Chapter 8Chapter OutlineWhat Is a Business Cycle?Slide 4Slide 5Figure 8.1 A business cycleSlide 7Slide 8Slide 9Slide 10Slide 11Table 8.1 NBER Business Cycle Turning Points and Durations of Post–1854 Business CyclesSlide 13Slide 14The American Business Cycle: The Historical RecordThe American Business Cycle: The Historical RecordSlide 17Slide 18Slide 19Slide 20Slide 21Slide 22Slide 23Slide 24Slide 25Business Cycle FactsSlide 27Slide 28Slide 29Slide 30Slide 31Slide 32Summary 10Figure 8.2 Cyclical behavior of the index of industrial productionFigure 8.3 Cyclical behavior of consumption and investmentFigure 8.4 Cyclical behavior of civilian employmentFigure 8.5 Cyclical behavior of the unemployment rateFigure 8.6 Cyclical behavior of average labor productivity and the real wageSlide 39Slide 40Slide 41Slide 42Slide 43Figure 8.9 Industrial production indexes in six major countriesSlide 45Slide 46Slide 47Slide 48Business Cycle Analysis: A PreviewBusiness Cycle AnalysisSlide 51Slide 52Slide 53Slide 54Figure 8.10 The aggregate demand–aggregate supply modelSlide 56Figure 8.11 An adverse aggregate demand shockSlide 58Slide 59Slide 60Figure 8.12 An adverse aggregate supply shock© 2008 Pearson Addison-Wesley. All rights reservedBusiness CyclesChapter 8© 2008 Pearson Addison-Wesley. All rights reserved8-2Chapter Outline•What is a Business Cycle?•The American Business Cycle: The Historical Record•Business Cycle Facts•Business Cycle Analysis: A Preview© 2008 Pearson Addison-Wesley. All rights reserved8-3What Is a Business Cycle? •U.S. research on cycles began in 1920 at the National Bureau of Economic Research (NBER)–NBER maintains the business cycle chronology—a detailed history of business cycles–NBER sponsors business cycle studies© 2008 Pearson Addison-Wesley. All rights reserved8-4What Is a Business Cycle? •Burns and Mitchell (Measuring Business Cycles, 1946) makes five main points about business cycles:1. Business cycles are fluctuations of aggregate economic activity, not a specific variable2. There are expansions and contractions3. Economic variables show comovement—they have regular and predictable patterns of behavior over the course of the business cycle4. The business cycle is recurrent, but not periodic5. The business cycle is persistent© 2008 Pearson Addison-Wesley. All rights reserved8-5What Is a Business Cycle? •Expansions and contractions–Aggregate economic activity declines in a contraction or recession until it reaches a trough (Fig. 8.1)© 2008 Pearson Addison-Wesley. All rights reserved8-6Figure 8.1 A business cycle© 2008 Pearson Addison-Wesley. All rights reserved8-7What Is a Business Cycle? •Expansions and contractions–After a trough, activity increases in an expansion or boom until it reaches a peak–A particularly severe recession is called a depression–The sequence from one peak to the next, or from one trough to the next, is a business cycle–Peaks and troughs are turning points–Turning points are officially designated by the NBER Business Cycle Dating Committee© 2008 Pearson Addison-Wesley. All rights reserved8-8What Is a Business Cycle? •The business cycle is recurrent, but not periodic–Recurrent means the pattern of contraction–trough–expansion–peak occurs again and again–Not being periodic means that it doesn't occur at regular, predictable intervals© 2008 Pearson Addison-Wesley. All rights reserved8-9What Is a Business Cycle? •The business cycle is persistent–Declines are followed by further declines; growth is followed by more growth–Because of persistence, forecasting turning points is quite important© 2008 Pearson Addison-Wesley. All rights reserved8-10What Is a Business Cycle? •NBER BCD committee waits a long time to make a decision–July 1990 peak announced April 1991 (9 months–March 1991 trough announced December 1992 (21 months)–March 2001 peak announced November 2001 (8 months)–November 2001 trough announced July 2003 (20 months)•Why? Data revisions; need to be sure of turning point, not temporary movement© 2008 Pearson Addison-Wesley. All rights reserved8-11What Is a Business Cycle? For latest cycle determination, go tohttp://www.nber.org/cycles/cyclesmain.html© 2008 Pearson Addison-Wesley. All rights reserved8-12Table 8.1 NBER Business Cycle Turning Points and Durations of Post–1854 Business Cycles© 2008 Pearson Addison-Wesley. All rights reserved8-13What Is a Business Cycle? •Should we even care about the business cycle?•Robert Lucas (University of Chicago): NO© 2008 Pearson Addison-Wesley. All rights reserved8-14What Is a Business Cycle? •In Models of Business Cycles, Lucas says:–Cost of business cycle instability since World War II is very low–The cost is one-fifth the cost of having an inflation rate of 10%–So if faced with the choice of eliminating all recessions and having a 10% inflation rate, or having recessions the size we've had since 1945 and having no inflation at all, Lucas argues we should take the latter–He suggests that we should move toward a microeconomic view of the business cycle© 2008 Pearson Addison-Wesley. All rights reserved8-15The American Business Cycle:The Historical Record •Pre–World War I period•Recessions were common from 1865 to 1917–338 months of contraction and 382 months of expansion [compared with 518 months of expansion and 96 months of contraction from 1945 to 1996]–Longest contraction on record was 65 months, from October 1873 to March 1879© 2008 Pearson Addison-Wesley. All rights reserved8-16The American Business Cycle:The Historical Record•The Great Depression and World War II–The worst economic contraction was the Great Depression of the 1930s–Real GDP fell nearly 30% from the peak in August 1929 to the trough in March 1933–The unemployment rate rose from 3% to nearly 25%–Thousands of banks failed, the stock market collapsed, many farmers went bankrupt, and international trade was halted© 2008 Pearson Addison-Wesley. All rights reserved8-17The American Business Cycle:The Historical Record•The Great Depression and World War II–There were really two business cycles in the Great Depression•A contraction from August 1929 to March 1933, followed by an expansion that peaked in May 1937•A contraction from May 1937 to June 1938–By May 1937, output had nearly returned to its 1929 peak, but the unemployment rate was high (14%)–In 1939 the unemployment rate was over 17%© 2008 Pearson