CHAPTER 8

BUSINESS CYCLES: AN INTRODUCTION

Intermediate Macroeconomics, Fall 2014
Professor Todd Keister

What is the business cycle?

There are clean patterns in aggregate activity

changes

in GDP over time are not purely random

many businesses experience good or bad conditions
at the same time

Definition of the business cycle:

fluctuations

in aggregate economic activity

in which many economic activities expand and
contract together
in a recurring fashion

trend (think of
Solow, Romer)

output gap

In the U.S., business cycles are dated by the

National Bureau of Economic Research (NBER)
private,

non-profit group

Use multiple criteria

including

judgment (no strict rules)

Turning points are dated after the fact

i.e.,

announce that recession ended 6 months ago

NBER Recession Dates

U.S. real GDP per capita

1900-2013

Sources: Federal Reserve Bank of St. Louis, FRED Database. http://research.stlouisfed.org/fred2/; and for data before
1960, Maddison, Angus. Historical statistics. http://www.ggdc.net/maddison/

Contractions have become less frequent, shorter, and less severe

Co-movement

Many economic activities move together over the

business cycle
A particular variable is classified as either:
Procyclical

moves up during expansions and down

during contractions
Countercyclical moves down during expansions and
up during contractions
Acyclical ups and downs do not coincide well with
those of the business cycle

Timing

A particular variable is classified as either:

leading

reaches peak/trough before the turning

points of a business cycle
lagging reaches peak/trough after the turning points
of a business cycle
coincident reaches peak/trough at the same time of
a business cycle

Note: all classifications are imperfect

predicting

future activity is inherently difficult

Examples: Consumer spending

Investment

Unemployment

Inflation

Stock prices

Credit spreads

International synchronization

Source: International Monetary Fund. International Financial Statistics. http://www.imfstatistics.org/imf/

One theory

Suppose we add supply shocks to the Romer model

supply

shock = random changes in

Solow

equation:

Romer

equation:

Examples:
oil

= +

changes randomly
over time

prices, weather, inventions, government policies

Q: What would the time path of look like?

Romer model with supply shocks

yPt

log scale

slope = g*

t
Looks similar to actual data for U.S., other countries

However

This model is missing many elements that seem to be

important

inflation and monetary policy

unemployment

business and consumer confidence, etc.

Does not offer much guidance for govt. policy

We will come back to this model later on, but for now

Want to develop a more comprehensive theory

The AD/AS model

First step: Aggregate Demand

investment
monetary
combine

and saving (Chapter 9)

policy (Chapter 10)

to create AD curve (also in Chapter 10)

Then: Aggregate Supply (Chap 11)

Combine AD & AS (Chaps. 12)

Study government policy and recent experience

with very low interest rates (Chap 13)