CHAPTER 13

Business cycles and what they mean for economists

SOME BASICS

Macroeconomics

Requires different thinking than microeconomics Cake vs ingredients Totals or wholes Measured by real GDP Measure of aggregate output = spending = income Fluctuations = business cycle Signals economic performance and need for policy

Aggregates

Macroeconomic activity

Is it necessary to look at this level?

THE BUSINESS CYCLE Defined

Aggregate Economic activity Cyclical variations Long term trend

Peak Trend

Economic activity

Trough

Time
3

MORE DETAIL
Economic activity

Time
4

FINDING THE REFERENCE CYCLE

Reference cycle = business cycle Using specific cycles

First

get cycles of individual sectors SARB collects 200 time series Reference cycle = average of all specific cycles

Using diffusion indices

If

>50% of specific cycles expand = upswing If <50% of specific cycles expand = downswing Turning points
5

REFERENCE CYCLE
Economic activity

Time
6

COMPOSITE INDICATORS (1)

Leading business cycle indicator

Business

confidence Share prices Major trading partners Commodity prices M1 + many more

Can you explain why?

COMPOSITE INDICATORS (2)

Coincident business cycle indicator

Vehicle

sales Non-agricultural employment Industrial production Utilisation of capacity + many more

Can you explain why?

COMPOSITE INDICATORS (3)

Lagging business cycle indicator

Commercial Labour

vehicles sold

costs Hours worked in construction Real capital formation + many more

Can you explain why?

REAL GDP IN SA
1080000 1060000 1040000

R million

1020000 1000000 980000 960000 940000 920000

2002

2003

2004

10

ECONOMIC GROWTH IN SA
6

% change in real GDP

5 4 3 2 1 0

20 02

20 03

20 04

11

COMPOSITE INDICATORS IN SA
150 140 Leading Coincident Lagging

Jun2000 = 100

130 120 110 100 90

03

00 3

l2 0

00 4

n2

Ju

n2

Ja

Ja

Ju

l2 0

04

12

WHAT IT ALL MEANS FOR POLICY

The danger of instability

Stability

allows for planning Especially investment Investment drives economic growth

Related to other macroeconomic objectives, especially:

Price

stability, unemployment and balance of payments

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EVENTS AROUND A RECOVERY

Economic activity Firms increase Disinflation as production without spending real investment continues to fall

Central bank drops interest rates to stimulate the economy Spending starts to rise

Moderate economic growth as economy moves into recovery

Time
14

EVENTS AROUND A BOOM

Economic activity Current account deficits & depreciation More imports Less saving Demand for credit rises Spending and real investment accelerates Employment increases Wages rise

Exports fall
Inflation starts to rise

Central bank responds to inflation & current account problems by increasing the interest rate

Time
15

EVENTS AROUND A RECESSION

Economic activity

Spending and investment slows down, but inflation remains high and current account problems persist

Signs of an increase in unemployment

Spending starts to fall - inflation falls and so do imports

If there is no policy response, a slump may ensue

Time
16

SLUMP AND DEPRESSION

Economic activity Investment falls and business close down Significant increase in unemployment Recent economic policy may influence the path of the business cycle here

Inappropriate policy leads to depression

Deflation and widespread economic suffering Time

17

BROAD SUMMARY

Downswing

Lower spending and economic growth Rising unemployment Possibly lower inflation Current account surplus Higher spending and economic growth Possibly lower unemployment Higher inflation Current account deficit

Upswing

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ECONOMIC POLICY

Policy options & their instruments

Monetary policy - interest rates & money supply Fiscal policy - government spending and taxation Balance of payments policy - tariffs, export subsidies, currency manipulation Incomes policy - control of prices and wages Expansionary economic policy attempt to increase aggregate spending Restrictive policy attempt to reduce aggregate spending
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Categories of response

POLICY RESPONSES
Economic activity Expansionary policy in this phase to stimulate spending and investment Restrictive policy in this phase to bring inflation and current account under control

interest rate or MS or G or T

interest rate or MS or G or T

Time
20

10

THE INTENDED RESULT

Economic activity

Time
21

WHAT CAUSES BUSINESS CYCLES?

Is the system inherently unstable?

Similar

to organisms and natural systems We need to reduce fluctuations through economic policy

Or is it made unstable by interference?

Shower

theory Economic policy creates the instability it tries to prevent We should not interfere laissez faire
22

11

THE SHOWER THEORY

Economic activity interest rate Central bank becomes aware of inflation problem Effect of policy kicks in

Time Effect lag of 12-24 months

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