1. Definitions and Fundamentals Business cycle = cyclical change in business activities length of phase amplitude t KuB 1.1U. van Suntum 1 U van Suntum, Vorlesung KuB 1

Cycle-types (Josef Schumpeter, Business Cycles, 1939) Kitchins (3 years storage-cycles) Juglars (10 years investment-cycles) Kondratieffs (50 – 60 years construction and innovation-cycles) GDP real time t GDP real time t Reality: Cycle-types overlap KuB 1.1U. van Suntum 2 Theory: ideal types U van Suntum, Vorlesung KuB 2

Previous classification of cycle-phases (Gottfried Haberler, Prosperity and Depression, 1937) GDP real GDP trend time t 1. boom2. recession 3. crisis4. recovery today: rising trend => growth rates of GDP are relevant KuB 1.1U. van Suntum 3 U van Suntum, Vorlesung KuB 3

Business Cycle vs. Economic Growth Definition I: growth = trend of GDP cycles = cyclical deviations from trend Definition II: growth = rise in potential output cycles = cyclical change of capacity utilization t ln BIP PP ln BIP t Trend KuB 1.1U. van Suntum 4 U van Suntum, Vorlesung KuB 4

Definitions KuB 1.1 Capacity utilization: Output-Gap: (PO = potential output) U. van Suntum 5 U van Suntum, Vorlesung KuB 5

KuB 1.1U. van Suntum 6 U van Suntum, Vorlesung KuB 6

Alternative definitions of a recession (cf. SVR JG 2008, S. 78) Common definition : recession = real GDP (seasonally adjusted) declines for several (mostly: three) quarters shortcomings: lagged publication of GDP, frequent revisions National Bureau of Economic Research : recession = substantial decline in several indicators (GDP, industrial production, sales…) for more than a few months shortcomings: lagged publication, not very precise SVR : recession = decline of a (negative) relative output-gap of at least 2/3 of potential growth rate shortcomings: different calculations of potential output, definition sophisticated U. van Suntum, KuB 7 U van Suntum, Vorlesung KuB 7

Example for SVR-definition of a recession (cf. JG 2008/09, S. 80) Relative Output-gap 2008: + 0,9% Relative Output-gap 2009: - 0,5% =>decline of output-gap -1,4 percentage points potential output growth 2008: 1,6% Two thirds from that: 1,1% Difference > 0? 1,4 > 1,1 Output-gap 2009 <0? -0,5 < 0 recession U. van Suntum, KuB 8 U van Suntum, Vorlesung KuB 8

KuB 1.1 Cycle phases according to German Council of Economic Advisors (capacity utilization) GDP real /PO Upper turning point lower turning point Normal level of CU timeupswingdownswing U. van Suntum 9 U van Suntum, Vorlesung KuB 9

Concept of anticyclical business cycle policy (Keynes 1936) General Idea: Smoothing of cycles upswing: Budget-surplus, contractionary policy downswing/recession: Budget-deficits, expansionary policy on average (long run): balanced budget KuB 1.1U. van Suntum 10 U van Suntum, Vorlesung KuB 10

KuB 1.1 Classification of cycle indicators leading (e.g. orders) coinciding (e.g. industrial production) lagging (e.g. employment) „hard“(e.g. retail sales) „weak“ (e.g. consumer confidence) single (e.g. quantity of money) composite (e.g. FAZ-Indikator) real (e.g. orders, production) monetary (e.g. interest rates, prices) U. van Suntum 11 U van Suntum, Vorlesung KuB 11

g GDP t ( leading indicators ) ( coinciding indicators ) ( lagging indicators ) KuB 1.1U. van Suntum 12 U van Suntum, Vorlesung KuB 12

orders business climate consumer confidence stocks monetary growth interest rate spread Leading indicators KuB 1.1U. van Suntum 13 U van Suntum, Vorlesung KuB 13

industrial production GDP capacity utilization output gap retail sales Coinciding indicators KuB 1.1U. van Suntum 14 U van Suntum, Vorlesung KuB 14

inflation rate unemployment rate employment growth interest rates Lagging indicators KuB 1.1U. van Suntum 15 U van Suntum, Vorlesung KuB 15

KuB 1.1 Confidence indicators in Germany Ifo-business expectations industrie ZEW-business cycle expectations U. van Suntum 16 U van Suntum, Vorlesung KuB 16

KuB 1.1U. van Suntum 17 U van Suntum, Vorlesung KuB 17

U. van SuntumKuB 1.1 U van Suntum, Vorlesung KuB 18

GDP g BIP t t 0 Turning points: Level vs. Growth rate => Turning points of growth are leading KuB 1.1U. van Suntum 19 U van Suntum, Vorlesung KuB 19

Why cycle forecast is principally limited *) *) Source: S. Klein, Alles Zufall, Hamburg 2004, S. 50 f. KuB KuB 4 20 U van Suntum, Vorlesung KuB 20

Small inexactness... KuB KuB 4 21 U van Suntum, Vorlesung KuB 21

...amounts to total ignorance! KuB KuB 4 22 U van Suntum, Vorlesung KuB 22

GDP-forecast and reality reality in year t 1,0%0,2%-0,1% 1,8% SVR in autumn t-1 2,8%0,7%1,0%1,5% Institutes in spring t 0,7%0,9%0,5%1,5% KuB KuB 4 23 U van Suntum, Vorlesung KuB 23

% KuB KuB 4 24 U van Suntum, Vorlesung KuB 24

SVR-forecast vs naive forecast KuB KuB 4 25 U van Suntum, Vorlesung KuB 25

Digression: continuous vs. discrete growth KuB 1.1U. van Suntum 26 discrete: continuous: discrete rates are both better applicable in empirical research and more easily accessible continuous rates are both better applicable in theoretical research and more elegant U van Suntum, Vorlesung KuB 26

KuB 1.1U. van Suntum 27 Digression (continued): calculus using growth rates discrete: continuous: Only with small growth rates are the differences negligible! U van Suntum, Vorlesung KuB 27

KuB 1.1 Exercise (I) U. van Suntum 28 U van Suntum, Vorlesung KuB 28

KuB 1.1 Exercise (II) U. van Suntum 29 U van Suntum, Vorlesung KuB 29

Learning goals / review questions How do we classify the business cycle? How do we define capacity utilization and the output gap Which indicators are leading, lagging, coincident? What are the differences and comparative advantages of discrete vs. continuous growth rates? How do we calculate them? U. van SuntumKuB 1.1 U van Suntum, Vorlesung KuB 30