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Lecture 6

PM Lecture 6 Recession, Depression, Expansion and Booms The Business Cycle

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Boston University
CAS EC 102
Jay Zagorsky

PM Lecture #6: Recession, Depression, Expansion and Booms: The Business Cycle Monday, April 7, 2014 5:57 PM Overview - The economyconstantly oscillates (goes up and down) - These oscillationsare called business cycles and are natural fluctuations in the overall economy - While individuals cannot do anything about them, it is important to understand the business cycle since it directly affects mostpeople and almost all businesses ○ Difficulty of getting a job is based on both individual skills and general economicconditions ○ Difficulty of getting a loan is based both on individual credit situation and general economic conditions - Over the long run, all capital countries have grown ○ Since 1929, US real economygrew about 13 fold, in the last 19 years, US have 30% more output - Over the short run, growth fluctuates sharply from year-to-year 4 Key Business Cycle Definitions - Recession:Period of declining rea GDP, falling incomes,and rising unemployment - Depression:Severe recession, incomes fall dramatically, huge numbers of people are unemployed and GDP plummets - Expansion: Period of rising real GDP, increasing average incomesand falling unemployment - Boom:Period of very rapid expansion, incomes soar, almost no one is unemployedand GDP rapidly expands Recessions are Both Good and Bad - Bad: People lose jobs, homes, skills and savings - Good: Fraud is uncovered,weak businesses eliminated and new businesses created - Good: Fraud is uncovered,weak businesses eliminated and new businesses created 3 Key Facts About Fluctuations - Economicfluctuations are irregular and unpredictable - Most macroeconomicvariables fluctuate together - As output falls, unemploymentrises What is A Recession? - Significant decline in activity spread across the economy,lasting morethan a few months, visible in industrial production, employment,income, and wholesale-retailtrade - Beings just after the economyreaches a peak of activity and ends when the economyreaches it though. Betweentrough and peak, the economyis in an expansion. ○ A recession is when the 1st derivative of the sate of the economyis negative ○ An expansion is when the 1st derivative of the state of the economyis positive What about Prices? - A recession has nothing to do with price changes. It is possible to have a recession with falling OR with rising prices - Stagflation: Recession with rising prices Who Calls a Recession? - Congressional reports claim that a recession is when we have 2 quarters of negative real GDP growth - Actually, a recession is when the National Bureau of EconomicResearch declares that one has occurred ○ The NBER said that the most recent recession began in December 2007and ended in June 2009  From 1945-2012,there has been 11 business cycles  The average recession lasted just 11 months  The average expansion lasted 59 months ○ How Do The NBER Decide?  They DO NOT use GDP, why not? □ GDP is quarterly data, not monthly □ GDP data are frequently revised □ GDP data are not constant  They look primarily at 4 indicators  They look primarily at 4 indicators □ Monthly employmentin the entire economy □ Monthly personal income less transfer payments(in real terms, adjusted for inflation) □ Monthly sales of manufacturing and trade (in real terms, adjusted for inflation) □ Industrial production What Can Gov't Do about The Ups and Downs in the Economy? - The Great Depression altered thinking throughout the world, prior to the early 1930s, most economistsbelieved in a laissez faire system t - Keynes is the first major economistto promotean activist role for the governmentin "The General Theory of Employment, Interest and Money" - Timing and the type of gov't policy really matters Governmenthas 3 choices - MonetaryPolicy: Central bank has the ability to change the money supply and interest rates; these actions in the short run impact the economy ○ Central bank changes either money supply or interest rates to influence aggregate demand  To slow economydown, increase interest rates OR decrease money supply  To speed economyup, decrease interest rates OR increase the money supply - Fiscal Policy: Gov't can change its taxes and expenditure policies; these actions in the medium run have a large impact on the economy ○ Policies are designed to influence savings, investment and growth in the long run OR in the short run, the gov't can purchase more or less goods and servicesto directly shift aggregate demand - Do Nothing Policy Lags - Monetaryand fiscal policy impact the economywith a substantial and often unpredictable lag ○ Monetarypolicy changes begin having a substantial impact about 6 months after a change is made ○ Fiscal policy changes take even longer, the policy process that go
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