Engel curves

An Engel curve plots the amount consumed of a product as you increaseincome

0

0.5

1

1.5

2

2.5

3

3.5

1 2 3 4 5

Co

nsu

mp

tio

n o

n G

oo

d T

ype

i

Income

Engel Curves by Consumption Type

Non-Durable Goods Durable Goods


Income Elasticities and Business Cycle Volatility

Definition: Income Elasticity

A good i ’s income elasticity is defined to be the percent change inconsumption of i for a 1 percent change in income. That is

ηi =%∆xi%∆Y

1 Suppose that output falls so that we become poorer2 The amount that consumption of goods fall depends on the good’s

income elasticity3 More income elastic goods fall more4 Non-durable consumption tends to be a necessity (ηi < 1): we always

need to eat.5 Durable consumption may be a luxury (ηi > 1): we can put off

purchasing a new car


Transmission Mechanisms

Income elasticity explanation is nice, but inconsistent with permanentincome hypothesis.

⇒ Why wouldn’t we just consumption smooth if shocks truly temporary?

Need mechanism to make temporary shock permanent. Possibilities

1 Pass-through to investment (Real Business Cycle Theory)2 Financial constraints: shocks require deleveraging3 Adjustment costs force large drops in anticipation of future shocks4 Businesses/workers do not enter during recessions ⇒ missing

generation of ideas/human capital growth


Unemployment Rate Clearly Pro-Cyclical

0

2

4

6

8

10

12

1947 1952 1957 1962 1967 1972 1977 1982 1987 1992 1997 2002 2007 2012

Un

emp

loym

en

t R

ate

(%)


Real Business Cycle (RBC) in words

Developed by Kydland and Prescott (1982) [won them the Nobel Prize]

1 There is a temporary fundamental shock in period 0 (e.g. productivityshock)

2 Return to working is lower, so households supply less labor

3 That reduces income in the economy by more than if productivityshock were only change

4 Smaller pie today + consumption smoothing ⇒ less capitalacquisition

5 End up with smaller capital stock in period 1, so lessoutput/consumption in period 1

6 Thus temporary shock spills over into future periods


Short-Run Productivity Shocks: What are they?

Much of our theory revolves around a production function of the form

Y = AF (K , L)

so that output Y is a function of capital K and labor L, multiplied bya productivity parameter A

Easy to think about long run growth in A from technology/education

But what could be an exogenous temporary downward shock in A?

1 Weather (particularly for agriculture)2 Adjustments to new technology requires learning3 “Forgetting” how to do something (maybe from firm exit/retirement)4 Wartime destruction5 Strikes6 Shifts in regulation/laws/institutions7 Infrastructure depreciation




Y = AF (K , L)



But what could be an exogenous temporary downward shock in A?1 Weather (particularly for agriculture)

2 Adjustments to new technology requires learning3 “Forgetting” how to do something (maybe from firm exit/retirement)4 Wartime destruction5 Strikes6 Shifts in regulation/laws/institutions7 Infrastructure depreciation




Y = AF (K , L)



But what could be an exogenous temporary downward shock in A?1 Weather (particularly for agriculture)2 Adjustments to new technology requires learning

3 “Forgetting” how to do something (maybe from firm exit/retirement)4 Wartime destruction5 Strikes6 Shifts in regulation/laws/institutions7 Infrastructure depreciation




Y = AF (K , L)



But what could be an exogenous temporary downward shock in A?1 Weather (particularly for agriculture)2 Adjustments to new technology requires learning3 “Forgetting” how to do something (maybe from firm exit/retirement)

4 Wartime destruction5 Strikes6 Shifts in regulation/laws/institutions7 Infrastructure depreciation




Y = AF (K , L)



But what could be an exogenous temporary downward shock in A?1 Weather (particularly for agriculture)2 Adjustments to new technology requires learning3 “Forgetting” how to do something (maybe from firm exit/retirement)4 Wartime destruction

5 Strikes6 Shifts in regulation/laws/institutions7 Infrastructure depreciation




Y = AF (K , L)



But what could be an exogenous temporary downward shock in A?1 Weather (particularly for agriculture)2 Adjustments to new technology requires learning3 “Forgetting” how to do something (maybe from firm exit/retirement)4 Wartime destruction5 Strikes

6 Shifts in regulation/laws/institutions7 Infrastructure depreciation




Y = AF (K , L)



But what could be an exogenous temporary downward shock in A?1 Weather (particularly for agriculture)2 Adjustments to new technology requires learning3 “Forgetting” how to do something (maybe from firm exit/retirement)4 Wartime destruction5 Strikes6 Shifts in regulation/laws/institutions

7 Infrastructure depreciation




Y = AF (K , L)



But what could be an exogenous temporary downward shock in A?1 Weather (particularly for agriculture)2 Adjustments to new technology requires learning3 “Forgetting” how to do something (maybe from firm exit/retirement)4 Wartime destruction5 Strikes6 Shifts in regulation/laws/institutions7 Infrastructure depreciation


econ 202: macroeconomics i lecture 9 - business cycle...

Documents