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slide 1 Business Cycles  Business Cycles – Business cycles are 2-year to 5-year fluctuations around trends in real GDP and other related variables – A recession is a large fall in the growth of real GDP and related variables A depression is an especially large recession

slide 2 Business Cycles

slide 3 Real GDP Growth in the United States Average growth rate = 3.5%

slide 4 Recessions in the U.S. since World War II Year and quarter of peak in RGDP Number of quarters until trough in RGDP Change in RGDP, peak to trough (%) 1948:4 1953:2 1957:3 1960:1 1970:3 1973:4 1980:1 1981:3 1990: No simple regular or cyclical pattern: output changes very considerably in size and spacing

slide 5 Behavior of the Components of Output in Recessions Component of GDP Average Share in GDP (%) Average Share in fall in GDP in recessions relative to normal growth (%) Consumption Durables Nondurables Services Investment Residential Business Fixed Inventories Net Export Gov’t Purchases Fluctuations are distributed very unevenly over the components of output

slide 6 Cyclical Behavior of Key Macroeconomic Variables  Procyclical variable – An economic variable that moves in the “same” direction as aggregate economic activity industrial production, consumption, investment, employment, real wage, inflation, stock prices  Countercyclical variable – An economic variable that moves in the “opposite” direction as aggregate economic activity unemployment

slide 7 Cyclical behavior of the index of industrial production

slide 8 Cyclical behavior of consumption and investment

slide 9 Cyclical behavior of civilian employment

slide 10 Cyclical behavior of the unemployment rate

slide 11 Cyclical behavior of average labor productivity and the real wage

slide 12 Supply shocks A supply shock alters production costs, affects the prices that firms charge. (also called price shocks) Examples of adverse supply shocks:  Bad weather reduces crop yields, pushing up food prices.  Workers unionize, negotiate wage increases.  New environmental regulations require firms to reduce emissions. Firms charge higher prices to help cover the costs of compliance. (Favorable supply shocks lower costs and prices.)

slide 13 CASE STUDY: The 1970s oil shocks  Early 1970s: OPEC coordinates a reduction in the supply of oil.  Oil prices rose 11% in % in % in 1975  Such sharp oil price increases are supply shocks because they significantly impact production costs and prices.

slide 14 SRAS 1 Y P AD LRAS Y2Y2 The oil price shock shifts SRAS up, causing output and employment to fall. A B In absence of further price shocks, prices will fall over time and economy moves back toward full employment. SRAS 2 CASE STUDY: The 1970s oil shocks A

slide 15 CASE STUDY: The 1970s oil shocks Predicted effects of the oil price shock: inflation  output  unemployment  …and then a gradual recovery.

slide 16 CASE STUDY: The 1970s oil shocks Late 1970s: As economy was recovering, oil prices shot up again, causing another huge supply shock!!!

slide 17 CASE STUDY: The 1980s oil shocks 1980s: A favorable supply shock-- a significant fall in oil prices. As the model would predict, inflation and unemployment fell: