1. BUSINESS CYCLES
Recurring changes in the level of business and economic activity over time
Economy grows,
reaches a peak,
begins a downturn
followed by a period of negative growth (recession)
Ends in a trough before the next upturn

3. To be considered a cycle, NBER has 4 Factors
1. Depth and Rebound (Amplitude):
Economic activity must show a
significant decline followed by a rebound
Length of Recessions and Recovery (Duration
Should be at least one year (to avoid any seasonal fluctuations)

4. 3.Impact on the Economy (Diffusion)
Must be broadly based throughout many industries and economic activities
Displacement and Utilization
Classify the cycle by degree of severity or strength

5. Measures the degree of disruption from recessions and degree of utilization from expansions
2 common displacement measures:
Unemployment & capital utilization
Business Cycle Dating Committee of the NBER delineates business cycles in the US

6. A second NBER definition is
Deviation cycle Or
More commonly, Growth cycles
Growth cycle is a significant deviation around the trend rate of change
Short term fluctuations in aggregate economic activity
Must meet the same duration criteria applied to business cycles

7. Measuring Business Cycles
The BC is analyzed by the following procedures:
NBER = A growth cycle method
Shumpeter = An equilibrium points method
EPA (Economic Planning Agency) = Diffusion Index
Australian Deviation cycle = high and low growth rates

8. Normal lower bound Slowdown Expansion slowdown Trend dec inc Recession
BOOM
Slowdown
Expansion
slowdown P S S
Trend G E T E
dec
inc
Normal lower bound
Recession

9. Example:
Product sales rarely grow in a constant fashion
There may be an underlying trend but
There are likely to be deviations from this trend
Deviations could be the result of cycles in the data

10. Schumpeter above Upswing phase Recession Phase Equilibrium
MSV
Schumpeter
above
Upswing phase
Recession Phase
Equilibrium
Inflection point
Inflection point
Inflection point be l ow
Revival
Depression phase

11. Each phase is defined as follows:
Recession:
A period of decline in aggregate economic activity lasting at least one year with widely diffused effects on the economy
Recovery:
A rebound period in aggregate activity characterized by relative stable prices, expanding output and productivity

12. Cycles will always occur so we need to work out ways of
predicting the timing,
predicting the amplitude
Providing suitable planning responses from a corporate point of view

13. Why Cycles?
Because of the existence of a lag between a force and the response to that force
Lags in business and economic forces and the response to those forces
e.g.
Change in demand level and corporate response in terms of higher output

14. Demand increases
Business executive may not recognize change immediately
May be reluctant to change output unless she knows that demand will endure
Takes time for production to fully adjust to demand
In the meantime, stock levels have dropped
Production will have to rise further to build stocks back up

15. The lag between action and reaction continues to apply
It takes time for production to react to the satisfactory levels of stock
By the time production returns to satisfactory level, stocks are way up.
So production is reduced below demand to reduce stock
Back to original situation and cycle repeats itself again

16. 5 Types of cycles Agricultural or Cobweb Cycles
Inventory or Kitchin Cycles
Fixed Investments or Juglar cycles
Building or Kuznets Cycles
Kondratieff Cycles

17. Agricultural or Cobweb cycles
Best known sector cycle in economics
Cobweb pattern – Nicholas Kaldor
Regular fluctuations occur in agricultural production because
The following period’s production is determined by current or past prices
The current price is determined by current production

18. Inventory or Kitchin or Metzler Cycles
Inventory fluctuations are caused by holding of inventories.
We hold inventories to:
Smooth production
Product more cost-effective lot sizes
To buffer stock and prevent lost sales due to insufficient stock
To take advantage of lower prices

19. Metzler’s Model Assumption: System is in equilibrium MPC = 0.6
Income = production for expected sales, inventories and investment
In current period, desired inventories are equal to a difference between actual and expected sales in the preceding period

20. Metzler’s Conclusion Total income approaches equilibrium
Inventories lag behind income

21. Fixed Investment Cycles or Juglar Cycles
Clement Juglar analyzed a behaviour of fixed investments
Fixed investments = business expenditures on equipments and structures
Conclusion:
Fixed investment has a longer life than inventories.
Fixed investment cycles is from 7 – 11 years

22. Building cycle or Kuznet cycle (construction cycle)
Both short term (tied to credit markets) and
Long term (tied to functions of demographics)
Building cycle was constructed to understand the phases of the real estate cycle (which is very important for investment)

23. Story:
During economic booms, demand for labour increases which in turn puts pressure on wages
Increased economic activity causes new family formations
Sparks the demand for new housing units
Boosts the economic output more
Process begins again

24. Building cycle has 4 phased
Development:
Demand picks up, and housing starts follows.
Low vacancy rates and rising rents.
Reaches maturity after about 3 – 5 years
Aggressive bidding up of land prices is a turning point

25. Overbuilding:
Housing sales outpaces home sales
Adjustment
Builders react to declining sales and curtails housing starts

26. Acquisition:
Housing starts continue to decline.
home sales are still firm
Building activity is further reduced though vacancy rates have peaked

27. Kondratieff Cycles (Long Wave cycles)
Long wave cycles with durations of 45 and 60 years.
4 Long wave theories in economic development
Shumpeter’s three-cycles schema
Forrester’s System Dynamics
Burns and Mitchell’s cycle of cycles
Rostow’s Stages of Long term growth

28. Forecasting Cycles Several methods to predict turning points
Cyclical Indexes using the decomposition method
Econometric and MARIMA models
Use of Composite Index based on business indicators
Pressure cycles

29. Cyclical indexes
Cyclical component is the wave-like movement along the long-term trend
Measure by the Cyclical Factors in the decomposition method
CF = Y/ TSI =
Actual data divided by Trend, Seasonal and Irregular
CMA / CMAT

30. A CF > 1  a deseasonlized value above long term trend.
Very difficult to analyze and forecast but can give insights into where an cyclical variable is headed.
Check the length and amplitude of the cycle and that may help you predict the next turning point.

31. Pay attention to periodicity and amplitude and make a projection.
1st Peak = July 1976 (Q3)
Trough=Jan 1979 (Q1)
Amplitude = 10 quarters
2nd peak, trough = July 1981 (Q3), Jan 86 (Q1) 18 quarters
3rd peak, trough = July 90 (Q3), Jan 95 (Q1)  18 quarters

32. Average period between peak and trough is 15
Average period between peak and trough is 15.3 quarters with a standard deviation of 4.6
Last peak was April 2003 (Q2) so expect a trough sometime around Oct 2005 (Q4) (about 10 quarters later)

33. Using Business Indicators
Operates usual up to 12 months ahead
Aim to anticipate turning points by
Constructing a series which displays maxima and minima some months ahead, as the data series you wish to forecast
Leading Indicators

34. Three classes of business Indicators:
Leading Indicators
Co-incident indicators
Lagging Indicators

35. Leading Indicators
These indicators forecast the timing of turning points not the magnitude of upswing or downswing.
Used to help anticipate turning points
They are used for event-timing forecasting

36. e.g. Stock building is an important factor in describing the cyclical movement in industrial production
Interest rates lead stock building in the economy
Interest rates is a leading indicator of industrial production
We don’t rely on one time series but number of time series which have properties of leading indicators and form an index out of them

37. Coincident Indicators
This guards against one series not giving the right information at the turning point
Coincident Indicators
These indicators measure how the economy (variable) is currently performing. An index is also the best measure

38. Lagging Indicators
Lags behind the general state of the economy (Variable) both on the up and down.
A composite index is also computed for this
Leading indicators change directions ahead of turns in the variable
Coincident turn at about the same time as the variable
Lagging follows the variable

39. Selection of Leading Indicators
Economic significance: must be backed by economic theory
Statistically adequate: Series should not be frequently or heavily revised
Historical conformity with business cycle:
Consistent patterns of rise and fall in line with the business cycle

40. 4. Cyclical timing records as leaders:
Must have be consistent as a leader
Smoothness:
Data series must be smooth for turning points to be easily identified
Promptness of publication:
It is of no use creating an indicator with a lead of 12 months if the data is published a year after the event.