Download The Business Cycle

Unit 2:
The Government,
Banking and the
Economy
Who in government has
the responsibility to
respond when the
economy is in trouble?
The President?
Congress?
The Fed?
Keeping watch
over…
THE BUSINESS CYCLE
Business cycle
The Business Cycle
Contraction vs. Expansion
 Peak vs. Trough
 Recession vs. Depression

Recession Characteristics…
2 Quarters declining GNP
6-18 months
unemployment rates rise
stable (or declining) prices
Why & How
does this
happen?
Variables that determine the
Business Cycle… WHY ???
Business
Investments
Interest rates & Credit
Consumer expectations
External shocks
Business Investments
 Investment
spending increases GDP and
maintains expansion - growth
 Business
cuts leads to a decline in aggregate
(total) demand & GDP slows/contractsrecession
 Business cuts causes a reduction in output &
income in other sectors & GDP
slows/contracts- recession
Interest Rates & Credit
Business and consumers’ spending are
influenced by rates and availability of credit
As
rates climb, or loans become hard to get,
spending and investment dries up, as does job
growth
 (CONTRACTION
– RECESSION)
This is what happened throughout 2009 after
many big banks collapsed!
Consumer expectations
Expectations breed fear or hope…
Consumers
expect layoffs – stop
spending!
Consumers expect raises – spend more!
Consumer expectations become selffulfilling prophesies
External shocks
Some factor indirectly has an impact on
the economy…
 Drought,
war, oil embargo, etc. can
affect aggregate supply
 As
supply changes, so does production
and price, thus impacting GDP (1970s
OPEC Oil crisis)
Who in government has
the responsibility to
respond when the
economy is in trouble?
The President?
Congress?
The Fed?
Monetary Policy

Controlled by the Federal Reserve
 The Bank for Banks
 Board of Governors,
 Janet Yellen


Regional Banks
Goal: To expand or contract the amount of
money in supply so as to control spending and
inflation and manage the business cycle
Three Methods
 Interest rates
 Open Market Operations
 Reserve requirement
2009
http://www.pbs.org/newshour/makingsense/how-candid-should-janet-yellen-bewatching-emerging-markets-overreact-tofed-transparency/
Monetary Policy
The Federal Reserve’s
attempt to control the
business cycle
How…
track the economic indicators, and control the amount of
money in supply
how does the FED
know when these
events are taking
place??
Economic
Indicators
Economic Indicators

Unemployment
 Types:
Frictional (always exists)
seasonal
structural (changing society)
cyclical (accd. to business cycle)

Inflation
Changes to the Consumer Price Index

Economic Growth
Gross National / Domestic Product
Define the three methods of
Monetary Policy…
Open Market Operations
 Discount rate
 Reserve requirement

Interest Rates
(Discount Rate)
The rate the Fed charges banks to borrow
money
 Lower the rate – expansionary
 Raise the rate - contractionary

Interest Rates
Mortgage Calculator
Open Market Operations
The Fed’s buying and selling of US
securities (bonds) to add or subtract from
the reserves of the nation’s banking
system
 Purchase of bonds – expansionary
 Sale of bonds - contactionary

Reserve
Requirements
The fraction of money (based on total
money) banks are required to keep on
reserve
 The amount of money banks ‘have on
hand’ – or can’t loan out to borrowers
 Set as a %
 Lower the percentage – expansionary
 Raise the percentage – contractionary

Practice scenarios…
7% Inflation
4% Unemployment
3% GNP Growth
Rate
6 % Inflation
9 % Unemployment
10% Unemployment
-2% GNP Growth
2 %inflation
FISCAL POLICY
Other alternatives…
Who else is responsible?
Fiscal Policy
Congress/President adjust federal taxes
and federal spending
 Meant to control aggregate demand and
sometimes aggregate supply

 Like
monetary policy, it can be expansionary
or contractionary

Intended to monitor and adjust the
Business cycle
Circular flow…includes the
government…
When and how does the Government
enact an expansionary fiscal policy?

When? During a Recession or …
 high
unemployment, low business and consumer spending,
declining GNP

How?
 Government
raises aggregate demand by becoming a
major consumer (spending)
 Government cuts taxes, thus raising aggregate demand, or
allowing people more disposable income

Problems/Controversy?
 National
debt/deficit
 Where is the money going?
When and how does the Government
enact an contractionary fiscal policy?


When? Economy is growing quickly – Inflation results
How?
 Government
lowers aggregate demand by cutting
government spending
 Government raises taxes, thus lowering aggregate demand,
or decreasing the amount of personal disposable income

Problems/Controversy?
 What
programs should be cut by the government?
Examining trends
U.S. federal spending as a percentage of gross national product from
1790 to 1990.