Business Cycles Empirical Properties

What do we mean by “The Business Cycle”?

Gross Domestic Product:

Since WWII, Nominal GDP has grown at an average annual rate of 6.8%

Gross Domestic Product:

Since WWII, Nominal GDP has grown at an average annual rate of 6.8% However, we know that some of this growth is simply due to prices.

Nominal vs. Real GDP:

What do we mean by “The Business Cycle”? Since WWII, real GDP in the US has grown an average of 3.5% per year. (The remaining 3.3% is a pure inflation effect)

Real GDP:

Detrending We can take any macroeconomic variable and break it down into 4 distinct frequencies: –Growth (Many Years)

Detrending We can take any macroeconomic variable and break it down into 4 distinct frequencies: –Growth (Many Years) –Business Cycle (1-2 Years)

Detrending We can take any macroeconomic variable and break it down into 4 distinct frequencies: –Growth (Many Years) –Business Cycle (1-2 Years) –Seasonal (Months)

Detrending We can take any macroeconomic variable and break it down into 4 distinct frequencies: –Growth (Many Years) –Business Cycle (1-2 Years) –Seasonal (Months) –Noise (< Month)

Detrending Before we can do any statistical tests, we must remove the growth component from the data (note: the seasonal component has already been removed) However, to do this, we need to know what the what the growth component is……this is very tricky! (Example: Global Warming)

Hypothesis 1: Linear Growth

Detrended?

Stationary Series If we have detrended properly, then the residual should be stationary (i.e. constant over time) While there are statistical tests to determine stationarity, we will rely on the “eyeball method”!

Hypothesis 2: Exponential Growth

Deviations From Trend

What do we mean by “The Business Cycle”? Since WWII, the US has experienced 11 recessions (followed by 11 expansions).

What do we mean by “The Business Cycle”? Since WWII, the US has experienced 11 recessions (followed by 11 expansions). The average contraction lasts 11 months while the average expansion lasts 15 months.

What do we mean by “The Business Cycle”? Since WWII, the US has experienced 11 recessions (followed by 11 expansions). The average contraction lasts 11 months while the average expansion lasts 15 months. Empirically, each of these recessions (and expansions) look “similar”

Characteristics of Business Cycles When we say that all recessions/expansions “look similar”, we mean that there seem to be consistent statistical relationships between GDP and the behavior of other economic variables.

Characteristics of Business Cycles When we say that all recessions/expansions “look similar”, we mean that there seem to be consistent statistical relationships between GDP and the behavior of other economic variables. Correlation (procyclical, countercyclical)

Characteristics of Business Cycles When we say that all recessions/expansions “look similar”, we mean that there seem to be consistent statistical relationships between GDP and the behavior of other economic variables. Correlation (procyclical, countercyclical) Timing (leading, coincident, lagging)

Characteristics of Business Cycles When we say that all recessions/expansions “look similar”, we mean that there seem to be consistent statistical relationships between GDP and the behavior of other economic variables. Correlation (procyclical, countercyclical) Timing (leading, coincident, lagging) Relative Volatility

% Deviations From Trend

GDP vs. Investment Std. Dev. (Y) = 4.09 Std. Dev. (I) = CORR(Y,I) =.55

GDP vs. Investment

Std. Dev. (Y) = 4.09 Std. Dev. (I) = CORR(Y,I) =.55 Investment is Procyclical and is Coincident with GDP

% Deviations From Trend

GDP vs. Government Purchases Std. Dev. (Y) = 4.09 Std. Dev. (G) = 11.2 CORR(Y,G) =.58

GDP vs. Government Purchases

Std. Dev. (Y) = 4.09 Std. Dev. (G) = 11.2 CORR(Y,G) =.58 Government Purchases is Procyclical and Leading