Business Cycles

Chapter 8

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 Business Cycle Terms

• Direction of movement
– Pro-cyclical – tending to move in the same direction as GDP
– Countercyclical – tending to move in the opposite direction
of GDP
• Timing of movement
– Peak – time when aggregate economic activity stops rising
and begins falling
– Trough – time when aggregate economic activity stops
falling and begins rising
– Boom or expansion – period when economic activity is rising
– Recession – period when economic activity is falling (at least
two consecutive quarters)
– Turning point - peaks or troughs

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 Figure 8.1 A business cycle
Contraction
is not
defined here
as output
below
potential.

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 Business Cycle Facts

• Business cycles are not all alike, but they do have features in
common which our macro models should capture
• Variables like industrial production, consumption, investment,
and employment are pro-cyclical. They are also coincident with
the cycle meaning that they have the same timing. Almost all
economic models imply these variables are pro-cyclical.
• Other variables like inflation, real wages, and money growth
also tend to be pro-cyclical. This behavior allows us to
discriminate among models and among causes of business
cycles.
• To predict cycles, we want leading indicators, variables which
change direction prior to the cycle – problems with false signals

8-4
 Table 8.1 NBER Business Cycle Turning Points
and Durations of Post–1854 Business Cycles

Contractions are
shorter and further
apart as time has
progressed.
Business cycles are
asymmetric.
Expansions are much
longer than
contractions.

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 Has the US business cycle become less
severe?
Figure 8.2 GDP growth, 1960-2009

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Figure 8.3 Standard deviation of GDP
growth, 1960-2009

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 Pro-Cyclical, Coincident Variables

• Industrial production
• Consumption
• Business fixed investment
• Employment
• These are variables used to classify
periods as contractions or expansions.

8-9
 Figure 8.4 Cyclical behavior of the index of
industrial production

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 Figure 8.5 Cyclical behavior of
consumption and investment
Expenditures on
durable goods are
much more
cyclical than
other
expenditures.
Why?
Inventory
investment is
also highly pro-
cyclical and
leading.

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 Figure 8.6 Cyclical behavior of civilian
employment

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 Figure 8.7 Cyclical behavior of the
unemployment rate

Unemployment is
counter-cyclical

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 The Job Finding Rate and the Job Loss
Rate

• The probability that someone finds or

loses a job in a given month changes
over time
• The job finding rate is the probability
that someone who is unemployed will
find a job during the month, but that
probability declines in recessions and
increases in expansions

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Figure 8.10 The job finding rate, 1976–
2009

8-15
Figure 8.11 The job loss rate

8-16
 Figure 8.8 Cyclical behavior of average
labor productivity and the real wage

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 Labor productivity is pro-cyclical

• Does labor really become less

productive – technological regress – in
recession
• Labor force utilization
• Production function Y=AKα(uN)(1- α)
• Labor productivity is Y/N=A(K/N)αu(1- α)

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 Real Wages = MPN

• A Classical model says that the cyclical

behavior of real wages should mirror the
cyclical behavior of the marginal product
of labor (not average product of labor
but they tend to move together)
• Real wages are slightly pro-cyclical –
but don’t always seem to move with the
cycle.

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 Figure 8.9 Cyclical behavior of nominal
money growth and inflation
Money
growth and
inflation are
both
procyclical.
Money
growth leads
and inflation
lags, but not
always.

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 Figure 8.10 Cyclical behavior of the
nominal interest rate

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 Figure 8.11 Industrial production indexes
in six major countries
There is some
co-movement
in industrial
production
(and hence in
the business
cycle) across
countries.

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 Summary and Conclusion

• Business cycles are not regular and are

not all alike.
• Cycles have different lengths and
turning points are hard to predict.
• All variables do not behave exactly the
same over each cycle.
• However, there are regularities we want
our models to capture.

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