Chapter 3 Business Cycle Measurement Macroeconomics 6th Edition Stephen D. Williamson Copyright © 2018, 2015, 2011 Pearson Education, Inc. All rights reserved.

Learning Objectives, Part I 3.1 State the key regularities in GDP fluctuations. 3.2 Explain the importance of comovement among economic time series. 3.3 State the key properties of comovements among the components of GDP. This chapter deals with some of the key regularities in business cycle activity that we can measure in the data. We will use these regularities in subsequent chapters to help us evaluate business cycle models. Independent of that, every good macroeconomist should understand these key regularities in the data, and have them at his or her fingertips. Copyright © 2018, 2015, 2011 Pearson Education, Inc. All rights reserved.

Learning Objectives, Part II 3.4 Discuss why comovements between the price level and real GDP and between the inflation rate and real GDP are important to our understanding of business cycles. 3.5 State the key comovements among labor market variables and real GDP. Copyright © 2018, 2015, 2011 Pearson Education, Inc. All rights reserved.

Learning Objectives, Part III 3.6 Explain the importance of seasonal adjustment. 3.7 State the key business cycle facts. Copyright © 2018, 2015, 2011 Pearson Education, Inc. All rights reserved.

Regularities in GDP Fluctuations Business Cycles are fluctuations about trend in real GDP. The turning points in the deviations of real GDP from trend are peaks and troughs. Persistent positive deviations from trend are booms and persistent negative deviations from trend are recessions. This is a basic definition of what we consider business cycles. Business cycles are persistent deviations in real GDP from trend – booms and recessions. Copyright © 2018, 2015, 2011 Pearson Education, Inc. All rights reserved.

Figure 3.1 Idealized Business Cycles Though the data is much more choppy than this, real GDP follows a cycle about trend, much like a cosine wave in physics, with peaks and troughs. Copyright © 2018, 2015, 2011 Pearson Education, Inc. All rights reserved.

Deviations From Trend in Real GDP are Irregular The fluctuations in GDP about trend are quite choppy. There is no regularity in the amplitude of fluctuations in real GDP about trend. There is no regularity in the frequency of fluctuations in real GDP about trend. In contrast to a cosine wave in physics, real GDP fluctuations about trend are not regular – they are highly irregular, i.e. noisy. The amplitude is not regular, and neither is the frequency. Thus, it is hard to predict recessions, and hard to predict their severity. Copyright © 2018, 2015, 2011 Pearson Education, Inc. All rights reserved.

Figure 3.2 Percentage Deviations from Trend in Real GDP The figure shows actual percentage deviations from trend in real GDP in the United States since 1947. This illustrates the irregularity in business cycles. But, note that deviations from trend are persistent – that’s important. Copyright © 2018, 2015, 2011 Pearson Education, Inc. All rights reserved.

Figure 3.3 Time Series Plots of x and y This slide and the next exhibits correlation, as we would observe it in time series data, and in scatter plots. Copyright © 2018, 2015, 2011 Pearson Education, Inc. All rights reserved.

Figure 3.4 Correlations Between Variables y and x If two time series are perfectly positively (negatively) correlated, then a scatter plot will be a positively (negatively) sloped straight line. Otherwise, correlation is determined by the slope of a straight line that is the best fit to the data. Copyright © 2018, 2015, 2011 Pearson Education, Inc. All rights reserved.

Correlation with Real GDP If the deviations from trend in a macroeconomic variable are positively (negatively) correlated with the deviations from trend in real GDP, then that variable is procyclical (countercyclical). If a macroeconomic variable is neither procyclical nor countercyclical, it is acyclical. Correlation with real GDP is important. We say that time series are procyclical, countercyclical, or acyclical, according to whether the time series is positively, negatively, or not correlated with real GDP. Copyright © 2018, 2015, 2011 Pearson Education, Inc. All rights reserved.

Figure 3.5 Imports and GDP This is an example to illustrate correlation and cyclicality. In the time series, we can see that imports and real GDP are positively correlated, i.e. imports are procyclical. Copyright © 2018, 2015, 2011 Pearson Education, Inc. All rights reserved.

Figure 3.6 Scatter Plot of Imports and GDP In the scatter plot, a positively sloped straight line would best fit the data, so imports and real GDP are positively correlated. Imports are procyclical. Copyright © 2018, 2015, 2011 Pearson Education, Inc. All rights reserved.

Figure 3.7 Leading and Lagging Variables Another key element of time series behavior is lead/lag relationships. The figure shows examples where x leads GDP, and where y is a lagging variable. Copyright © 2018, 2015, 2011 Pearson Education, Inc. All rights reserved.

Figure 3.8 Percentage Deviations in Real GDP and Housing Starts Housing starts are an example of an economic time series that leads real GDP. Typically, when a house is started, it implies that residential investment will take place over several months in the future, and residential investment is a component of real GDP. Further, people build houses when they anticipated economic activity will be high in the future, so that the houses can be sold. Thus, housing starts tend to lead aggregate economic activity. Copyright © 2018, 2015, 2011 Pearson Education, Inc. All rights reserved.

Behavior of Key Macroeconomic Variables Components of GDP: consumption and investment. The price level and inflation. Labor market variables: employment, real wage, average labor productivity. In the next slides, we will look at the behavior of some key macroeconomic variables, all of which play key roles in the models we will construct in the subsequent chapters. Copyright © 2018, 2015, 2011 Pearson Education, Inc. All rights reserved.

Figure 3.9 Percentage Deviations from Trend in Real Consumption and Real GDP Consumption is a large fraction of GDP (about 70%), and it is smooth relative to GDP, and procyclical. Copyright © 2018, 2015, 2011 Pearson Education, Inc. All rights reserved.

Figure 3.10 Percentage Deviations from Trend in Real Investment and Real GDP Investment is much more volatile than is GDP, and it is procyclical. Copyright © 2018, 2015, 2011 Pearson Education, Inc. All rights reserved.

Figure 3.11 Percentage Deviations From Trend in the Price Level and Real GDP The correlation of the price level with real GDP is close to zero. This was not always so, as the price level tended to be negatively correlated with real GDP early in the post-World War II period. However, over some periods of time in history, the price level has been procyclical. Copyright © 2018, 2015, 2011 Pearson Education, Inc. All rights reserved.

Figure 3.12 The Inflation Rate and GDP A positive correlation in the data of in the inflation rate with real GDP would be evidence of a Phillips curve relation. There is a mildly positive correlation in the data in the figure – some evidence for the Phillips curve. Copyright © 2018, 2015, 2011 Pearson Education, Inc. All rights reserved.

Figure 3.13 Percentage Deviations from Trend in Employment and Real GDP Employment is procyclical, but is less variable than real GDP. Copyright © 2018, 2015, 2011 Pearson Education, Inc. All rights reserved.

Figure 3.14 Percentage Deviations from Trend in Average Labor Productivity and Real GDP The behavior of average labor productivity is sometimes important in distinguishing among theories of the business cycle. In the data, average labor productivity is procyclical. Copyright © 2018, 2015, 2011 Pearson Education, Inc. All rights reserved.

Figure 3.15 Seasonally Adjusted and Unadjusted Unemployment Rate Essentially all the data that macroeconomists look at is seasonally adjusted. Statisticians take account of the regular seasonal fluctuations in the data and try to take them out in a consistent way. The figure shows the difference between the unadjusted and adjusted data for the unemployment rate, to show the amount of seasonal variation that is taken out. Sometimes there are issues with seasonal adjustment – a problem is that seasonal adjustment is purely statistical and takes no account of economic factors. Copyright © 2018, 2015, 2011 Pearson Education, Inc. All rights reserved.

Table 3.1 Correlation Coefficients and Variability of Percentage Deviations from Trend Standard Deviation (% of S.D. of GDP Consumption 0.77 77 Investment 0.80 301 Employment 0.78 65 Average Labor Productivity 63 This table and the next are a convenient summary of key business cycle facts. These will be a useful reference, particularly in Chapters 13 and 14, where we study business cycle theory. Copyright © 2018, 2015, 2011 Pearson Education, Inc. All rights reserved.

Table 3.2 Summary of Business Cycle Facts Cyclicality Lead/Lag Variation Relative to GDP Consumption Procyclical Coincident Smaller Investment Larger Employment Lagging Real Wage ? Average Labor Productivity Copyright © 2018, 2015, 2011 Pearson Education, Inc. All rights reserved.