Real Business Cycles com

8/8/2019 Real Business Cycles com

http://slidepdf.com/reader/full/real-business-cycles-com 1/30

Real Business Cycles

FIN 30220: Macroeconomic

Analysis



-2.00

-1.50

-1.00

-0.50

0.00

0.50

1.00

1.50

2.00

2000-I 2002-I 2004-I

r ecession

Expansion

Peak

Trough

A Complete Business Cycle consists of an expansion and a contraction



GDP: Devi i end: 9 7

8

6

6

1 9 4 7 - I

1 9 4 9 -

1 9 5 2 -

1 9 5 5 - I I

1 9 5 8 - I

1 9 6 0 -

1 9 6 3 -

1 9 6 6 - I I

1 9 6 9 - I

1 9 7 1 -

1 9 7 4 -

1 9 7 7 - I I

1 9 8 0 - I

1 9 8 2 -

1 9 8 5 -

1 9 8 8 - I I

1 9 9 1 - I

1 9 9 3 -

1 9 9 6 -

1 9 9 9 - I I

2 0 0 2 - I

2 0 0 4 -

Since WWII, the US h exper ienced 10 c ntracti ns lasting an average

of 10 months (from peak to trough) ± 63 months from peak to peak



All business cycles are ³alike´ in that there are regular relationships

between arious macroeconomic statistics

99 - 992- 994- 996- 998- 2 - 2 2- 2 4-

P Consumption

Correlation = .8

Consumption is one of many pro-cyclical ariables (positive correlation)



All business cycles are ³alike´ in that there are regular relationships

between various macroeconomic statistics

1 5

1

0 5

0

0 5

1

1 5

5

1990 I 199 I 199 I 1996 I 1998 I 000 I 00 I 00 I

0

1

3

5

6

7

8

GD nemployment Rate

Correlation = 51

nemployment is one of few counter cyclical variables (negative correlation)



-2.

-2

-1.

-1

-0.

0

0.

1

1.

2

2.

1990-I 1992-I 1994-I 1996-I 1998-I 2000-I 2002-I 2004-I

-400

-200

0

200

400

600

800

1000

GDP Deficit

Corr elation = .003

All business cycles ar e ³alike´ in that ther e ar e r egular r elationships

between var ious macroeconomic statistics

The deficit is an example of an acyclical var iable (zero corr elation)



-

-

-4

-2

0

2

4

1 0 1 1

-5

-4

-3

-2

-1

0

1

2

3

45

GD oduc v

All bus ness c cles a e ³al ke´ n ha he e a e egula ela onsh ps

be ween va ous mac oeconom c s a s cs

oduc v s p o-c cl cal and leads he c cle



-8

-6

-4

-2

0

2

4

6

1980 1988 1996

0

2

4

6

8

10

12

14

16

GDP nf t n

A bus ness cyc es re ³ l ke´ n th t there re regul r rel t nsh ps

between v r us m cr ec nom c st t st cs

nf l t on s pr o-cycl c l nd l gs the cycle



Business Cycles: Stylized Facts

Variable Correlation Leading/Lagging

Consumption Pr o cyclical Coincident

Unemployment Counter cyclical Coincident

Real Wages Pr o cyclical Coincident

Inter est Rates Pr o cyclical Coincident

Pr oductivity Pr o cyclical Leading

Inflation Pr o cyclical Lagging

The goal of any business cycle model is to explain as many factsas possible



We have a simple economic model consisting of two markets

L

p

w

)( NLI l s

*

¹¹ º

¸©©ª

¨

p

w

* L

),( K Al

d

I S ,

r Y W S ,

*r

I S ,

'

,'L A

I

Y

L

),,( L K A F

* L

*Y

Labor markets deter mineemployment and the r eal

wage

Capital markets deter mineSavings, Investment, andthe r eal inter est r ate

Employment deter minesoutput and income

Real business cycle theor y

suggest that the business cycleis caused my r andomfluctuations in pr oductivity



We have developed a model with a labor market and a capital market. Suppose that a r andom,tempor ar y, negative pr oductivity shock hits the economy. (Assume no gover nment deficit)

L

p

w

)( NLI l s

*

¹¹ º

¸©©ª

¨

p

w

* L

),( K Al

d

I S ,

r Y W S ,

*r

I S ,

'

,'

L A I

Y

L

),,( L K A F

* L

*Y

Dr op inpr oductivity

For a given level of employment andcapital, pr oduction dr ops



L

p

w

)( N L I l s

*

¹¹ º

¸©©ª

¨

p

w

* L

),( K Al

d

I S ,

r Y W S ,

*r

I S ,

'

,'

L A I

Y

L

),,( L K A F

* L

*Y

Dr op inpr oductivity

The fir st market to r espondis the labor market

At the pr e r ecession r eal wage, the demand for labor dr ops due to the pr oductivity decline



L

p

w

)( N L I l s

*

¹¹ º

¸©©ª

¨

p

w

* L

),( K Al

d

I S ,

r Y W S ,

*r

I S ,

',' L A I

Y

L

),,( L K A F

* L

*Y

The dr op in employmentcr eates an additional dr op inpr oduction

The dr op in labor demand cr eates excess supply of labor ± r eal wages falland employment decr eases

Dr op inemployment



L

p

w

)( N L I l s

*

¹¹ º

¸©©ª

¨

p

w

* L

),( K Al

d

I S ,

r Y W S ,

*r

I S ,

',' L A I

Y

L

),,( L K A F

* L

*Y

ExpectedFutur epr oductivityis unaffected

ExpectedFutur eemploymentis unaffected

Dr op inIncome

Wealth isunaffected

Non Labor income isunaffected

The inter est r ate will need toadjust to equate the new level of savings

The capital market r eacts nextThe dr op in incomer elative to wealth causesa decline in savings



L

p

w

)( N L I l s

*

¹¹ º

¸©©ª

¨

p

w

* L

),( K Al

d

I S ,

r Y W S ,

*r

I S ,

',' L A I

Y

L

),,( L K A F

* L

*Y

ExpectedFutur epr oductivityis unaffected

ExpectedFutur eemploymentis unaffected

Dr op inIncome

Wealth isunaffected

Non Labor income isunaffected

The r eal inter est r ate r ises andlevels of savings and investmentfall

The dr op in savings cr eates excess demand for loanablefunds



Recall that today¶s investment deter minestomorr ow¶s capital stock.

I K K ! )1(' H

Tomorr ow¶scapital stock

Remainingpor tion of curr entcapital stock

Depreciation ate

Pur chases of NewCapital

If investment falls enough, the capital stock

shr inks ± this is what gives the r ecession³legs´



L

p

w

)( N L I l s

*

¹¹ º

¸©©ª

¨

p

w

* L

),( K Al

d

I S ,

r Y W S ,

*r

I S ,

',' L A I

Y

L

),,( L K A F

* L

*Y

Dr op incapital

A second labor marketr esponse fur ther lower s r ealwages and employment ±pr oduction falls fur ther

Even at the lower wage, a dr op in the capital stock fur ther depr esses labor demand



L

p

w

)( N L I l s

*

¹¹ º

¸©©ª

¨

p

w

* L

),( K Al

d

I S ,

r Y W S ,

*r

I S ,

',' L A I

Y

L

),,( L K A F

* L

*Y

Dr op inexpectedfutur eemployment

A second capital marketr esponse fur ther lower ssavings, and investment ±with both investment andsavings affected, theinter est r ate effect isambiguous

A dr op in the capital stock cr eates expectations of per sistent declines inemployment which begin to influence investment demand Income

continues tofall



How do we know when we¶ve hit r ock bottom (i.e. the tr ough)?

Y

K K

MPK

' K

Falling employment lower s the pr oductivity of capital (labor and capital ar e compliments while a falling capital stock r aises the pr oductivity of capital (diminishing MPK).Eventually, these two effects offset each other .

MP K



The ecession of 1 1 is officially dated from July 1 1 to November

1 2

2

1

1

2

1 1 1 2 1

12

1

2

2

roductivity m loyment G Investment



-

-

-

-

-

-

-

odu y Emp oym n In m n

Th on of off a y da f om Ju y o Ma h



-

-

-

-

-

-

-

-

-

odu y Emp oym n In m n

Th mo n on off a y da f om Ma h o

No mb



Ar e r ecessions caused by high oil pr ices?

Recession Dates



-

-6

-4

-2

2

4

6

4 8 2 6

2 99 98

Ar e jobless r ecover ies the new nor m?

Look at the change in employment following the last three recessions!

Employment (% Deviation from trend)



What was different about the 2001 Recession?

-

-

-4

-2

0

2

4

0 4 12 1

2001 1 1 1 1

Productivity was actually growing during the 2001 recession!!

Productivity (% Deviation from trend)



Collapse of the stock market

The Dow dr opped % f r om its Jan , high of $ ,

The Nasdaq dr opped % f r om its Mar ch , high of $ ,

The S&P dr opped % f r om its July , high of $ ,

Y K/Capital Over hang

A shar p r ise in oil pr ices (oil pr ices doubled in late )

Enr on/Accounting scandals

Terr or ism/SARS

As was mentioned ear lier , the r ecession was differ ent in that itwas almost entir ely dr iven by capital investment r ather thanpr oductivity



Can pr efer ence shocks cause r ecessions?

L

p )( NLI l s

*

¹¹ º

¸©©ª

¨

p

w

*l

I S ,

r

*r

Y

L* L

*Y

If r ecessions ar e caused by asudden dr op in labor supply,

then wages would becounter cyclical (r ising dur ingexpansions)

W Y S ,

L A I

, I S !

),(K Al

d

),,( L K A F



Can pr efer ence shocks cause r ecessions?

L

p )( NLI l s

*

¹¹ º

¸©©ª

¨

p

* L

),(K Al

d

I S ,

r W Y S ,

*r

I S ! L A

I ,

Y

L

),,( L K A F

* L

*Y

If households suddenly lower consumption expenditur es(incr ease savings), the dr op

in inter est r ates should tr igger an offsetting r ise ininvestment spending



It seems as if r andom fluctuations to pr oductivity ar e a goodexplanation for business cycles. However , ther e ar e a couplepr oblems«

If productivity is the root cause of

business cycles, we would expect a

correlation between productivity and

employment/output to be very close to

1 The actual correlation is around

Where do these productivity

fluctuations come from? Is it possible

to separate technology from capital?

Haven¶t we left something out?

Real Business Cycles com

Documents

Transcript of Real Business Cycles com