Macroeconomic Forces Chapter 2

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Macroeconomic ForcesChapter 2
2
Characteristics of the Business Cycle

• 1. Fluctuations in aggregate business activity
• 2. Characteristic of a market driven economy
• 3. Regular sequence of changes from expansion,
  downturn, contraction, recovery
• 4. Not periodic in duration, intensity, or
  scope.
• 5. Expansion and contraction occur in many
  phases of economic activity in both the real and
  financial sectors.
• 6. Cycles cannot be further subdivided into
  shorter cycles with similar characteristics

3
Duration of expansion, contraction, and full
cycle

• NBER reference dates http//www.nber.org/cycles.
  html/
• Macroeconomic data http//rfe.wustl.edu/Data/USMa
  cro/index.html
• Diffusion of industrial production

4
Past Business Cycles

• The 1970-75 Cycle (The Great Recession)
• Longest and most severe post-WWII recession (16
  months, 3.6 decline in real GDP, and 13 decline
  in industrial production)
• Causes of recession included both demand factors
  and supply factors
• a. Inflation due to relatively easy monetary
  policy prior to 1973
• b. Poor crop that drove up food prices
• c. Rapid increase in energy prices due to OPEC
  cartel
• d. Excessive inventory buildup and real estate
  speculation
• Endogenous forces set the stage for recovery as
  inflation slowed and inventories were worked
  down. Consumer debt was repaid and adjustments
  were made to higher energy prices.

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• The 1980 and 1981-82 Recessions
• Higher rates of inflation and lower real
  interest rates had maintained spending for
  housing and consumer durables until 1979. In
  late 1979 the Fed switched to monetary aggregates
  as a monetary policy target with resulting
  overnight increases in nominal interest rates.
  Private borrowing fell over 50 during the second
  quarter of 1980.
• In early July the Fed eased credit and interest
  rates fell resulting in renewed expansion over
  the 12 months from August 1980. Inflation
  remained in double-digit levels.
• The Fed again turned restrictive in and, together
  with high rates of inflation, pushed nominal
  interest rates upward to about 20 percent.
  Housing and consumer durable demand fell by over
  10 percent.
• Cooling inflation and tax cuts enacted in 1981
  led to economic recovery that continued from 1982
  to 1990 (92 months).

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• The 1990-91 Recession
• The official business cycle peak of July 1990 was
  not recognized until 9 months later and, in fact,
  real GDP did not fall until the fourth quarter of
  1990. Iraqs invasion of Kuwait occurred August
  1990 and public debate centered upon the impact
  of US involvement on domestic economic
  conditions.
• Higher debt loads by households and business and
  financial industry imbalances were a fundamental
  reason for the economic downturn. The invasion
  of Kuwait was probably a contributing factor.
• The economic recovery was slow relative to prior
  periods and, in fact, the unemployment rate
  increased because economic growth in the last
  three quarters of 1991 was 1.4, 1.8, and 0.3
  percent, respectively.

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• The 2001 recession
• Probably began in the second half of 2000 as
  industrial production declined in response to
  overinvestment in late 1990s
• Business investment in capital spending decreased
  and remained soft during recovery
• A relatively mild recession due to the resiliency
  of household spending and relatively strong
  housing demand.
• Labor markets reflect slow employment demand
  relative to output (jobless recovery)

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Five Lessons from 2001 Cycle

• Structural imbalances take time to resolve,
  especially in the capital goods sector.
• Uncertainty matters for economic decisions by
  business and households.
• September 11, 2001 terrorist attack
• Corporate financial reporting scandal
• Iraq war
• Aggregate monetary policy can mitigate recession
• Tax cuts and government spending boost economic
  activity
• Strong productivity growth raises standards of
  living but require much faster growth in order to
  raise employment

9
Indicator forecasting

• Strengths and weaknesses of indicator method
• Useful in identifying reference dates with
  composite measures
• May confirm strength of recovery or downturn
• May give false signals

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Econometric models

• Structural equations in early models did not link
  sufficiently to the financial sector (simple
  Keynesian with lags)
• Financial sector added in second generation
  models with greater disaggregated detail.
• Aggregate supply added after Great Recession.
• Macro models serve as a driver for industry and
  firm level projections that may be purchased from
  commercial vendors.