1. Copyright © 2011 Pearson Education. All rights reserved. Business Cycles Chapter 8

2. Copyright © 2011 Pearson Education. All rights reserved. 8-2 Fig 8.1 A business cycle

3. Copyright © 2011 Pearson Education. All rights reserved. 8-3 Business Cycle Facts All business cycles have features in common. But no two business cycles are identical. Features in common: The business cycle is recurrent, but not periodic. The business cycle is persistent.

4. Copyright © 2011 Pearson Education. All rights reserved. 8-4 Business Cycle Facts All business cycles have features in common –Comovements among economic variables (1) direction –Procyclical: in the same direction –Countercyclical: in the opposite direction –Acyclical: with no clear pattern (2) timing –Leading: in advance –Coincident: at the same time –Lagging: after

5. Copyright © 2011 Pearson Education. All rights reserved. 8-5 Summary 10

6. Copyright © 2011 Pearson Education. All rights reserved. 8-6 Fig 8.6 Cyclical behavior of the index of industrial production Source: Federal Reserve Bank of St. Louis FRED database at research.stlouisfed.org/fred2/series/INDPRO.

7. Copyright © 2011 Pearson Education. All rights reserved. 8-7 Fig 8.9 Cyclical behavior of the unemployment rate Source: Federal Reserve Bank of St. Louis FRED database at research.stlouisfed.org/fred2/series/UNRATE.

8. Copyright © 2011 Pearson Education. All rights reserved. 8-8 Business Cycle Facts (3) volatility A plot of the standard deviation (Fig8.3) confirms the decline in volatility. The reduction in output’s volatility remains unexplained.

9. Copyright © 2011 Pearson Education. All rights reserved. 8-9 Fig 8.3 Standard deviation of GDP growth, 1960-2009 Source: Authors’ calculations from data on real GDP from the Federal Reserve Bank of St. Louis FRED database, research.stlouisfed.org/fred2/GDPC1.

10. Copyright © 2011 Pearson Education. All rights reserved. 8-10 Fig 8.10 The job finding rate, 1976–2009 Source: Shigeru Fujita and Garey Ramey, “The Cyclicality of Separation and Job Finding Rates,” International Economic Review, May 2009, pp. 415– 430; data updated by Shigeru Fujita.

11. Copyright © 2011 Pearson Education. All rights reserved. 8-11 Fig 8.11 The job loss rate Source: Shigeru Fujita and Garey Ramey, “The Cyclicality of Separation and Job Finding Rates,” International Economic Review, May 2009, pp. 415–430; data updated by Shigeru Fujita.

12. Copyright © 2011 Pearson Education. All rights reserved. 8-12 Flow in/ flow out the job finding rate: f the job loss rate: ℓ

13. Copyright © 2011 Pearson Education. All rights reserved. 8-13 Table 8.2 Jobs Lost and Gained In an Expansion and a Recession

14. Copyright © 2011 Pearson Education. All rights reserved. 8-14 Business Cycle Facts Table 10.2 the job finding rate declines substantially more than the job loss rate rises during recessions Since the job loss rate applies to many more people, job loss is the main force in increased unemployment rates during recessions

15. Copyright © 2011 Pearson Education. All rights reserved. 8-15 Fig 8.12 Cyclical behavior of average labor productivity and the real wage Source: Federal Reserve Bank of St. Louis FRED database at research.stlouisfed.org/fred2 series OPHNFB (productivity) and COMPRNFB (real wage).

16. Copyright © 2011 Pearson Education. All rights reserved. 8-16 Fig 8.13 Cyclical behavior of nominal money growth and inflation Source: Federal Reserve Bank of St. Louis FRED database at research.stlouisfed.org/fred2 series M2SL and CPIAUCSL.

17. Copyright © 2011 Pearson Education. All rights reserved. 8-17 Fig 8.14 Cyclical behavior of the nominal interest rate, 1947–2009 Source: Federal Reserve Bank of St. Louis FRED database at research.stlouisfed.org/fred2/series/TB3MS.

18. Copyright © 2011 Pearson Education. All rights reserved. 8-18 International aspects of the business cycle The cyclical behavior of key economic variables in other countries is similar to that in the United States –Major industrial countries frequently have recessions and expansions at about the same time –each economy faces small fluctuations that aren't shared with other countries

19. Copyright © 2011 Pearson Education. All rights reserved. 8-19 Business Cycle Analysis: A Preview What explains business cycle fluctuations? –2 major components of business cycle theories A description of the shocks A model of how the economy responds to shocks –2 major business cycle theories classical theory Keynesian theory –Study both theories in aggregate demand-aggregate supply (AD-AS) framework

20. Copyright © 2011 Pearson Education. All rights reserved. 8-20 AD-AS model Aggregate demand and aggregate supply: a brief introduction –The model (along with the building block IS-LM model) will be developed in chapters 9-11 –The model has 3 main components: all plotted in (P, Y) space aggregate demand curve (AD) short-run aggregate supply curve (SRAS) long-run aggregate supply curve (LRAS)

21. Copyright © 2011 Pearson Education. All rights reserved. 8-21 Aggregate demand curve (AD) AD shows quantity of goods and services demanded (Yd) for any price level (P) Higher P means less aggregate demand (lower Yd), so the aggregate demand curve slopes downward; reasons why discussed in chapter 9 An increase in AD for a given P shifts AD curve up and to the right –eg: a rise in the stock market increases consumption, shifting AD curve up and to the right –eg: a decline in government purchases shifts AD curve down and to the left

22. Copyright © 2011 Pearson Education. All rights reserved. 8-22 Aggregate supply curve (AS) AS curve shows how much output producers are willing to supply (Ys) at any given price level (P) The short-run aggregate supply curve (SRAS) is horizontal; prices are fixed in the short run. The long-run aggregate supply curve (LRAS) is vertical at the full-employment level of output Equilibrium –SR equilibrium: AD curve intersects SRAS curve –LR equilibrium: AD curve intersects LRAS curve

23. Copyright © 2011 Pearson Education. All rights reserved. 8-23 Fig 8.16 The AD–AS model

24. Copyright © 2011 Pearson Education. All rights reserved. 8-24 AD shocks An AD shock is a change that shifts AD curve –eg: a negative AD shock (Fig. 8.17) The AD curve shifts down and to the left SR equilibrium occurs where AD curve intersects SRAS curve  output falls, price level is unchanged LR equilibrium occurs where AD curve intersects LRAS curve  output returns to its original level, price level has fallen.

25. Copyright © 2011 Pearson Education. All rights reserved. 8-25 Fig 8.17 An adverse aggregate demand shock

26. Copyright © 2011 Pearson Education. All rights reserved. 8-26 AD shocks How long does it take to get to the long run? Classical theory: prices adjust rapidly –So recessions are short-lived –No need for government intervention Keynesian theory: prices (and wages) adjust slowly –Adjustment may take several years –So the government can fight recessions by taking action to shift the AD curve

27. Copyright © 2011 Pearson Education. All rights reserved. 8-27 AS shocks Classicals view AS shocks as the main cause of fluctuations in output. An AS shock is a shift of the LRAS curve. –eg, things like changes in productivity or labor supply. –eg: a negative AS shock (Fig. 8.18) AS shock reduces full-employment output, causing LRAS curve to shift left New equilibrium has lower output and higher price level So recession is accompanied by higher price level –Keynesians also recognize the importance of supply shocks; their views are discussed in Ch11.

28. Copyright © 2011 Pearson Education. All rights reserved. 8-28 Fig 8.18 An adverse AS shock