chapter 3: Macroeconomic Fluctuations Flashcards
Contraction/Recession
A contraction or a recession is a period during which Y < 0
(Stylized Facts) Ineluctability
Business cycles exist always and everywhere.
(Stylized Facts) Irregularity
Business cycles are highly irregular, and therefore imperfectly predictable, as to their timing as well as to their amplitude.
(Stylized Facts)
Positive Correlations
Several real macroeconomic variables are strongly and positively correlated to real GDP (possibly with a lag). Such variables are
called “procyclical”.
(Stylized Facts)
Negative Correlations
Several real macroeconomic variables are strongly and negatively correlated to real GDP (possibly with a lag). Such variables are
called “countercyclical”.
AD
Aggregate Demand Curve
AS
Aggregate Supply Curve has a relationship between:
- total quantity of final G&S supplied by domestic suppliers
- general level of prices of final domestic production (P)
We are interested in fluctuations of
1 real economic activity (real GDP and correlated variables such as income, employment, consumption. . .)
2 prices
We distinguish
fluctuations
over long periods ➙ Growth trend
short-run fluctuations ➙ Business cycle
The growth trend
is the underlying long-term movement of
economic activity.
( the average annual growth rate over a long period)
The business cycle
describes the deviations of real GDP from its
growth trend
with Succession of:
- Peak: Point where the considered variable begins to decline
- Trough: Point where the considered variable begins to rise
Depression
A depression is a severe recession (at least 10% of cumulated contraction of Y)
Peak
Point where the considered variable begins to decline
Trough
Point where the considered variable begins to rise
Expansion/Boom
Depending on the context, an expansion describes the period during which Y> 0 or Y > Y trend.
The period during which Y > Y trend is also called a boom.
AD–AS Model is used to
Used to understand macroeconomic fluctuations
AD also depends on the behaviour of the Central Bank by:
1 Through interest rates
2 By regulating the financial sector
AD Curve
Why A Downward-Sloping Curve?
1 Substitution effect between domestic & foreign productions
2 Income effect
3 Interest Rates
Short-Run AS
Why An Upward-Sloping Inverted-L Curve?
1 Two physical limits to aggregate supply:
☞ Activity level at full capacity of profitable production
☞ Activity level at full employment of available labour
2 At lower activity levels, production capacities are under-used, there is unemployment and AS is more
horizontal because in the short-run,
Aggregate Demand Shock
An aggregate demand shock designates any change in the determinants of demand for domestic final G&S at a given general price level.
At least four simultaneous negative AD shocks can be identified
1 Credit crunch ➙ C and I fall
2 Negative wealth effect due to falling asset prices ➙ C and I fall
3 Loss of confidence due to uncertainty as to the seriousness of the crisis ➙ C and I fall
4 World trade contraction due to the first 3 shocks
➙ EX falls
☞ Public authorities have several instruments to stabilize the business cycle
➥ Fiscal Policy
➥ Monetary Policy
Expansionary Fiscal Policy
Increase in government spendings and/or reduction in net taxes aimed at increasing aggregate output
➥ At any given P ➙ G and/or C, I (through tax cut) increase
➥ AD shifts to the right
Contractionary Fiscal Policy
Reduction in government spendings and/or increase in net taxes aimed at reducing budget deficit
➥ At any given P
➙ G and/or C, I (through tax raise) decrease
➥ AD shifts to the lef
Expansionary Monetary Policy
Increase in money supply aimed at increasing aggregate output
➥ At any given P, any/both of the following increase
➙ C, I (through interest rate change)
➙ EX (through exchange rate change)
➥ AD shifts to the right
Contractionary monetary Policy
Reduction in money supply aimed at slowing down inflation
➥ At any given P, any/both of the following decrease
➙ C, I (through interest rate change)
➙ EX (through exchange rate change)
➥ AD shifts to the lef
Aggregate Supply Shock
An aggregate supply shock designates any change in the domestic supply of final G&S at a given general price level.
Stagflation
Stagflation—contraction of stagnation and inflation—designates a period of recession (or very weak economic growth) accompanied with inflation
Two kinds of inflation
1 Demand-driven inflation (“demand-pull inflation”) in case of positive AD shock
2 Supply-driven inflation (“cost-push inflation”) in case of negative AS shock
negative inflation
Shows that economic activity grows faster (because of production cost-reducing technological breakthrough, for instance) than money supply
➥ Not problematic, rather good news
➥ Very easy to remedy, at no cost
deflation
Shows that the economy is in a recession
➥ Deflation trap, difficult to escape: very worrying
Deflation is worrying for at least four reasons
1 Debts and debt repayments increase in real terms
2 Agents anticipating falling future prices delay important purchases ➥ C and I are reduced
3 Entrepreneurs anticipating falling output prices would be reluctant to engage into new activities
4 The CB is ill-equipped to fight deflation because
Hyperinflation
Hyperinflation is generally defined as inflation that exceeds 50% per month.
☞ Always caused by excess growth of money supply
