These notes were made for the ECO4006F course in a previous year. I have been informed that the syllabus has been changed since then and so please take note of which chapters are included in these notes and whether they correspond to the course. Message me if you have any queries.
Good notes for Real Business Cycle portion of the course
By: alexmurphy1 • 4 months ago
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By: tainefrost11 • 4 months ago
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By: alexmurphy1 • 4 months ago
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By: alexmurphy1 • 4 months ago
I am sorry they are not entirely useful for your exam. I assume you have a different lecturer to who I had. I hope what information was relevant was helpful to you, and good luck for the exam season. If you could please let me know which sections are relevant I will update the description of the notes.
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Business Cycles
Why Understanding Business Cycles is Important
• Recessions are a major source of concern for policy makers and general public
• Workers lose their jobs, homeowners go bankrupt and consumers suffer
capital losses on their assets
• The study of business cycles analyses short term fluctuations in economic activity i.e.
how/why the economy alternates between expansions and contractions.
• Expansion = rapid growth and recessions = downturns in economic activity
- Usually use log of real GDP on y axis
- Blue line is the long run trend
- Green line is the actual GDP data
- Peak –> trough, output is declining and trough –> peak there is an increase in
economic activity
Consequences of Recessions: Zimbabwe Example
- Been in recession since around 1997
- Inflation is high, prices are high and growth is low
- Recession lead to collapse of infrastructure, low income, meaning there is little capital
to start businesses in the informal sector even
- They tried to dollarize the currency (accepted many different currencies)
o They couldn’t print money therefore it was meant to control inflation
o In 2012 there was high growth but by implementing dollarizing without
addressing problems with the economy, the gains in growth are diminished
, - Shows a decline in private demand (demand by private households)
o When it is negative, the public demand is positive but when it is not geared
towards capital expenditure it doesn’t stimulate the economy (e.g. payment of
salaries doesn’t increase growth)
- Zimbabwe: High unemployment, parallel markets (illegal markets where goods and
foreign currencies are traded)
o A parallel market is where the trade of G&S occurs outside the legalized route
o E.g. if trade a dollar on parallel market you could buy a flight to Dubai
o Different exchange rates for cash and bank transfers – therefore multiple ER
in the parallel markets making it difficult to equalize these rates
- Poverty and deterioration of infrastructure
• Thus understanding business cycles is not only of academic interest.
• It may help the economist to offer advice to policy makers on reducing business
fluctuations (through stabilisation policy i.e. MP and FP)
• Understanding business cycles also helps to avoid misguided macroeconomic policy
that actually amplifies the business cycle.
• NB: No two cycles are identical but the usually have some important features in
common
Unemployment and political extremism in Germany, 1924-1933 (above)
- As share of Nazi votes increases, unemployment increases by more
- Political extremism can be aggravating features for business cycles
- Economic depression made it easier for Hitler to gather support
- Similar to how Zim printed money to fund the war in the DRC and land reform
,South Africa Example
- Slumps caused by things like load shedding disrupting economic activity,
downgrading the economy which decreases investor sentiment and also decreases
portfolio inflows which is supposed to cover the CA deficit
South Africa Example
- Over time SA unemployment has increased
- Recessions also caused by global slowdowns of commodity prices – when china
changed to a more services growth path this led to less demand for commodities,
decreasing their prices and therefore slowing our growth.
- Population growth outpacing economic growth = poverty
• Global slowdown of commodity prices
• Economic growth is low and outpaced by population growth
• Youth unemployment (ages 15-24) almost 55% in Q1:2017
• Low economic growth means unemployment will likely increase, and inequality is
unlikely to improve
• Political uncertainty, e.g. Electoral calendar and cabinet reshuffles reduce confidence
and deter investment which aggravates recessions
South Africa Example
Supply side factors
❖ Decline in agriculture and mining – due to drought and lower commodity prices
❖ Weak growth in financial services and other business cycle sensitive sectors because if
sector strongly linked to BC in recessions these suffers
Demand side factors
❖ Decline in private investment – as a private consumer you want to invest but your income
is too low. If pvt demand is affected by low income then pvt supply is affected as well.
,❖ Weakening business confidence
❖ Decline in private consumption (due to tighter credit conditions and high unemployment)
DEFINING BUSINESS CYCLES
“Business cycles are a type of fluctuation found in the aggregate economic activity (all
variables in GDP equation are declining) of nations that organize their work mainly in
business enterprises: a cycle consists of expansions occurring at about the same time in
many economic activities, followed by similarly general recessions, contractions and
revivals which merge into the expansion phase of the next cycle; this sequence of changes is
recurrent but not periodic; in duration business cycles vary from more than one year to ten
or twelve years; they are not divisible into shorter cycles of similar character with amplitudes
approximating their own (need to de-seasonalize variables). Fluctuations tend to be persistent
and self-reinforcing”
Several points are emphasized:
1. Aggregate Economic Activity: BC are characterized by the co-movement of a
large number of economic activities and not just by movements in a single
variable like real GDP
2. Organization in business enterprises: BC are a phenomenon occurring in
decentralized market economies. Although they had several other problems,
socialist economies of Easters Europe did not go through business cycles like
the Western World.
3. Expansions and contractions: BC are characterised by periods of expansion
followed by periods of contraction
4. Duration of more than a year (persistence): A full BC lasts for more than a
year. Fluctuations of shorter duration don’t have the features characteristic of
business cycles. They are also persistent in that once an expansion starts it
usually lasts a while during which the expansionary forces tend to be self-
reinforcing and the same for a contraction.
5. Recurrent but no periodic: Their period varies from a year to 11/12 years.
Dating Business Cycles
•This entails identifying the turning points of the business cycle (i.e. The peak and trough)
, •The length of the business cycle is measured from trough to trough.
•From the figure on the following slide we see that:
• Business cycles are far from regular and periodic.
• Business cycle expansions have tended to last longer and contractions have on
average been shorter after the Second World War.
US business cycle expansions and contractions
- Expansions tend to hold longer than contractions as long run trend is upward
o This is engineered through policy (implement policies which encourage
growth)
o Recessions are inevitable because in the short run political instability, Covid
19 etc. there will be downturns – things both within and beyond our control
- In developing countries, they say supply side factors are more NB
- Changes in upward quarters are greater than downswings
MEASURING BUSINESS CYCLES
• We need a method for separating the growth trend from the cyclical component of a
variable like GDP
yt =gt +ct
where yt is the log of GDP, gt is the growth trend, and ct the cyclical component
- We only observe yt so we need a way to estimate gt and ct
o Our assumption is that on average yt = gt
o The equation also implies that as long as the amplitude of fluctuations in the
cyclical component of the business cycle remains constant, the absolute
amplitude of the BC fluctuations in real GDP will rise in proportion to the
trend level of output so that the percentage deviations of actual output from
trend output over the BC will tend to stay constant over time
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