Chapter 8. Business Cycles. Overhead.F2016

Chapter 8: Business Cycles: Abel, Bernanke, Croushore, Kneebone
Economics 303: OVERHEADS: D. McClintock
Chapter 8
Business Cycles
Table of Contents
8.1 What is a Business Cycle?
8.2 The Canadian Business Cycle
8.3 Business Cycle Facts
8.4 Business Cycle Analysis: A Preview
Intellectual property of Douglas McClintock and authors cited above Page 1

8.1) What is a Business Cycle?

In general, a business cycle is changes in aggregate economic activity
(or changes in real GDP) over a period of time.
Definitions
1) Aggregate Economic Activity: This means changes in real GDP
over time. (not nominal GDP) A landmark study by Arthur Burns
and Wesley Mitchell, (1946 – Titled Measuring Business Cycles)
also thought it was important to look at other indicators of activity,
such as employment and financial market variables. (stock prices,
profits)
2) Expansions and Contractions: A period of time when economic

activity is falling (recession or contraction) this indicates that
unemployment is rising, aggregate sales and corporate profits are
falling and firms are experiencing excess capacity. The low point
of the business cycle is called a trough.
If real GDP falls for 6 months, then the economy is experiencing a
recession. If real GDP is falling for two years or more, this is a
depression.
When real GDP is rising, this is an expansionary or recovery
period. (Sometimes called a boom period) and the high point of
the expansion is called the peak.
The entire sequence of decline followed by a recovery, measured from

peak to peak or trough to tough, is a business cycle.

3) Recurrent but not periodic: The business cycle is not periodic in

that it does not occur at regular, predictable intervals and does not
last for a fixed or predetermined length of time.
4) Persistence: Usually when an economy is experiencing an
expansionary phase, it is followed by an expansion. Similarly,
when an economy is suffering from a downturn, it is followed by a
further downturn. This is called persistence.
Because movements in economic activity have some persistence,
economic forecasters are always on the lookout for turn points,
which are likely to indicate a change in direction of economic
activity. (These would include a change in employment numbers,
housing starts, investment spending etc.)

8.2 The Canadian Business Cycle

Why have Business Cycles Become Less Severe?

Stock and Watson studied US data from 1960 to 2001 and found that
volatility in economic activity declined markedly during this time. (see
page 238) They called this period the Great Moderation.
Why did volatility decline during this period?

1) Better monetary policy (20% to 30%)
2) Good luck in terms of smaller shocks to economic activity. (40% to
50%
This was US data but for Canada, I would think that more generous
social programs have helped, such as employment insurance, welfare,
universal health care and government sponsored day care in some
provinces.


8.3 Business Cycle Facts
The Cyclical Behaviour of Economic Variables: Direction and Timing

Two Characteristics
1) Directions in which macroeconomic variables move
i) Procyclical: An economic variable that moves in the same
direction as economic activity (Up in expansions, down in
contractions) Examples would include government spending1,
investment spending, consumer spending and housing sales.
ii) Countercyclical: An economic variable the moves in the opposite

direction as aggregate economic activity. (Down in expansions, up
in contractions) Examples would include government spending,
bankruptcies, unemployment)
iii) Acyclical: These are variables that do not display a clear pattern
over the business cycle. Examples would include real wages and
real interest rates.
1
Government spending could also be countercyclical

2) Timing of the variables turning points (Peaks and Troughs)

i) Leading variable: This is a variable that tends to move in advance
of aggregate economic activity. (see Table 8.2)
ii) Coincidence variable: This is a variable that occurs at the same
time as the corresponding peaks and troughs.
iii) Lagging variable: This is a variable that tends to occur later than
the corresponding peaks and troughs.

The Index of Leading Indicators (8.2)

The index of leading indicators is weighted average of 10 economic
variables that lead the business cycle. Statistics Canada releases the
index in the first week of each month and publishes it in the Canadian
Economic Observer.
COMPONENTS OF THE INDEX OF LEADING INDICATORS
1 Retail sales of furniture and appliances

2 Retail sales of other durable goods
3 Housing outlays sales
4 Shipment to inventory ratio for finished manufactured
goods
5 New orders for durable goods
6 Average workweek in manufacturing
7 Employment in business and personal services
8 TSE composite stock price index
9 Money Supply (M1+)
10 US composite leading index

Insert Figure 8.3
The Cyclical Behaviour of Key Macroeconomic Variables

Variable Direction Timing
Production
Industrial Production2 Procyclical
Expenditure
Consumption Procyclical
Business fixed investment Procyclical
Inventory investment Procyclical
Imports
Exports
2
Durable goods (autos, trucks, furniture, appliances etc.) are more volatile than nondurable goods and services.

Labour Market Variables

Employment Procyclical
Unemployment Countercyclical
Average labour productivity Procyclical
Real wage Acyclical
Money Growth and Inflation

Money growth Procyclical
Inflation Procyclical
Financial Variables
Stock prices Procyclical
Nominal interest rates Procyclical
Real interest rates Acyclical

Insert Figures 8.4 – 8.12


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Chapter 8: Business Cycles: Abel, Bernanke, Croushore, Kneebone

Economics 303: OVERHEADS: D. McClintock

8.2 The Canadian Business Cycle

8.3 Business Cycle Facts

8.4 Business Cycle Analysis: A Preview

Intellectual property of Douglas McClintock and authors cited above Page 1

8.1) What is a Business Cycle?

2) Expansions and Contractions: A period of time when economic

The entire sequence of decline followed by a recovery, measured from

Intellectual property of Douglas McClintock and authors cited above Page 2

3) Recurrent but not periodic: The business cycle is not periodic in

Intellectual property of Douglas McClintock and authors cited above Page 3

8.2 The Canadian Business Cycle

Intellectual property of Douglas McClintock and authors cited above Page 4

Why have Business Cycles Become Less Severe?

Why did volatility decline during this period?

Intellectual property of Douglas McClintock and authors cited above Page 5

Intellectual property of Douglas McClintock and authors cited above Page 6

8.3 Business Cycle Facts

The Cyclical Behaviour of Economic Variables: Direction and Timing

ii) Countercyclical: An economic variable the moves in the opposite

Intellectual property of Douglas McClintock and authors cited above Page 7

2) Timing of the variables turning points (Peaks and Troughs)

Intellectual property of Douglas McClintock and authors cited above Page 8

The Index of Leading Indicators (8.2)

COMPONENTS OF THE INDEX OF LEADING INDICATORS

1 Retail sales of furniture and appliances

Intellectual property of Douglas McClintock and authors cited above Page 9

Insert Figure 8.3

The Cyclical Behaviour of Key Macroeconomic Variables

Intellectual property of Douglas McClintock and authors cited above Page 10

Labour Market Variables

Money Growth and Inflation

Intellectual property of Douglas McClintock and authors cited above Page 11

Insert Figures 8.4 – 8.12

Intellectual property of Douglas McClintock and authors cited above Page 12

Intellectual property of Douglas McClintock and authors cited above Page 13

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