Download Real Business Cycles

Real Business Cycles
Supply Side Economics
The Real Economy
• Neoclassical (Supply Side) Economics
suggests that business cycles are the result
of random disturbances to productivity.
The Real Economy
• Neoclassical (Supply Side) Economics
suggests that business cycles are the result
of random disturbances to productivity.
• The initial impact takes place in labor
markets (employment/output)
The Real Economy
• Neoclassical (Supply Side) Economics
suggests that business cycles are the result
of random disturbances to productivity.
• The initial impact takes place in labor
markets (employment/output)
• Capital markets determine the impact on
future labor markets (Investment today
affects the capital stock in the future)
Example: A negative supply
shock
• Consider an unanticipated
rise in oil prices
(permanent enough to
impact capital
investment).
28
24
20
16
12
8
4
0
0
100
200
300
400
500
Example: A negative supply
shock
• Consider an unanticipated
rise in oil prices
(permanent enough to
impact capital
investment).
• This drop in productivity
lowers labor demand
resulting in lower wages,
lower employment, and
lower output
28
24
20
16
12
8
4
0
0
100
200
300
400
500
Example: A negative supply
shock
• Now, moving to capital
markets, the drop in
productivity ( from lower
employment as well as high oil
prices) lowers investment
demand
20
16
12
8
4
0
0
100
200
300
400
500
Example: A negative supply
shock
• Now, moving to capital
markets, the drop in
productivity ( from lower
employment as well as high oil
prices) lowers investment
demand
• Lower investment demand
causes interest rates,
investment, and savings to fall
20
16
12
8
4
0
0
100
200
300
400
500
Investment and the Capital Stock
• Recall that investment is defined as the purchase of new
capital goods.
Investment and the Capital Stock
• Recall that investment is defined as the purchase of new
capital goods.
• Capital goods are constantly wearing out (depreciation).
Therefore, positive investment is needed to maintain the
current capital stock.
Investment and the Capital Stock
• Recall that investment is defined as the purchase of new
capital goods.
• Capital goods are constantly wearing out (depreciation).
Therefore, positive investment is needed to maintain the
current capital stock.
• The capital stock evolves according to
K (Future) = (1-dep)*K + I
Investment and the Capital Stock
• Recall that investment is defined as the purchase of new
capital goods.
• Capital goods are constantly wearing out (depreciation).
Therefore, positive investment is needed to maintain the
current capital stock.
• The capital stock evolves according to
K (Future) = (1-dep)*K + I
• A large enough drop in current investment causes the
capital stock to shrink.
Example: A negative supply
shock
• With a lower capital stock,
labor productivity drops
(capital and labor are
complements) causing
another drop in labor
demand
28
24
20
16
12
8
4
0
0
100
200
300
400
500
Example: A negative supply
shock
• With a lower capital stock,
labor productivity drops
(capital and labor are
complements) causing
another drop in labor
demand
• Therefore, wages,
employment, and output
continue to fall
28
24
20
16
12
8
4
0
0
100
200
300
400
500
Example: A negative supply
shock
• Lower employment causes
another drop in capital
investment (not as big as the
previous decline – the capital
stock is lower than it was
before)
20
16
12
8
4
0
0
100
200
300
400
500
Example: A negative supply
shock
• Lower employment causes
another drop in capital
investment (not as big as the
previous decline – the capital
stock is lower than it was
before)
• Interest rates and investment
continue to fall
20
16
12
8
4
0
0
100
200
300
400
500
Example: A Negative supply
shock
1
0.9
0.8
0.7
0.6
0.5
0.4
0.3
0.2
0.1
0
Employment
Output
Wages
Investment
Capital
0
Example: A Negative supply
shock
0
-1
-2
-3
-4
-5
-6
-7
0
1st Qtr
Employment
Output
Wages
Investment
Capital
Example: A Negative supply
shock
0
-1 0
1st Qtr
2nd Qtr
-2
-3
-4
-5
-6
-7
-8
-9
Employment
Output
Wages
Investment
Capital
Example: A Negative supply
shock
0
-1 0
1st Qtr
2nd Qtr
3rd Qtr
-2
-3
-4
-5
-6
-7
-8
-9
Employment
Output
Wages
Investment
Capital
Example: A Negative supply
shock
0
0
1st Qtr
2nd Qtr
3rd Qtr
4th Qtr
-2
-4
-6
-8
-10
-12
Employment
Output
Wages
Investment
Capital
Example: A Negative supply
shock
0
0
1st Qtr 2nd Qtr 3rd Qtr 4th Qtr
5th Qtr
-2
-4
-6
-8
-10
-12
Employment
Output
Wages
Investment
Capital
Example: A Negative supply
shock
6
4
2
0
-2 0
-4
-6
-8
-10
-12
-14
1st Qtr
2nd
Qtr
3rd
Qtr
4th Qtr 5th Qtr 6th Qtr
Employment
Output
Wages
Investment
Capital
Example: A Negative supply
shock
8
6
4
2
0
-2 0
-4
-6
-8
-10
-12
-14
1st
Qtr
2nd
Qtr
3rd
Qtr
4th
Qtr
5th
Qtr
6th
Qtr
7th
Qtr
Employment
Output
Wages
Investment
Capital
Example: A Negative supply
shock
8
6
4
2
0
-2 0
-4
-6
-8
-10
-12
-14
1st
Qtr
2nd
Qtr
3rd
Qtr
4th
Qtr
5th
Qtr
6th
Qtr
7th
Qtr
8th
Qtr
Employment
Output
Wages
Investment
Capital
Example: A Negative supply
shock
8
6
4
2
0
-2 0
-4
-6
-8
-10
-12
-14
1st 2nd 3rd 4th 5th 6th 7th 8th 9th
Qtr Qtr Qtr Qtr Qtr Qtr Qtr Qtr Qtr
Employment
Output
Wages
Investment
Capital
Example: A negative supply
shock
8
6
4
2
0
-2 0
-4
-6
-8
-10
-12
-14
1st 2nd 3rd 4th 5th 6th 7th 8th 9th 10th
Qtr Qtr Qtr Qtr Qtr Qtr Qtr Qtr Qtr Qtr
Employment
Output
Wages
Investment
Capital
-1
-2
-3
-4
12/1/02
8/1/02
4/1/02
12/1/01
8/1/01
4/1/01
12/1/00
8/1/00
4/1/00
12/1/99
8/1/99
4/1/99
The Recession of 2001
3
2
1
0
GDP
Consumption
Productivity
-5
Jan-03
Sep-02
May-02
Jan-02
Sep-01
May-01
Jan-01
Sep-00
May-00
Jan-00
Sep-99
May-99
-10
Jan-99
The Recession of 2001
25
20
15
10
Investment
5
0
1/
1/
99
5/
1/
9
9/ 9
1/
99
1/
1/
0
5/ 0
1/
00
9/
1/
0
1/ 0
1/
01
5/
1/
0
9/ 1
1/
01
1/
1/
0
5/ 2
1/
02
9/
1/
0
1/ 2
1/
03
5/
1/
03
The Recession of 2001
3
7
2.5
2
6
1.5
1
0.5
0
-0.5
-1
-1.5
-2
5
4
3
2
1
0
Employment
Interest
What caused the 2001 recession?
What caused the current
recession?
• Collapse of the stock market
• The Dow dropped 30% from its Jan 14, 2000 high of $11,722
• The Nasdaq dropped 75% from its March 10, 2000 high of
$5,132
• The S&P 500 dropped 45% from its July 17, 2000 high of
$1,517
What caused the current
recession?
• Collapse of the stock market
• The Dow dropped 30% from its Jan 14, 2000 high of $11,722
• The Nasdaq dropped 75% from its March 10, 2000 high of
$5,132
• The S&P 500 dropped 45% from its July 17, 2000 high of
$1,517
• Y2K/Capital Overhang
What caused the current
recession?
• Collapse of the stock market
• The Dow dropped 30% from its Jan 14, 2000 high of $11,722
• The Nasdaq dropped 75% from its March 10, 2000 high of
$5,132
• The S&P 500 dropped 45% from its July 17, 2000 high of
$1,517
• Y2K/Capital Overhang
• A sharp rise in oil prices (oil prices doubled in late 1999)
What caused the current
recession?
• Collapse of the stock market
• The Dow dropped 30% from its Jan 14, 2000 high of $11,722
• The Nasdaq dropped 75% from its March 10, 2000 high of
$5,132
• The S&P 500 dropped 45% from its July 17, 2000 high of
$1,517
• Y2K/Capital Overhang
• A sharp rise in oil prices (oil prices doubled in late 1999)
• Enron/Accounting scandals
What caused the current
recession?
• Collapse of the stock market
• The Dow dropped 30% from its Jan 14, 2000 high of $11,722
• The Nasdaq dropped 75% from its March 10, 2000 high of
$5,132
• The S&P 500 dropped 45% from its July 17, 2000 high of
$1,517
•
•
•
•
Y2K/Capital Overhang
A sharp rise in oil prices (oil prices doubled in late 1999)
Enron/Accounting scandals
Terrorism/SARS