Lecture 2 Business Cycle

Question 1

Features of the business cycle?

Answer 1

1. Business cycles are fluctuations of aggregate economic activity.
2. There are expansions and contractions.
3. Economic variable show comovement - they have regular and predictable patterns of behaviour over the course of the business cylce
4. The business cycle is recurrent, but not periodic (e.g. not a recession every 10 years), but there will be one for sure.
5. The business cycle is persistent (seasonal events arent business cylce)

(at negative growth rate - raise in unemployment (could be a sign for a recession))

Question 2

Name procyclical, countercyclical, acyclical and volatility facts.

Answer 2

Procyclical:
Coincident: industrial production, consumption, business fixed investment
Leading: average labour productiity, money growth, stock prices
Lagging: inflation, nominal interest rates
Time not designated: government purchases, real wage

Countercyclical: unemployment

Acyclical: real interest rates

Volatility: durable goods eg cars production is more volatile than nondurable goods and services. Investment spending is more volatile than consumption

Question 3

RBC model

Answer 3

Any business cycle has two components: model which describes how key macroeconomic variables respond to economic shocks and description of the types of shocks believed to affect the economy the most. Real shocks to the economy are the primary cause of business cycles.

Question 4

Name examples of real shock

Answer 4

Shocks to the production fct, size of labour force, real quantity of government purchase, shocks to the spending and saving decisions of consumers. Largest role is played by shocks to the production function eg new product. techniques, changes in the quality of labor or capital, changes in government regulations…..

Nominal shocks are shocks to money supply or demand.

Question 5

Calibration in steps!

Answer 5

1. Formulating an economic question.
2. Selection of model design
3. Choice of functional forms for the primitives of the model
4. Choice of parameters and stochastic processes for the exog. variables
5. Selection of a metric to compare the outcomes of the model relative to a set of stylized facts
6. Policy analysis is required

Question 6

Major element of RBC

Answer 6

makes quantitative not just qualitative predicitions about the business cycle. Use method of calibration to work out a detailed numeric example….simulate what happens when the shocks arise, under specified variables and model. In general question: How to do empirical work? There are also other ways..

Question 7

Are productivity shocks the only source of recessions?

Answer 7

Except of oil price shocks, there are no productivity shocks that one can easily identify that caused recession. It also doesnt have to be a big shock, instead cumulation of many small shocks. Shocks can cause business cycle. But there are large shocks which arent productivity shocks.

Question 8

What do Keynesians think?

Answer 8

Keynsians think aggregate demand shocks are the primary source of business cycle fluctuations and Keynesian theory fits certain business cycle facts eg employment fluctuates in the same direction as output, money is procyclical and lagging (also inflation): Price level declines after recession.