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Economics: Reading #2: Understanding Business Cycle, .....................…
Economics: Reading #2: Understanding Business Cycle
Business Cycle
Definition
Business cycle
are recurrent expansions and contractions in economic activity affecting broad segments of the economy.
Real gross domestic product (GDP)
and the
rate of unemployment
are the key variables used to determine the current phase of cycle
Business cycle is recurring but not at equal intervals
Phase of Business Cycle
Recovery
The economy is going through the "trough", actual output is lowest. Economic activity, consumer & business spending, us below potential but is starting to increase, closing the negative output gap
Expansion
Output increase & the rate of growth is above average. Actual output rises above potential output, & the economy enters the so-called boom phase. Consumers increase spending, and companies increase production, employment, and investment. Prices and interest rates may star increasing.
Slowdown
Output reaches highest. The growth rate slower, Consumers remain optimistic, but companies may reply on overtime rather than using new hires to meet demand. Inflation slows at some point, and price levels may decrease.
Contraction
Output falls, consumer and business confidence declines. Companies reduce cost by reducing employment If the decline is moderate, this phase < the expansion phase
Types of Cycles
Classical cycle
Fluctuations in the level of economic activity
The contraction phases between peaks & troughs are often short, while expansion phases are much longer.
It is not used extensively by academics & practitioners because not breakdown GDP between short term fluctuations & long-run trends
Growth cycle
Fluctuations in economic activity around the long-term potential (trend growth level), how much actual economic activity is below or above trend growth in economic activity.
Peaks generally are reached earlier and troughs later in time, compared with the classical view. The time periods beloew & above trend growth are of similar length
It dissects overall economic activity into a part driven by long-run trends and a part reflecting short-run fluctuations.
Growth rate cycle
Fluctuations in the growth rate of economic activity (e.g., GDP growth rate).
Peaks and troughs are mostly earlier than the 2 others
It is not necessary to first estimate a long-run growth path.
Note
The vertical lines indicate troughs and peaks when using either the classical, growth, or growth rate cycle definition of a business cycle. The growth cycle reflects the percentage deviation of output relative to its trend. The growth rates in the growth rate cycle are calcylated as annualized month-over-month growth rates.
Characteristics of economic phases
Recovery
Description
:
Economy going through a trough. Negative output gap starts to narrow
Activity levels: Consumer and businesses
Activity levels are below potential but start to increase
Employment
Layoffs slow. Businesses rely on overtime before moving to hiring. Unemployment remains higher than average.
Inflation
Inflation remains moderate
Expansion
Description
Economy enjoying an upswing. Positive output gap opens
Activity levels: Consumer and businesses
Activity measures show above-average growth rates
Employment
Businesses move from using overtime and temporary employees to hiring. Unemployment rate stabilizes and starts falling
Inflation
Inflation picks up modestly
Slowdown
Description
Economy going through a peak. Positive output gap starts to narrow
Activity levels: Consumer and businesses
Activity measures are above average but decelerating. Moving to below-average rates of growth
Employment
Business continue hiring but at a slower pace. Unemployment rate continues to fall but at decreasing rates.
Inflation
Inflaiton further accelerates
Contraction
Description
Economy weakens and may go into a recession. Negative output gap opens
Activity levels: Consumer and businesses
Activity measures are below potential. Growth is lower than normal
Employment
Businesses first cut hours, eliminate overtime, and greeze hiring, followed by outright layoffs. Unemployment rate starts to rise
Inflation
Inflation decelerates but with a lag
Lead and lags in business and consumer decision making
Recovery
Risky assets
will be
upward
Higher
expected profit into corporate bonds and stocks
Equity markets hit a trough about 3-6 months before economy bottoms out and well before the economic indicators turn up
Expansion
The boom: economic growth "testing the limits", strong confidence, profit, and credit growth
Companies expand so much
(1) compete to hire worker - > raise wages
(2) relying on strong cash flows and borrowing
The goverment/ central bank may
step in
if concerned about the economy overheating
Slowdown
Saft assets
(gov bonds - the asset more hiighly prized during recession) may have
lower prices and thus higher yields
Investors may fear
high inflation
-> higher
norminal yields
Contraction
High values
on
safer
assets:
Goverment securities;
Shares of
companies with steady (or growing)
positive cash flows (utilities and producers of staple goods)
When do recessions begin and end?
(1). A country experiences
2 consecutive quarters
of negative real GDP growth
(2). Use the principles of Burns & Mitchell to several macroeconomic variables (not just real GDP growth)
(3). Analyze numerous time series of data focusing on
employment, industrical production, and sales
according to National Bureau of Economic Research (NBER) (n organization that dates business cycles in the US)
Describe credit cycles
Definition
Credit cycles
refer to cyclical fluctuations in interest rates and availability of loans (credit)
During expansion, the willingess of leanders to extend creidt is high -> credit i smore available and cheaper (low interest rates)
During contraction, lenders "tighten" -> credit less available and more expensive (high interest rates)
Credit cycles may amplify business cycle
When coincide with credit cycle, expansions tend to be stronger and contraction deeper and longer lasting
Credit cycles have been longer in duration than business cycles on average
Business activity and resource use fluctuation
Recovery
Employment
Layoffs slow
, increases
overtime
before moving to hiring.
Unemployment still
high
Capital Spending
Low but increasing, focus on efficiency rather than capcity
Sales and production
Decline in sales slows
Sales subsequantly recover
Production upturn follows but lags behind sales growth.
Over time, production approaches normal levels as excess inventories from the downturn are cleared
Inventory to sales ratio
Begins to falls
Expansion
Employment
Hiring more
Unemployment stabilizes & starts falling
Capital Spending
Focus on capacity expansion
Sales and prodcution
Sales increase
Production risesfast to keep up with sales growth and to replenish finished products.
Increases the demand for intermediate products.
"Inventory rebuilding or restocking stage"
Inventory to sales ratio
Ratio stable
Slowdown
Employment
Hiring slower
Unemployment
fall
but at
slowly rates
Capital Spending
Continue to increase capacity
Sales and prodcution
Sales slow faster than production
"Inventories increase"
Economic slowdown leads to production cutbacks and order cancellations
Inventory to sales ratio
Ratio increases
Contraction
Employment
Cut working hours
-> freeze hiring -> outrigh layoffs.
Unemployment starts to
rises
Capital Spending
No need to expand, cutbacks in capital spending
Sales and production
Businesses produce at rates below the sales volumes
necessary to dispose of unwanted inventories
Inventory to sales ratio
Ratio begins to fall back to normal
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