Business Cycles Flashcards
What are business cycles?
Recurrent expansions and contractions in economic activity affecting broad segments of the economy.
What are important characteristics of business cycles?
Rely mainly on business enterprises - not agrarian societies or centrally planned economies.
The cycle has an expected sequence of phases, alternating between expansion and contraction (upswings and downturns).
Such phases occur at about the same time throughout the economy.
Cycles are recurrent; they happen again and again but not in a periodic way, they do not all have the same intensity and duration.
In which two broad phases can you divide a business cycle?
Expansion or upswing (with peak) and contraction or downturn (with trough)
What is a classical cycle?
Refers to fluctuations in the level of economic activity (measured by GDP). The contraction phases are often short, whereas expansion phases are much longer.
What is a growth cycle?
Refers to fluctuations in economic activity around the long-term potential or trend growth level. The focus is on how much actual economic activity is below or above trend growth in economic activity.
What is a growth rate cycle?
Refers to fluctuations in the growth rate of economic activity. Peaks and troughs are mostly recognized earlier than when using the other two definitions. One advantage of this approach is that it is not necessary to first estimate a long-run growth path.
What are the four phases of a business cycle?
Recovery
Expansion
Slowdown
Contraction
What is the recovery phase of a business cycle?
The economy is going through the trough of the cycle, where actual output is at its lowest level relative to potential output. Economic activity is below potential but is starting to increase, closing the negative output gap.
What is the expansion phase of a business cycle?
The recovery gathers pace, output increases, and the rate of growth is above average. Actual output rises above potential output and the economy enters to so-called boom phase. Consumers increase spending, and companies increase production, employment, and investment. Prices and interest rates may start increasing. As the expansion continues, the economy may start to experience shortages in factors of production.
What is the slowdown phase of a business cycle?
Output of the economy reaches its highest level relative to potential output. The growth rate begins to slow, and the positive output gap begins to narrow. Consumers remain optimistic about the economy, but companies may rely on overtime rather than using new hires to meet demand. Inflation slows at some point, and price levels may decrease.
What is the contraction phase of a business cycle?
Actual economic output falls below potential economic output. Consumer and business confidence declines. Companies reduce costs by eliminating overtime and reducing employment. The economy may experience declines in absolute economic activity; a recession or even a depression.
How does inflation move with the cycle phases?
Inflation remains moderate in recovery phase, picks up pace in expansion, accelerates further in slowdown, and decelerates in contraction. Hence, it has a lag.
How are investors behaving throughout the phases?
Recovery: risky assets will be repriced upwards and markets will start incorporating higher profit expectations into prices of bonds and stocks.
Expansion: strong confidence, profit and credit growth. Also, companies expand largely which raises wages. Central bank can step in if concerned about overheating.
Slowdown: risky assets are at high prices and safer assets at lower prices but therefore higher yields.
Contraction: safer assets become wanted again.
When is an economy stated to be in a recession?
After the real GDP has two consecutive quarters of negative growth.
What is a credit cycle?
They describe the changing availability and pricing of credit. They describe growth in private sector credit, which is essential for business investments and household purchases of real estate.
How does a credit cycle reflect a business cycle?
When the economy is strong or improving, the willingness of lenders to extend credit, and on favorable terms, is high.
When the economy is weak or weakening, lenders pull back by making it less available and more expensive.
How are employment and business cycles related?
When the economy enters recovery, business rely on overtime before moving to hiring. Unemployment remains higher than average.
In expansion, business move from overtime to hiring, unemployment rate stabilizes and starts falling.
In slowdown, business continue hiring but at slower pace, unemployment rates still falling but at slower rates.
In contraction, business first cut hours, eliminate overtime and freeze hiring. Unemployment rates starts to rise.
How are capital spending and business cycles related?
In recovery, businesses have low but increasing capital spending as companies start to enjoy better conditions. Since interest rates are low, also more investment.
In expansion, companies enjoy favorable conditions to spend and they will.
In slowdown, interest rates will be higher, aimed at reducing overheating and reducing investment.
In contraction, cutbacks.
What are leading, coincident and lagging economic indicators?
Leading economic indicators have turning points that usually precede those of the overall economy. Useful for predicting.
Coincident economic indicators have turning points that are usually close to those of the overall economy.
Lagging economic indicators have turning points that take place later than those of the overall economy.
Name some examples of leading, coincident and lagging economic indicators.
Leading:
Stock market
Housing prices
Retail sales
Interest spread
Building permits
Coincident:
Real personal incomes
Manufacturing and trade sales
Industrial production index
Lagging:
Duration of unemployment
Inventory to sales ratio
Inflation
Change in labor costs
Prime lending rate
What is a composite indicator?
Indicator that exists of multiple variables that tend to move together.
What is the Conference Board Leading Economic Index (LEI)?
A composite leading indicator consisting of 10 component parts.
What are the ten components of the LEI?
Average weekly hours (business will cut overtime before laying off workers in a downturn and increase it before rehiring in an upturn. It moves up and down before economy)
Average weekly initial claims for unemployment insurance (test of layoffs and rehiring)
Manufacturers’ new orders for consumer goods and materials (businesses cannot wait too long to meet demand without ordering. Orders tend to lead at upturns and downturns)
ISM new order index (reflects month on month change in new orders for final sales. Decline in new orders can signal weak demand)
Manufacturers’ new orders for non-defense capital goods (captures business expectations and offers first signal of movement up or down)
Building permits for new private housing units (Signals new construction activity as permits required before new building can begin)
S&P500 Index (stocks tend to anticipate economic turning points)
Leading credit index (reflects strength of financial system to endure stress)
Interest rate spread between 10 year treasury yield and overnight borrowing rates
Average consumer expectations for business conditions (survey based)
Leading, coincident and lagging indicators are based on historical cyclical observations!
What is a diffusion index?
It reflects the proportion of the index’s components that are moving in a pattern consistent with the overall index.
