Macroeconomics: Business Cycles and Shocks

Question 1

Output gap:

Answer 1

• Difference between potential and actual output (See EC131)
• Growth and Cycles:
• Expansions occurring at the same time in many economic sectors, followed by similarly general recessions, contractions and revivals.
• Fluctuations occur in aggregate activity, not particular
sectors
• Business cycles are recurrent, but not periodic
• Cycles have at least two different stages: expansions and
contractions
• Once economy enters into one of the stages, it tends to
stay there for some time
• Regular and predictable co-movements between variables
over the cycles
• Co-movement around a trend.

Question 2

Business Cycles

• Definition:

Answer 2

Alternating periods of faster and slower (or even negative) growth rates. The economy goes from boom to recession and back to boom. (Unit 13, p.548, The Economy, The Core Team)

• Ongoing debates causes/drivers 
• Driven by theories and empirical 
	• Key variables
	• Expectations and Behaviour 
	(psychology)
	• Corrections - smooth or sticky

Question 3

What causes/drives Business Cycles?

Answer 3

• Terminology: procyclical; countercyclical; acyclical.
  
  • Volatility of Real GDP (approx. 1.3-1.7% around trend)
  • Cyclical component of Real GDP is highly persistent (positive deviations are followed with high likelihood of positive deviations)
  • Positive deviations from trend are more likely than negative deviations i.e. recessions are short and sharp; expansions are long and gradual

It is rare that growth rate of Real GDP is negative.

Question 4

Business Cycles

Consumption:

Answer 4

○ Large proportion of Real GDP e.g. Eurozone mid 50s%
○ Cyclical component less than 1%
○ Expectations - Y changes temporary or permanent
○ Financial Markets - Intertemporal Smoothing

Question 5

Business Cycles

Investment:

Answer 5

Smaller proportion of Real GDP e.g. 20%

• Cyclical component approx. 3%+
• Inertia, stickiness, longer ‘lead times’ (labour markets, decision-making and impact of productivity changes)

Question 6

Cumulative Causation

Answer 6

• Relationship between AD now and t+1etc., and between AD and AS
Dynamic complexity of the market mechanism

Question 7

Cumulative Causation

definition

Answer 7

“operation of markets…as a continuous process in which economic forces interact upon one another in a cumulative way, thus making for changes in one direction to induce supporting changes which push the system further away from its initial position” (Ricoy 1987)

Question 8

Hysteresis

Answer 8

• Natural science concept
  
  • Martin (2012) ‘spring analogy’
  • Economics interpretation around movement of stable equilibrium following ‘shock’
  • E.g. impact of recessionary shocks on the (national) labour market, and permanent upward shift in an economy’s so-called ‘natural (or non-accelerating inflation) rate of unemployment.

‘Permanent’ damage to resources, capabilities, expectations etc. Following negative shock