Business Cycle Facts

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Real Output of the U.S. economy

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Introduction Since the Industrial Revolution, the

economies of the US, like many other countries, have grown tremendously.

This long-term economic expansion has been periodically interrupted by temporary declines in economic activities and then followed by recovery.

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Long-run Economic Growth

Business Cycles

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Introduction The observed changes in aggregate economic activity

can be decomposed into two parts: Long-run economic growth: the changes in economic

performance over a long period of time, say between 1870 and 2007.

Business cycles: fluctuations in economic activities about the long-run trend.

What is a business cycle?

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What is a business cycle ? Lucas defines the business cycle as the

recurrent fluctuations of output about trend and the co-movements among other aggregate time series.

Other, important, “aggregate time series” include employment, aggregate investment, inflation rate etc.

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Recessions The period of time during which aggregate economic

activity falls below trend is a contraction or recession. If the recession is particularly severe, it becomes a

depression. During a recession, many sectors of the economy

experience declining sales and production, and workers are laid off or forced to work only part-time.

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Expansions After reaching the low point of the contraction (the

trough), aggregate economic activity begins to increase. The period of time during which aggregate economic

activity grows above trend is an expansion or a boom. The high point of the expansion is called a peak.

A complete cycle is measured from peak to peak or trough to trough.

Key business cycle facts(which any successful theory is supposed to explain)

Persistent deviations from trend in GDP; High correlation between hours worked and GDP.

Source: Prescott’s Nobel lecture

Consumption is relatively smooth while investment is more volatile than output (deviations in both variables are positively correlated with output deviations)

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Business cycles are recurrent, not predictable, and asymmetric

they do not occur at regular, predictable intervals of time (in fact no one knows for sure when they will happen)

they do not last for a fixed or predetermined length of time (once a cycle begins no one knows for sure when it will end).

Business cycles are often asymmetric: the contraction period is short and sudden, the expansion period is long and slow.

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Cyclical Behavior of Economic Variables

An economic variable that moves in the same direction as real GDP is called procyclical.

An economic variable that moves in the opposite direction to real GDP is called countercyclical.

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Procyclical Variable

Time

Real GDP

Procyclical variable

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Countercyclical Variable

Time

Real GDP

Countercyclical variable

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Cyclical Behavior of Economic Variables An economic variable is a leading variable if it tends to

move in advance of real GDP.

This means the peaks and troughs in a leading variable occur before the corresponding peaks and troughs in real GDP.

Economic observers are interested in economic variables that consistently lead the business cycle because they use such variables to forecast the future course of the economy (of course consistent relations can suddenly break down…!)

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Leading Variable

Time

Real GDP

Leading variable

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Business Cycle Facts (1)

Variable Direction Timing

Consumption Procyclical Coincident

Business Fixed Investment Procyclical Coincident

Residential Investment Procyclical Leading

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Business Cycle Facts (2)

Variable Direction Timing

Employment Procyclical Coincident

Unemployment Countercyclical ——

Inflation Procyclical Lagging

Stock Prices Procyclical Leading