Macro

economics

Topic 10
Business Cycle
Business Cycle

• The economy performance repeating itself throughout the decades

• It is expected that the cycle caused by two reasons:
• Change of demand
• Change of supply
Demand Shock
• Lower demand – lower GDP and lower price
• Recession or economic slowdown, price is relatively stable or even drop

• Example:
• COVID-19 at 2020 – control movement discourage economic activities, thus
lesser demand
Lower Price
Lower GDP
Supply Shock
• Lower supply – higher price and lower GDP
• “stagflation”
• Example: 2022 – energy price, supply disruption
• Global growth is forecast to slow from 6.0 percent in 2021 to 3.2 percent in
2022 and 2.7 percent in 2023.
• International Monetary Fund, Oct 2022
Invisible Hand

• How the economic cycle is formed?

• In classical view, the market is adjust by itself – through supply and demand
• One more concept here: Long Run Aggregate Supply
• The production capacity in the long run is fixed – thus vertical
Demand Shock
Short Run
• For example
• Demand shock – lower GDP – higher unemployment
• recession
Short run
Demand Shock
Long Run
• Labors willing to take lower wage – lower labor cost – lower production cost
• Encourage production as the cost is lower – thus GDP increased
• Recovery or expansion
Long Run
• When production increased – demand increased
• More economic activities – spending greater in the market
• Higher demand – higher price as more transaction now
• Higher price – higher inflation – higher production cost
• Thus, it discourages production – lower production – lower GDP
• Economy slow down, recession
• Without any intervention, the economy will form the cycle by itself
Government Intervention

• But, it takes time

• Example:
• Great Depression, worldwide economic downturn that began in 1929 and lasted
until about 1939

• Why it lasts until 1939? Because World War II is there to solve the problem…
Government Intervention
Fiscal Policy
• Government to spend more, or make the market to spend more
• Government spends more – more government purchases
• Make the market spends more – lower tax in the market
Example – low tax
indirectly through tax relief
Example – government spending

• Higher Education students will receive a one-off payment of RM200 each as part
of the Prihatin Rakyat Economic Stimulus Package announced to cushion the
economic impact of the Covid-19 outbreak.
• March, 2020
Government Intervention
Monetary Policy
• Central Bank to encourage borrowing and spending
• Lower interest, cheaper to borrow
• Example: Overnight Policy Rate (OPR) in Malaysia
• Historical low at 1.75% between 2020 and 2022
Effectiveness of policies

• Stagflation due to supply shock

• Example: year 2022
Supply shock causing
Higher price
Lower GDP

The government can either

Option 1: encourage spending

Option 2: discourage spending

Option 1: Encourage Spending
It causes greater demand

It solves the low GDP

As it is now having greater GDP

BUT it causes greater inflation

Where the price is even higher
Option 2: Discourage spending
It causes lower demand

It solves the inflation

As it is now having lower price

BUT it causes lower GDP

Recession is even worst
• The problem of stagflation – GDP is lower and Price is higher – at the same time
• The tools available can address either one, but not both
U.S. decision
Higher interest rate
Discourage borrowing
Control inflation
Lower inflation
• And lower GDP growth
High inflation in US but not Malaysia

• Maybe it wouldn’t
affect us?
• Higher interest rate in U.S.
• It means if you have extra money, save (or invest) in US promise greater return
than any other countries
• What happen next is, the capital around the world flow to US
• And, if everyone needs US dollar
Most currencies in the world are now
DEPRECIATING
Regardless developed, or developing countries
• What can an economy do to prevent the currency depreciation?
• The gap of local interest rate and U.S. interest rate must be smaller
• Thus, even if Malaysia is not suffered from high inflation as U.S., interest rate
need to be increased as well
• The impact?
• The economy slow down is estimated for global economy, not only U.S.
• Remind: higher interest discourage economic activities, lower demand, which
reduce GDP
• “Global growth is forecast to slow from 6.0 percent in 2021 to 3.2 percent in
2022 and 2.7 percent in 2023.”
• International Monetary Fund, Oct 2022
Is this something new?

• Look at oil price crisis 1970s

• From $1.7 in year 1971 to $35 in year 1980
• It caused high inflation in U.S. between 1970s and 1980s
• The response: high interest rate policy
GDP and Inflation

• Why inflation is more a concern?

• Hyperinflation is a disaster
• 2000s – Zimbabwe
• 2010s – Venezuela
• 2020s – Sri Lanka, Turkey, and more could come