11 Jul Economic Business cycles Unemployment – inflation Find an article related to the topics reviewed under this Module, summarize it, and propose a discussion? second post-I will sen
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Economic Business cycles Unemployment – inflation Macro & international economics
ECON 6644
Managing in a Global Economy
Summer II 2022 – Module 2
Dr. Claude J. Chereau
Economic growth & business cycles
Economic Growth
Two types of growth
Economic growth is the fundamental determinant of the long-run success of any nation, the basis source of rising living standards, and the key to meeting the needs of the American people.
Economic Report of the President, 1992
Measures of Growth
Growth rate
Percentage change in real GDP from one year to the next
Economic growth is an exponential process
Small changes compound from year to year
A shortcut method of indicating growth rate is to use the Rule of 72:
To find how many years it takes to double GDP, divide 72 by the growth rate
At 3.5% growth rate, GDP will double in about 20 years
GDP per capita
GDP per worker
Real GDP divided by the labor force => a measure of productivity
If the labor force grows faster than the population, GDP per capita grows and living standards rise
Productivity is better measured by output per labor-hour
Increases in GDP per capita over recent decades are due to the rising productivity of the average American worker.
Productivity growth
When long-run growth of the labor force has stabilized
Continued growth in real GDP must rely on productivity growth
Technology
Growth rate of Growth rate of Growth rate of
total output = labor force + productivity
Causes, Sources, & Effects of Economic Growth
Causes of economic growth
Little understanding about causes of growth
Role of social and political influences
Sources of economic growth
Productivity gains
Other sources include
Better labor quality
Increased capital investment
Development of new products and production techniques
Improved management
Supportive government policies
Effects of economic growth
Growth is usually biased
It occurs in one sector more than others, causing relative supply to change
E.g., rapid growth has occurred in U.S. computer industries but relatively little growth has occurred in U.S. textile industries
Sources of Productivity gains
Increase in labor skills
More capital
An increase in the ratio of capital to labor
Primary determinant of labor productivity
Technological advancements
Scientific research
Product development
Innovations in production techniques
Improved management
Better use of available resources in the production process
Fostering new
entrepreneurship
Lower potential growth: potential causes
Demographics
Ageing in certain markets (e.g., developed economies)
High debt ratios that slow spending
Fall in corporate capital spending (global investment slump)
Hysteresis: the cycle affects the trend
Rise in income/wealth inequality
Slow structural reforms
Persistent global savings glut
What causes economic slumps?
Basically anything, e.g.,
Mid-sized bubbles, from private equity debt to emerging markets
The 79-82 double dip: Fed tightening to bring inflation down
2001: the tech bubble
2007-2009: financial crisis due to housing bust
Drop in consumer confidence brought on by oil price hikes and Gulf War jitters
Post-Cold War drawdown in defense spending
Pandemics
Covid-19
Ukraine/Russia war
Effects of Economic Slowdown
Impacts on household income
Reduced production means layoffs
decreased household income
Reduced income means less spending, and AD shifts further to the left away from full-employment
A relatively small problem could snowball into a much larger problem.
Economic business cycles
Business cycles
Alternating periods of economic growth and contraction
Long-term growth rate of the U.S. economy is approximately 3 percent a year
Some years GDP grows much faster; in other years growth is slower
Macroeconomics tries to explain
Alternating periods of growth and contraction that characterize the business cycle
How & why economies grow
What causes the recurrent ups and downs known as the business cycle
Three central questions
How stable is a market-driven economy?
What forces cause instability?
What, if anything, can the government do to promote steady economic growth?
International trade & financial flows tie nations together
The Business Cycle in U.S. History
Growth rate averages 3%, but the economy fluctuates around that average, occasionally achieving negative GDP growth or decline.
Business Cycle
Variations around a growth trend that slopes upward
4 parts
The peak, where GDP maximizes
Contraction, where GDP declines
The trough, where GDP minimizes
Recovery, where GDP increases
Terms associated with business cycles:
Economic growth
Real GDP grows faster than 3%
Growth recession
Real GDP grows, but slower than 3%
The economy expands too slowly
Recession
Real GDP contracts (for two or more consecutive quarters)
Depression
An extremely deep recession
Defining the different phases of a business cycle
| Business cycles | Fluctuations in general level of economic activity (measured by changes in real GDP & rate of unemployment) |
| Expansion | Economy is growing, +2-3% Unemployment reaches its natural rate Inflation near 2% target Stock market high |
| Peak (or boom) | GDP > 3% Inflation > 2% Irrational exuberance => asset bubbles |
| Contraction | GDP < 2%, if negative for 2 trimesters => recession Unemployment begins to rise Stocks enter a bear market |
| Recessionary trough | When economy hits bottom Economy transitions from contraction phase to expansion |
14
Recovery Shapes
https://www.businessinsider.com/recession-recovery-shapes
15
Business cycle: Where does the global economy currently stands?
The global economy is still growing
Yet, showdown
Ongoing Ukraine /Russia war
Tighter monetary policy by the Fed in the US to tackle rising inflation
16
Macroeconomic Outcomes
Aggregate Demand vs. Aggregate Supply
The Circular Flow of the Economy
Macro outcomes: Aggregate Demand vs. Aggregate Supply
Macro outcomes are transmitted through supply or demand
Environment characterized by limited resources & choice
=> scarcity vs. opportunity cost
Demand behavior & supply behavior interact in a market
A product/service has a market demand
People are willing/able to buy it at some price in the market
Determinants are taste, income, expectations, other goods, # buyers
A product/service has a market supply
Businesses are willing/able to produce, & sell it at some price in the market
Determinants are technology, factor costs, taxes, subsidies, expectations, other goods, # sellers
Aggregate Demand and Supply
Aggregate demand (AD)
Total quantity of output (real GDP) demanded at alternative price levels (price index) in a given time period
Collective behavior of all buyers in the marketplace
Comprises all goods and services
Aggregate supply (AS)
Total quantity of output (real GDP) producers are willing and able to supply at alternative price levels (price index) in a given time period
Collective behavior of all suppliers (sellers) in the marketplace.
Comprises all goods and services
The vertical axis represents a price level or price index, not a particular price of one good. This is not identical to a market model for one good.
The horizontal axis is total output, not output for one product. Total output is measured by real GDP.
AD and AS graphs are stylized representations that model, not replicate, the macroeconomy.
The Circular Flow of the Economy
https://www.ceicdata.com/en/united-states/consumer-confidence-index/consumer-confidence-index
Aggregate demand
Components of Aggregate demand
consumption (C)
investment (I)
government spending (G)
net exports (X – M)
| $ tn | GDP | |
| Consumption | 15.7 | 69% |
| Investment | 3.9 | 17% |
| Government | 4.0 | 18% |
| Net Exports | (0.9) | (4%) |
| 2021 GDP | 22.7 | 100% |
Based on nominal annualized GDP
a/o June 30, 2021: $22.7tn
1- Consumption
Expenditure by consumers on final goods and services
Largest component of aggregate demand
https://fred.stlouisfed.org/series/PCE
https://www.theglobaleconomy.com/rankings/consumption_GDP/
Covid vs. Consumption (2020)
| Jan 31 | 14,880 bn | |
| Feb 29 | 14,877 bn | – |
| Mar 31 | 13,879 bn | – 6.7% |
| Apr 30 | 12,112 bn | – 12.7% |
| May 31 | 13,165 bn | +8.7% |
| Jun 30 | 14,014 bn | +6.4% |
| Jul 31 | 14,224 bn | +1.5% |
| Aug 31 | 14,397 bn | +1.2% |
| Sep 30 | 14,583 bn | +1.3% |
| Oct 31 | 14,620 bn | + 0.3% |
| Nov 30 | 14,533 bn | – 0.6% |
| Dec 31 | 14,494 bn | -.0.3% |
Consumption Function
Autonomous consumption (a)
Determined by something other than income
Savings or borrowed funds
Income-dependent consumption (bYD)
Consumer spending that increases as income increases
YD: Disposable income
Total = Autonomous + Income-dependent
Consumption Consumption Consumption
C = a + bYD
Consumption vs. Income
Consumption = Disposal Income – Saving
C = YD – S
Disposal Income YD = Y – T
YD = Income – Taxes
Disposable Income vs. Consumption
Average propensity to consume (APC)
Average propensity to save
When household income increases, consumer spending increases as well => marginal propensity to consumer
APC = Total consumption = C
Total disposable income YD
APS = 1 – APC
Marginal Propensity to Consume/Save
Marginal Propensity to Consume
(MPC)
Marginal fraction of each additional (marginal) dollar of disposable income spent on consumption
MPC = ∆ C / ∆ YD
Marginal Propensity to Save
(MPS)
Marginal fraction of each additional (marginal) dollar of disposable income saved
MPS = ∆ S / ∆ YD
MPC + MPS = 1
MPC & MPS predict consumer behavior
A change in consumption (C) causes AD to shift
. AD will shift in response to changes in:
Income
Expectations (consumer confidence)
Wealth
Credit conditions
Tax policy
Shifts in AD can be a cause of macro instability
2- Investment
Expenditures on new plants, equipment, structures, plus changes in inventories
Investment spending
Inversely related to interest rate
Most volatile category of spending
If expectations of future sales improve,
investment function shifts right, as will AD
=> vice versa applies
Currently, businesses putting off investment as wait for clarity on full cost of COVID
Investment in the global economy (as %GDP)
https://www.theglobaleconomy.com/rankings/investment_percent_of_gdp/
Foreign Direct Investment (FDI)
Many countries rely on FDI inflows as key source of aggregate demand and driver of real growth
Global FDI inflows – 2007-2021 (Billions of dollars and per cent)
3- Government Spending
Federal spending can be increased to counter spending decreases in the other components
Basis of Keynesian demand-side policy
Budget deficit (detailed later in this Module)
Yet, state and local spending to decrease when consumption & investment spending decrease
Balanced budget requirements
=> instability
Government spending multiplier
aka as fiscal multiplier (or simply the multiplier) represents the multiple by which GDP increases or decreases in response to an increase and decrease in government expenditures
Reciprocal of the marginal propensity to save (MPS)
4- Trade balance (X – M)
Economic downturns in other countries lead to a decrease in U.S. exports (X), and vice versa
Economic downturns in the U.S. lead to a decrease in U.S. imports (M), and vice versa
If X – M decreases, AD shifts left
If X – M increases, AD shifts right
Determinants of trade balance
Saving vs. Investment
Real exchange rate
Disposable income
Further explored in Modules 4 – 6
Anticipating AD shifts
The Index of Leading Indicators
List of 10 gauges that are supposed to indicate in what direction the economy is moving
How is the index used?
If index rises => good news for the economy (and vice versa)
Changes in the index are used to forecast changes in GDP and turns in the business cycle
The purpose of this index is to help predict movements in GDP and the business cycle in the economy tomorrow.
Average weekly hours worked by manufacturing workers
Average number of initial applications for unemployment insurance
Amount of manufacturers' new orders for consumer goods and materials
Speed of delivery of new merchandise to vendors from suppliers
Number of new orders for capital goods unrelated to defense
Number of new building permits
for residential buildings
S&P 500 stock index
Inflation-adjusted monetary supply (M2)
Spread between long and short interest rates
Consumer sentiment
Consumer Confidence Index
Barometer of the US economy based on consumers’ perceptions of business/employment
The CCI has deteriorated since March
March 2020: 118.8 (from 132.6 In Feb) – basis 1985 = 100
August 2020: 84.80 (after a bump in June at 98.3)
July 2021: 129.1 (unchanged from June after rise over past 5 months)
The Present Situation Index – based on consumers’ assessment of current business and labor market conditions – moved up in July to 160.3 from 159.6
The Expectations Index – based on consumers’ short-term outlook for income, business and labor market conditions – unchanged in July (108.4) from June (108.5)
Consumer confidence index
https://www.ceicdata.com/en/united-states/consumer-confidence-index/consumer-confidence-index
Global Leading Economic Index Data
Composite Leading Indicator (CLI)
Provides early signals of turning points in business cycles
Shows short-term economic movements in qualitative rather than quantitative terms
https://data.oecd.org/leadind/composite-leading-indicator-cli.htm
(May 2022)
https://www.oecd-ilibrary.org/economics/main-economic-indicators_22195009 (May 2022)
Policies that affect AD
To be explored in Module 3
To be explored in Module 3
Aggregate supply
Aggregate supply (AS)
Total quantity of output (real GDP) producers are willing & able to supply at alternative price levels in a given time period
Collective behavior of all suppliers (sellers) in the marketplace
Comprises all goods and services
AS slopes upward => suppliers bring more goods and services to market at higher price levels, and vice versa
Price effect
Cost effect
There is a maximum capacity to produce at any time in an economy
As output nears that capacity, output increases slowdown but price increases accelerate.
When considering the Aggregate Supply curve, we need to distinguish short-run and long-run
Short-run:
In the short-run, households & businesses are unable to adjust these prices when unexpected changes occur, including unexpected changes in the price level
Period of time during which some prices, particularly those in resource markets, are set by prior contracts & agreements
Long-run:
Period of sufficient time so that people have opportunity to modify their behavior in response to price changes
Shape of the AS Curve
Short-Term
AS curve with an upward slope that increases near full employment
Inflation accelerates in that region of the curve as AD shifts right.
Long-Term
LRAS is related to the economy's production possibilities constraint
LRAS
YF
(full employment rate of output)
Change in price level does not affect quantity supplied in the long run.
Goods & Services (real GDP)
Potential GDP
Price Level
An economy’s full employment rate of output (YF), the largest output rate that is sustainable, is determined by supply of resources, level of technology, & structure of the institutions
These factors are insensitive to changes in the price level
Hence, the verticality of LRAS curve.
What Shifts the AS Curve?
Shifting AS right
Policies that provide incentives for suppliers to increase production
Tax incentives for saving, investment, and work
Human capital investment
Deregulation
Trade liberalization
Infrastructure development
Generates desirable macro outcomes
Shifting AS left
Policies that provide disincentives for suppliers to increase production
Tax increases for saving, investment, and work
Deteriorating human capital investment
Excessive, costly regulation
Trade restrictions
Decaying infrastructure
Negative external shocks, such as natural disasters and war
Generates undesirable macro outcomes
Output decreases, unemployment rises, and inflation increases
Supply-Side Policy
Policies that alter the willingness/ability to supply goods at various price levels will shift the aggregate supply curve
=> less inflation and less unemployment
Reduce marginal tax rates
High tax rates discourage extra work, investment, and saving shifting the AS curve to the left
Investments in human capital
Reduction of regulatory costs
Infrastructure development
Reduction of trade barriers
Macroeconomic Outcomes
Unemployment
Inflation
Unemployment
Civilian Population: 16 years and older
A snapshot of unemployment around the world – 2022
https://countryeconomy.com/unemployment
Inability of labor force participants to find jobs
When economy is growing, both unemployment rate & duration decrease
When the economy stagnates or goes into decline, both unemployment rate & duration increase
Idled resource, so the economy operates inside its PPC, in the inefficient zone.
Okun’s Law: a 1%increase in unemployment results in a 2 % decrease in GDP
Unemployment in the US
https://tradingeconomics.com/united-states/unemployment-rate
https://fred.stlouisfed.org/series/UNRATE
46
Measuring Unemployment
Unemployment rate: the proportion of the labor force that is unemployed
A person is counted as unemployed if he or she is not working but actively seeking work.
Measurement glitches
Underemployment
People who want full-time work in their field but can find only part-time work or work at jobs below their capability.
They are counted as employed
People who must claim to be looking for work in order to receive public assistance or unemployment compensation but don’t really want to take a job.
They are counted as unemployed (Phantom unemployment)
Discouraged workers
Former job seekers who have given up and no longer actively seek employment.
They drop out of the labor force.
Numbers increase during times of high unemployment.
They are no longer counted in unemployment statistics
Defining Full Employment
Full employment is not the same as zero unemployment
Full employment: the lowest unemployment rate compatible with price stability; zero cyclical unemployment.
-Some frictional and structural unemployment will exist at full employment.
The four categories of unemployment.
1. Seasonal unemployment
2. Fictional unemployment
3. Structural unemployment
4. Cyclical unemployment
At full employment, all of these exist except cyclical unemployment
Near full employment when rising prices signal near production capacity – that is, on the PPC, and near the inflationary flashpoint
Inflationary flashpoint: the rate of output at which inflationary pressures intensify
At or below 4% unemployment.
Categories of unemployment
| Seasonal unemployment: due to seasonal changes in employment The Labor Department reports seasonally adjusted unemployment rates for every month Unemployment data exclude effects of seasonal unemployment | Frictional unemployment: brief periods of unemployment (between jobs or into labor market) Adequate demand for frictionally unemployed Have skills required for existing jobs |
| Structural unemployment: caused by mismatch skills/location of job seekers vs. requirements/location of available jobs Caused by a change in: market for the product made Technology Process by which the goods are made Workers require retraining or relocation | Cyclical unemployment: caused by a decline in economic activity Demand for products decreases and workers get laid off excess supply of workers for remaining available jobs The economy must grow at least as fast as the labor force to avoid cyclical unemployment. |
The “Natural” Rate of Unemployment
Long-term rate of unemployment determined by structural forces in labor and product markets
Changes in Structural Unemployment
Changes in structural unemployment come from changes in society itself
Growing numbers of youth and women
Changes in transfer payments for the jobless
Changes in products demanded by consumers
Changes in how (and where) products are made
During periods of change, structural unemployment increases
When changes are fully absorbed, structural unemployment decreases
Human Costs of Unemployment
Loss of income
Loss of confidence
Social stress
Lost lives
Controversial topics related to unemployment
Unemployment vs. Trade
Unemployment vs. Technology
Unemployment vs. International labor Migration
Inflation
Prices of a specific market basket of goods are collected and computed into an average price level for that basket in a year
A rise in that average price level is inflation
A decrease in that average price level is deflation
Core problems of inflation
What kind of price increases are referred to as “inflation”?
Who is hurt and who is helped by inflation?
What is an appropriate goal for “price stability”?
Increase in average level of prices
Not a change in any specific price of a good, not a market function
Inflation
Prices of a specific market basket of goods are collected and computed into an average price level for that basket in a year
A rise in that average price level is inflation
A decrease in that average price level is deflation
Core problems of inflation
What kind of price increases are referred to as “inflation”?
Who is hurt and who is helped by inflation?
What is an appropriate goal for “price stability”?
Increase in average level of prices
Not a change in any specific price of a good, not a market function
https://fred.stlouisfed.org/graph/?g=rocU#
54
Measuring Inflation
Inflation rate
Annual percentage rate of increase in the average price level
Measuring inflation serves two purposes:
gauging the average rate of inflation
identifying its principal victims
Consumer price index (CPI):
Measure (index) of the average price of consumer goods and services
Used to calculate the inflation rate
Core inflation: changes in CPI, excluding food and energy prices, which are volatile
Other measures of inflation
Producer price index (PPI):
Changes in the average prices at intermediate steps of production
GDP deflator:
changes in prices of all goods and services included in GDP
Used to adjust nominal GDP to real GDP.
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