Lecture 29: Business Cycles and Schools of Thought Flashcards
What is an expansion? Where does it fall of the business cycle?
A period when the economy grows at a rate significantly above normal
a period between a trough and a peak
What is a strong, long expansion called?
a boom
Who’s GDP is more variable, Australia or NZ?
NZ
Economic fluctuations (business cycles) are ____________ in _______ and _________-
irregular
length
severity
Most macroeconomic quantities fluctuate ____________. What are some examples of this?
together
such as the economy slowing down, unemployment rises, investment slows
As output falls, unemployment _________
rises
Industries that produce durable goods are more/less affected than nondurable and service industries? Why is this?
more
because you can put off the consumption of a good (durable goods such as cars) because the economy is slowing down but you can’t put off the consumption of others (non-durable goods such as food)
What is a durable good? Give an example
this is a good that is expected to last more than 3 years such as car
What is a nondurable good? Give an example
goods that are consumed over a short period of time such as food
Recessions are usually followed by a decline in ___________ and may have been preceded by an increase in __________
inflation
inflation
Recessions are often caused by __________ tightening at the end of an __________
monetary
expansion
How does less inflation lead to recession?
There is less demand for goods and services, less demand for resources, less pressure on prices so the increase in prices is slow, not price decrease
How does monetary tightening lead to recession?
Monetary policy is about controlling interest rates and so a tightening would increase interest rates so it is more expensive to borrow money so there is more incentive to save not spend
Define determinants of the macro economy
things that effect the macro economy
What are three determinants of the macro economy?
- internal market forces
- external shocks
- policy levers
What are policy leavers?
fiscal and monetary policy to stabilise the economy and respond to external shocks
What are 5 outcomes from the macroeconomy?
output jobs prices growth international balances
Define the outcomes of the macro economy
stuff to measure
What is the role of monetary policy?
to control interest rates to keep inflation between 1-3%
Describe a recovery/expansion:
- What is happening to unemployment?
- What is happening to wages?
- What is happening to the inflation?
- What is happening to the outlook?
- What is happening to the willingness to spend?
- What is happening to the demand for goods?
- What is happening to the banks willingness to make loans?
- What is happening to business profits?
- what is happening to stock prices?
- What is happening to the general economic climate?
- unemployment is falling
- wages are increasing
- inflation is rising
- the outlook is optimistic
- people are more willing to spend
- the demand for goods increases
- banks are more willing to make loans
- business profits are rising
- stock prices are rising
- climate is more buoyant
Describe a peak:
- what is happening to the economic growth?
- What is happening to the real GDP?
- What is happening to business capacity and employment?
- What is happening to the general economic outlook?
- What is happening to the expectations on future investment?
- What is happening to inflation?
- What is happening to consumer spending on durable goods?
- What is happening to the economy?
- economic growth slows
- real GDP is at a maximum
- businesses are at full capacity and so new workers are employed
- the general economic outlook is cautious
- expectations on future investment is poor
- inflation is generally high
- consumers may hold off durable goods spending
- the economy begins to contract
Describe a recession/contraction:
- what is happening to business production?
- What is happening to real output?
- What is happening to unemployment?
- What is happening to the number of available jobs?
- What is happening to the banks willingness to lend?
- What is happening to inflation?
- What is happening to the general economic outlook?
- What is happening to consumption spending?
- businesses cut back production
- real output falls
- unemployment rises
- the number of available jobs declines
- banks reluctant to lend
- inflation is likely to decrease
- general economic outlook is pessimistic
- consumption spending falls
Describe a trough:
- where is this on the business cycle?
- What is happening to unemployment?
- What is happening to consumer spending?
- What is happening to general economic outlook?
- What is happening to inflation?
- What is it often called?
- at the lowest point in the cycle
- unemployment is at its highest
- consumer spending is very low
- general economic outlook is very poor
- inflation tends to be low
- usually called a depression
Prolonged contraction is called a __________ and it is defined as …..
depression
two or more consecutive quarters of negative real GDP growth
What are the four variables that causes changes in the business cycle?
- business investment
- interest rates and credit
- consumer expectations
- external shocks
How does business investment affect the business cycle?
The economy is expanding, sales and profit is rising, companies are investing in new plants/equipment, creating new jobs and more expansion. In contraction, the opposite is true
How does low interest rates affect the business cycle?
Low interest means means companies make new investments, adding jobs. When interest rates climb, investment dries up so there is less job growth
How does consumer expectations affect the business cycle?
Forecast of expanding economy fuels more spending, while fear of a recession decreases consumer spending
What are three different schools of thought?
- classical
- Keynesianism
- monetarism
Describe classical school of thought
- prices, wages and rates are flexible and markets always clear
- there is no unemployment so growth depends on the supply of production factors
- markets best achieve stability and growth rather than government intervention
- government policy for creating a conductive environment via market friendly policies with respect to education and research
- the government should just get out of the way and let markets to their thing
What is the issue with the classical school of thought?
This school of thought says that markets should be left alone as though there is an invisible hand and individual needs allocate resources efficiently. However, the market doesn’t always do this (eg. externalities)
Describe the Keynesian school of thought?
They believe in active government intervention via fiscal and monetary policy to manage the business cycle - spending more in recessions to stimulate demand and stimulating demand with lower rates
Keynesian economists rely on certain rigidities in the system such as
sticky wages and prices preventing clearing of supply and demand
What do monetarist economists believe?
- the role of the government is to control inflation by controlling the money supply
- markets typically clear and that participants have rational expectations
What Keynesian notion do monetarists reject?
that governments can manage aggregate demand and that attempts to do so are destabilising and likely to be inflationary
Compare Keynesian and Monetarism views
Keynesian emphasises the role that fiscal policy can play in stabilising the economy. Higher government spending in a recession can help the economy recover quicker. It is a mistake to wait for markets to clear like classical economic theory suggests
Monetarism sees the importance of controlling the money supply to control inflation. They are generally critical of expansionary fiscal policy arguing causes inflation or crowding so doesn’t help
