13-14 Flashcards
business cycles def
the business cycle is the fluctuations of output around its trend
product function is
a long-run model of output
output above trend
boom phase of business cycle
output significantly below trend
recession
how is the business cycle measured?
only by observing the GDP not its long-run trend
simple definition of recession of an economy
an economy is in recession if it experiences two consecutive quarters of negative growth
growth recession
when the economy keeps growing, but growth is lower than the long-run trend
depression
no precise definition, used to refer to a particularly bad and long-lasting recession
how to measure the output gap
- estimate trend (normal times)
- business cycle = actual GDP - trend (absolute measure)
- output gap = actual GDP / trend (% deviation) - estimate a production function
- use business surveys on capacity utilization
4 business cycles facts
- employment, consumption and investment are procyclical variables (they rise when GDP rises and vice versa)
- unemployment is countercyclical (it rises when GDP falls and vice versa)
- Expansions are longer than recessions; recessions are sharper than expansions
- cycles are correlated across sectors, regions and countries
Okun’s Law
when output falls, unemployment rises (2% output fall below trend –> 1% increase in unemployment)
Robert Lucas argument if business cycles are bad
- gains from increasing long-run growth are enormous
- gains from stabilizing business cycles are relatively small
motivation: aggregate consumption does not change much in recessions
but changes are very heterogeneous (across households and sectors)
=> the economy does not suffer much but somebody does
who is most influenced by the business cycle during a recession?
under 20 and above 46
unskilled manual
Distribution of impact of recession
- mostly fine for majority
- but sizable group of the population is badly hurt –> 1% of population suffers more than 10% consumption loss
- also, impact seems to be highest among the poorest
potential good out of recessions
- in booms, firms do not want to reorganize or change productive processes - it is too costly not to produce
- recessions can act as a pit stop to increase efficiency
Frisch-Slutsky Paradigm / Business cycle paradigm
idea: economy is subject to shocks = external impulses that affect the economy
- shocks create business cycles by affecting the economy through a propagation mechanism
examples of shocks affecting economies
- productivity shocks
- shifts in preferences
- changes in policy
- terms of trade shocks
how do shocks propagate?
- real business cycle theory
- business cycles are the efficient response of markets to the shocks that affected the economy - keynesian theory
- markets malfunction and the government should intervene to stabilize economy
real business cycle (RBC) theory
- business cycles are driven by changes in aggregate supply
- changes in TFP, changes in production costs
- idea: profit-maximizing decisions of firms and consumers respond to changes in TFP
- better TFP: firms want to hire more K and L, interest rates and wages rise, people consume more
- economy needs to be flexible: AS is verticl prices move fast; AD is downward slopping –> higher prices –> lower demand
thus, propagation mechanism is actually the efficient response of agents to mutated conditions in the market
Keynesian Viewpoint
- business cycles are driven by changes in aggregate demand
- questions whether markets actually work well during recessions
- argued that prices might not be able to adjust that quickly –> tend not to adjust downwards
- when prices do not adjust –> quantities have to move more because the market does not adjust
- sharp recessions and a potential role for governments
Keynesian viewpoint: market functions badly
- slow price adjustment
-wage rigidities - imperfect competition
- flaws in credit markets and banking sector
keynesian view of aggregate supply
- less vertical in the short run (but still vertical in the log run)
- firms may find it optimal to raise their production with a rise in the sales price
- hence in the short un, the level of prices affects output
In the short run…
demand determines output –> Keynesian model
in the long run…
supply determines output –> RBC model
from short run to long run
- as long as economy operates below capacity (recession) we can stimulate demand to raise output
- government: increase spending, lower taxes
central bank: lower nominal interest rate
combining short run and long run
- works at capacity, demand stimuli only raise prices
- we need to raise aggregate supply to raise output
(technology, human capital, institutions)
