Figure1 UK GDP Quarterly 1963:3-2001:1and its long run tend (----)

11.2

11.4

11.6

11.8

12

12.2

12.41

96

3:3

19

66

:3

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:3

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:3

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:3

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:3

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The Stylised Facts of the Business Cycle

Ref: Barro & Grilli Ch.1

Ryan (2002)

Ryan & Mullineux (1997)

Figure1 UK GDP Quarterly 1963:3-2001:1and its long run tend (----)

11.2

11.4

11.6

11.8

12

12.2

12.41

96

3:3

19

66

:3

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:3

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1. Output is growing over time

But the rate of growth fluctuates.

Figure1 UK GDP Quarterly 1963:3-2001:1and its long run tend (----)

11.2

11.4

11.6

11.8

12

12.2

12.41

96

3:3

19

66

:3

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:3

19

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However, the trend is upwards

Can we identify the trend?

Figure1 UK GDP Quarterly 1963:3-2001:1and its long run tend (----)

11.2

11.4

11.6

11.8

12

12.2

12.41

96

3:3

19

66

:3

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:3

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:3

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:3

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90

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96

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Figure1 UK GDP Quarterly 1963:3-2001:1and its long run tend (----)

11.2

11.4

11.6

11.8

12

12.2

12.41

96

3:3

19

66

:3

19

69

:3

19

72

:3

19

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Figure1 UK GDP Quarterly 1963:3-2001:1and its long run tend (----)

11.2

11.4

11.6

11.8

12

12.2

12.41

96

3:3

19

66

:3

19

69

:3

19

72

:3

19

75

:3

19

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:3

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81

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19

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90

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Figure1 UK GDP Quarterly 1963:3-2001:1and its long run tend (----)

11.2

11.4

11.6

11.8

12

12.2

12.41

96

3:3

19

66

:3

19

69

:3

19

72

:3

19

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19

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UK Business Cycle

-0.04

-0.02

0

0.02

0.04

0.06

19

63

:3

19

68

:4

19

74

:1

19

79

:2

19

84

:3

19

89

:4

19

95

:1

20

00

:2%^

De

via

tio

n f

rom

LR

T

ren

d

UK Business Cycle

-0.04

-0.02

0

0.02

0.04

0.06

19

63

:3

19

68

:4

19

74

:1

19

79

:2

19

84

:3

19

89

:4

19

95

:1

20

00

:2%^

De

via

tio

n f

rom

LR

T

ren

d

UK Business Cycle

-0.04

-0.02

0

0.02

0.04

0.06

19

63

:3

19

68

:4

19

74

:1

19

79

:2

19

84

:3

19

89

:4

19

95

:1

20

00

:2%^

De

via

tio

n f

rom

LR

T

ren

d

Q: Why does output fluctuate in this way

UK Business Cycle

-0.04

-0.02

0

0.02

0.04

0.06

19

63

:3

19

68

:4

19

74

:1

19

79

:2

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:3

19

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:4

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95

:1

20

00

:2%^

De

via

tio

n f

rom

LR

T

ren

d

Q: What is is happening to other variables as output fluctuates

fig

Three question:1. Does XXXX go up when Output is up, or does it go

down?

O

Rea

l nat

iona

l inc

ome

Time

Output

Called CORRELATION

fig

Two types of question1. Does XXXX go up when Output is up, or does it go

down?

O

Rea

l nat

iona

l inc

ome

Time

Output

XXXX is PROCYCLICAL - positive correlation

fig

Two types of question1. Does XXXX go up when Output is up, or does it go

down?

O

Rea

l nat

iona

l inc

ome

Time

Output

XXXX is COUNTER-CYCLICAL - Negative

correlation

fig

O

Rea

l nat

iona

l inc

ome

Time

Y

Q.2 Does XXXX fluctuate by more or less than Output?

fig

O

Rea

l nat

iona

l inc

ome

Time

Y

Q.2 Does XXXX fluctuate by more or less than Output?

Low-Standard Deviation

fig

O

Rea

l nat

iona

l inc

ome

Time

Y

High-Standard Deviation

Q.2 Does XXXX fluctuate by more or less than Output?

fig

Q.3 Does XXXX lead or lag Output?

O

Rea

l nat

iona

l inc

ome

Time

Output

XXXX is LEADING

fig

Q.3 Does XXXX lead or lag Output?

O

Rea

l nat

iona

l inc

ome

Time

Output

XXXX is LAGING

How Do We Characterize the Business Cycle?

• What other Variables are we interested in?

• Are they up or down when Output (GNP/GDP) is up?

• Do they fluctuate more or less than Output?

• Do they lead or lag output?• Make a List

The correlation between the cyclical component of real GDP and the cyclical component of

selected macroeconomic variables in the UK, 1950-90.

0.80.9

0.17

0.580.49

0.39

-0.87

0.4

-1

-0.8

-0.6

-0.4

-0.2

0

0.2

0.4

0.6

0.8

1

Cor

rela

tion

Source: Ryan (2002) (Data: 1963-2001)Barro and Grilli (1994). (Data 1950-90

Facts I

• Consumption and investment demand are highly procyclical.

• Government consumption is weakly procyclical.

• Employment is pro-cyclical- Unemployment is countercyclical.

• Output expands more than employment in a boom and falls more than employment in a recession.

The correlation between the cyclical component of real GDP and the cyclical component of

selected macroeconomic variables in the UK, 1950-90.

0.80.9

0.17

-0.87

0.40.26

-0.58

0.4

-1

-0.8

-0.6

-0.4

-0.2

0

0.2

0.4

0.6

0.8

1

C I G* UE Y/E* RIR P W/P*

Cor

rela

tion

Source: Ryan (2002) (Data: 1963-2001)Barro and Grilli (1994). (Data 1950-90

Facts I (Cont)• Real Interest rate is Acyclical • The Price level is COUNTERCYCLICAL• The real wage is acyclical or weakly

procyclical.

The standard deviation of selected macroeconomic variables, %, UK, 1963-2001.

1.54 1.42

7

3.63

1.6

0

1

2

3

4

5

6

7

8

Real GDP Non-DurCons

DurableCons

Investment Employment

std.

dev

iati

on

Source: Ryan (2002.

Facts I

Consumer Durables and Gross investments are, by far,

the most volatile component of real GDP.

Non-durable consumption demand isrelatively stable and fluctuate less that GDP

The correlation between the cyclical component of real GDP and monetary aggregates and the

GDP deflator in the UK, 1963-1993.

-0.6

-0.4

-0.2

0

0.2

0.4

0.6

Correlation

M0 M0/P M4 M4/P P

Source: Barro and Grilli (1994).

fig

Countercyclical and leading prices

O

Rea

l nat

iona

l inc

ome

Time

Which turning point does A belong to?

A

Peak

|Trough

Prices

Output

fig

Countercyclical and leading prices

O

Rea

l nat

iona

l inc

ome

Time

OutputInflation rising but prices are below trend

A

Peak

Trough

Prices

 St Dev Cross-Correlation of Output with:

Variable   X(t+4) X(t+3) X(t+2) X(t+1) X(t) X(t-1) X(t-2) X(t-3) X(t-4)

Output 1.54 0.31 0.50 0.65 0.80 1.00 0.80 0.65 0.50 0.30

Non-Durable Cons 1.42 0.19 0.36 0.50 0.64 0.79 0.67 0.59 0.49 0.36

Durable Cons 7.00 0.32 0.50 0.52 0.54 0.60 0.34 0.27 0.19 -0.01

Investment 3.63 0.19 0.32 0.42 0.53 0.66 0.63 0.56 0.50 0.36

prices 2.13 -0.42 -0.54 -0.61 -0.62 -0.61 -0.51 -0.41 -0.26 -0.12

Real Interest Rates 2.44 0.21 0.34 0.41 0.41 0.40 0.28 0.20 0.07 -0.07

Unemployment 14.51 0.23 0.04 -0.17 -0.38 -0.59 -0.74 -0.81 -0.79 -0.69

Wages 2.24 -0.48 -0.54 -0.59 -0.55 -0.49 -0.44 -0.36 -0.26 -0.10

1.Output is growing but fluctuates persistently and in an apparently systematic way;

2.Employment is procyclical, that is, it moves in the same direction as output. However, both the number of people employed and the number of hours worked fluctuates less than output (that is, firms are apparently reluctant to hire and fire). Hence productivity or output per worker is procyclical and varies considerably over the cycle;

3.Real Wages are procyclical, though the share of wages in GNP is countercyclical, that is, the share of labour in GNP falls as output rises. Thus real wages rise proportionally less than output in booms and fall proportionally less in recessions);

4. Non-durable consumption is procyclical but fluctuates less than output. It also leads the cycle slightly, that is, it rises or falls before output rises or falls in US data.

5. Consumption of consumer durables (henceforth durables) and investment are procyclical but fluctuate more than output; the former tends to lead the cycle while investment tends to rise or fall after (or lag) the change in output;

6. Both narrow money and broad money are procyclical. Narrow money is contemporaneous or slightly leading but broad money does not exhibit a consistent pattern of lags or leads across countries;

7. The price level is countercyclical and leading;

8. Interest rates are acyclical (there is no discernible pattern across business cycles).

Figure1 UK GDP Quarterly 1963:3-2001:1 with a linear trend

11.2

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Review of what you Do Know about Microeconomics

• Firm Industrypx

qx

AC

MC

Qx

px

qx1qx2

= si S=MC

Qx1 Qx2

px1

px2

Perfect Competition

Full Information

Perfectly Flexible Prices

D

Review of what you Don’t Know about Macroeconomics

• Microecomics MACROECONOMICSP

Y

Perfect Competition

Full Information

Perfectly Flexible Prices

px S=MC

Qx1 Qx2

D AD

LRAS

SRAS?

So in IS/LM-AD/AS

• LRAS – Vertical if have – Perfect Compt. – Rational Expectations– Flexible Prices

• SRAS – May be upward sloping if – Imperfect Competition– Non-Rational Expectations e.g. Adaptive– Rigid Prices

WRAP UP

• SO IS/LM-AD/AS is Macroeconomics with advanced Micro

• This module is easy • It is Microeconomics with baby micro• Will show that you can go a long way yo

explaining fluctuations in the economy with just baby micro

• ITS EASY PEASY LEMON SQUEAZY