Intro to Business Cycles

What are Business Cycles

Fluctuations of aggregate economic activity

not just single economic variable

Expansion: Trough to Peak
Contraction: Peak to Trough

Business cycles are recurrent but not periodic

Predicting Business Cycles

Leading Variables

• Tend to fluctuate in advance of overall economy
• Examples:
  • manufactures new orders of goods and materials
  • average weekly initial claims for unemployment insurance

Problems with leading variables:

• Macroeconomic data often revised
• No single leading variable can perfectly predict business cycles

Coincident Variables

• Fluctuate simultaneously with overall economy
• Four major:
  • Industrial production
  • Manufacturing and trade sales
  • nonfarm employment
  • real personal income

Lagging Variables

Tend to fluctuate after the changes in overall economy

• CPI, Wages, Nominal interest rate

Comovement of Variables

Tendency of many economic variables to move together in a predictable way over the business cycle

Three kinds of comovement:

Procyclical

Variables move in same direction as aggregate economic activity

• real GDP, consumption, investment

Countercyclical

Variables move in opposite direction of aggregate economic activity

• Unemployment

Okun’s Law:

$$\frac{Y-\bar{Y}}{\bar{Y}}=-2(u-\bar{u})$$ $$\frac{\Delta Y}{Y}=\frac{\Delta \bar{Y}}{\bar{Y}}-2(u-\bar{u})$$

$\bar{u}:$ natural rate of unemployment
$\bar{Y}:$ full-employment output

Thus a 1 percentage point increase in U $⟹$ 2% reduction in output relative to $\bar{Y}$

Acyclical

Variables that do not have a clear pattern over business cycle

• Real interest rate