4/21/02 8:29:04 PMTHEPARTHENONGROUPTHEPARTHENONGROUP200 STATESTREETBOSTON, MA 02109FEI Conference-ppt 1US Business Cycles,Theory & PracticeLecture 17FEI Conference-ppt 2•What Forces Create Major Business Cycles in the United States?•Generally, do recessions emanate from government policies or private sector decisions?US Business CyclesFEI Conference-ppt 3The Forces Creating Macroeconomic CyclesOil Price Shocks Are Also Commonly RecognizedThis Illustration Adapted from The Economist is Typical0%2%4%6%8%10%12%1950195119531955195719581960196219641965196719691971197219741976197819791981198319851986198819901992199319951997199920002002$0$10$20$30$40$50$60$70$80Unemployment RateReal Oil PriceUNEMPLOYMENT RATEREAL OIL PRICEFEI Conference-ppt 44.0%4.5%5.0%5.5%6.0%6.5%7.0%7.5%8.0%8.5%1993:11994:11995:11996:11997:11998:11999:12000:10.0%1.0%2.0%3.0%4.0%5.0%6.0%7.0%The Forces Creating Macroeconomic Cycles The “1 - 1 - 1 Rule”: 1% Lower Rates 1 Year Later Adds 1% to Growth10-Year Treasury Bond Yield,1 Year Earlier,left scaleReal GDP Growth,right scaleThis link between bond yields and the economy holdsuntil another major force exerts its influenceThis link between bond yields and the economy holdsuntil another major force exerts its influenceFEI Conference-ppt 5The Core Model • Reduced Form Model • Derived from Structural Model• C=C ( G, T, i, GNPW )• I = I ( G, T, i, GNPW ) • M = M ( G, T, i, GNPW )• X = X ( G, T, i, GNPW )• GNP = C+I+X-M +G•= GNP ( G, T, i, GNPW )Structural or Behavioral ModelC=C0 + C1 * (GDP - T) - C2 * iI= I0 + I1 * (GDP- GDP(-1)) + I2 * IM = M0 + M1 * Y + M2 * IX = X0 + X1 * GNPW + X2 * IG=GGDP=C+I+G+X-MSubstitute to eliminate all endogenous variables from left-side of each equationFEI Conference-ppt 6Wave-MakersAffecting the Circular Flow of Income and ProductionAdditive ForcesRestrictive ForcesExchange RatesPrivate Sector SpendingGDP = U.S. Output and IncomeStock MarketCompeting ImportsExportsGovernment SpendingIncome TaxesFederal Reserve & Interest RatesMajor Oil Price IncreasesConfidence ShocksA Reliable Economic Model• Economic models define the magnitudes and timing of market impacts flowing from policy changes or international shocks • Modern models begin with projections of 10-15 key domestic policies and global indicators• They then translate these into the consequences for prices, volumes, wages, and credit costs in 100+ specific marketsFEI Conference-ppt 7Forecasting Economic ForcesThe Economic Factors Controlling Growth are UnderstoodSource: US Bureau of Economic Activity, Parthenon analysisSimple Model of Real GDP GrowthReal GDP Growth Dependent Variable: @PCH(GDP96C)Method: Least SquaresDate: 09/24/01 Time: 11:27Sample(adjusted): 1976 2000Included observations: 25 after adjusting endpointsVariabletiming math expression Coefficient Std. Error t-StatisticC0.064 0.021 3.05 Potential Labor Force Growth lag 1 @PCH(LCFE+LCFE(-1))0.577 0.504 1.15 Bond Yield lag 1 RMGFCM10NS(-1)(0.006) 0.002 (3.30) Real Oil Price Inflation current PCOF/CPI-PCOF(-1)/CPI(-1)(0.002) 0.001 (2.30) " " " " lag 1 PCOF(-1)/CPI(-1)-PCOF(-2)/CPI(-2)(0.001) 0.001 (1.13) Real Exchange Rate Apprec. lag 1 @PCH(REALEXCHIND(-1))(0.093) 0.062 (1.50) Real Export Growth @PCH(EX96C)0.122 0.073 1.67 Real "G" Growth @PCH(GF/CPI)0.401 0.132 3.04 % Point Change in Tax Rate lag 1 TGF(-1)/GDP(-1)-TGF(-2)/GDP(-2)(1.583) 0.453 (3.50) Real Stock Mkt Growth lag 1 @PCH(JSAPNS(-1)/CPI)0.035 0.025 1.37 special shock: tax reform DTAXREFORM-5%0.018 (2.87) special shock: Gulf War DGULFWAR-4%0.012 (3.29) R-squared 0.84772 Mean dependent varAdjusted R-squared 0.718868 S.D. dependent varS.E. of regression 1.1%FEI Conference-ppt 8Forecasting Economic ForcesThe Economic Factors Controlling Growth are Understood-4%-2%0%2%4%6%8%Jan-76Jan-80Jan-84Jan-88Jan-92Jan-96Jan-00Real GDP GrowthPredicted GDP(Simple Model)Actual GDP• Supply “potential”- Growth in labor force and working age population- Growth in productivity due to technological advances• Government budgets- Growth in purchases- Changes in tax rates•Financial markets- Federal Reserve rates- Stock and bond market reactions • International events and policies- Export growth- Changes in manipulated commodity prices (e.g. oil)- Changes in foreign exchange value of dollar- Extreme consumer confidence shocks from conflict and turmoil10 Key Forces Controlling GDP GrowthSource: US Bureau of Economic Activity, Parthenon analysisFEI Conference-ppt 9The Forces Creating Macroeconomic CyclesOil Shocks (6.0%) (4.0%) (2.0%)0.0%2.0%4.0%6.0%8.0%1976197819801982198419861988199019921994199619982000Real GDP GrowthOil PricesIraq W arPercent of TotalFEI Conference-ppt 10The Forces Creating Macroeconomic CyclesDemographic Forces (4.0%) (2.0%)0.0%2.0%4.0%6.0%8.0%1976197719781979198019811982198319841985198619871988198919901991199219931994199519961997199819992000Real GDP GrowthCore Labor Force GrowthPercent of TotalFEI Conference-ppt 11The Forces Creating Macroeconomic CyclesFinance Factors (4.0%) (2.0%)0.0%2.0%4.0%6.0%8.0%19761977197819791980198119821983198419851986198719881989199019911992199319941995199619971998199920002001Real GDP GrowthSumStock MarketBond RatesPercent of TotalFEI Conference-ppt 12The Forces Creating Macroeconomic CyclesInternational Trade Factors-4%-2%0%2%4%6%8%19761977197819791980198119821983198419851986198719881989199019911992199319941995199619971998199920002001Real GDP GrowthSumExportsExchange RatePercent of TotalFEI Conference-ppt 13The Forces Creating Macroeconomic CyclesFederal Government Roles (6.0%) (4.0%) (2.0%)0.0%2.0%4.0%6.0%8.0%1976197719781979198019811982198319841985198619871988198919901991199219931994199519961997199819992000Real GDP GrowthTax Reform & Budget ShockSumTax Rate ChangesFederal PurchasesPercent of TotalFEI Conference-ppt 14The Forces Creating Macroeconomic CyclesFederal Policy Summary-6%-4%-2%0%2%4%6%8%1976197719781979198019811982198319841985198619871988198919901991199219931994199519961997199819992000Real GDP GrowthTotal FederalFiscalFinancialPercent of TotalFEI Conference-ppt 15The Forces Creating Macroeconomic Cycles- Before 2001, some observers thought the business cycle was dead- It wasn’t dead, just fitfully sleeping- The “nirvana” or “goldilocks” economy of recent years was due to:•Unusually stable federal government and Federal Reserve policies•A serendipitous balance of international forces- The private sector follows the
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