Download Business Cycles and Fluctuations

Business Cycles and
Fluctuations
Business Cycles in the
United States
• The business cycle consists of two
phases: expansion and recession.
• Recession begins with a peak and ends
with a trough.
• Expansion is the recovery from a
recession.
• If a recession becomes very severe, it
can turn into a depression.
Business Cycles in the
United States
• The worst depression in U.S. history was the
Great Depression, which began in 1929.
• The Great Depression was caused by various
factors, including excessive borrowing in the
1920s and global economic conditions.
• Since the Great Depression, the United
States has experienced several recessions,
but each was short compared with the
recovery that followed.
Business Cycles in the
United States
Causes of the Business Cycle
• Businesses reduce their capital expenditures
once they decide they have expanded enough.
• Businesses cut back their inventories at the first
sign of an economic slowdown.
• Businesses cut back on investment after an
innovation takes hold
• Tight money policies of the Federal Reserve
System slow the economy.
• External shocks, such as increases in oil prices
and international conflicts, can cause business
cycles.
Predicting Business Cycles
• Econometric models are macroeconomic
model that use algebraic equations to
describe how the economy behaves.
• The index of leading indicators is a
monthly statistical series that helps
economists predict the direction of future
economic activity.
UNEMPLOYMENT
Measuring Unemployment
• The Census Bureau surveys 50,000
homes each month.
• Each household must answer a series
of questions.
– Broken down into:
•
•
•
•
•
Non-institutional Population
Not in Labor Force
Labor Force
Employed
Unemployed
What is an Unemployed Person?
• People available for work who:
– Made a specific effort to find a
job during the past month
– Worked less than 1 hour for
pay or profit
– Worked in a family business
without pay for less than 15
hours a week
Unemployment Rate
• The number of unemployed
individuals divided by the total
number of persons in the civilian
labor force
• Unemployment rate rises during
recessions and comes down slowly
afterwards
• Affected by downturns in real
GDP – cost of a recession.
People NOT Counted
• People who have stopped looking for
work. “Dropouts”
• People who have no interest in
finding a job.
–
–
–
–
Retired persons
Housewives
Students
Disabled persons
Who Can Skew?
• People who hold part-time
jobs
• Person who has lost his highpaying job, but is working
part-time at a minimum wage
job.
American Labor Force
• 136.5 million people in the
labor force
• 0.1 % rise in the
unemployment rate means
that 136,500 people have lost
their jobs.
Kinds of Unemployment
• Frictional
• Structural
• Cyclical
• Seasonal
• Technological
Frictional
• Workers who are between jobs
• Will always be present. WHY?
Structural
• Occurs when a fundamental
change in the operations of the
economy reduces a demand for
workers & their skills
• Consumer tastes change and
therefore causes certain goods
to no longer be demanded.
Cyclical
• Related to swings in the business
cycle
• Recession: people don’t buy as
many durable goods (cars, homes)
– May result in lay-offs
– People usually get their jobs back
when the economy improves
Seasonal
• Results from changes in seasons
and demand for certain products
• Ex: construction
• Difference between seasonal and
cyclical:
– Cyclical follows the business cycle.
Can last 3-5 years.
– Seasonal can take place every year
despite the health of the economy
Technological
• Workers are replaced because
machines can do the work more
efficiently
Full Employment
• Lowest possible unemployment
rate with the economy growing
and all factors of production
being used as efficiently as
possible
• Acceptable unemployment rate =
below 5%
– (full employment is reached)
INFLATION
INFLATION
• A rise in the general price level
of goods/services - reported in
terms of annual rates of change
• Decrease in the value of money
INFLATION RATE
2nd year price level minus 1st yr price level
1st year price level
Example: (115-111) X 100 = 3.6%
111
X 100
CAUSES OF INFLATION
• Demand-pull:
– All sectors of the economy try to buy
more than the economy can produce
– Causes shortages
– Excess demand for goods and services
causes businesses to raise prices; this
can result when there is an increase in
the money supply also
CAUSES OF INFLATION
• Cost-push:
– labor negotiations as well as
an increase in the cost of
inputs causes businesses to
raise prices
CAUSES OF INFLATION
• Wage-price spiral: higher prices
force workers to ask for higher
wages; forces producers to recover
with higher prices; workers have
more money to spend and create
higher demand; self-perpetuating
Effects of Inflation: Effect #1
• The purchasing power of the dollar
falls - after inflation, a dollar buys
less than it did before
• Real vs. Nominal Income: real income
is expressed in terms of purchasing
power;
• Nominal income is expressed as an
actual dollar amount (ex: $50,000)
Question: Can someone's nominal income
increase but their
purchasing power decrease?
• YES!!! If there is
inflation, an increase in
nominal income may not
make a difference since
the dollar is worth less.
Who is hurt the most by
inflation?
• People on fixed incomes are
especially hurt because their money
buys less each month, unless they
receive a cost of living adjustment
(COLA) to keep up with inflation
Effects of Inflation: Effect #2
• Spending habits change
• Interest rates go up in times of
inflation
• This causes people to borrow
less, spend less, and some
businesses may have to lay off
workers
Effects of Inflation: Effect #3
• Speculative investing increases
to take advantage of higher
price level & diverts spending
from "normal" purchases, which
could lead to some structural
unemployment
How is Inflation Tracked?
• By comparing prices from one
year to the next
• These numbers are then
reported through the CPI
• CPI = Consumer Price Index
Consumer Price Index (CPI)
• The Labor Department surveyed the
purchasing patterns of consumers to
determine a group of about 400 items that
buyers typically use.
• These 400 items makes up a “Market
Basket”
• Each month surveyors check on the prices
of these items in cities across America.
• Results are used to compute what the
market basket costs compared to what it
cost in a base period.
Poverty and Distribution of
Income
The Distribution of Income
• The Lorenz curve
shows how the actual
distribution of income
differs from an equal
distribution.
• Since 1980 the
distribution of income
in the United States
has become more
unequal.
Reasons of Income Inequality
• Level of education affects people’s ability to get
high-paying jobs.
• Differences in wealth lead to difference in
income.
• Discrimination reduces the incomes of women
and minorities.
• Differences in abilities allow some people to
earn more than others.
• Monopoly power allows some groups, such as
doctors, to maintain high incomes.
Poverty
• Poverty is defined as having an income
below a certain level (poverty guidelines).
• Poverty in America is extensive: more
than 13 percent of the population lives in
poverty.
• Poverty has increased
– growing gap in the
distribution of income
– structural changes from a
goods production to a
service production
economy,
– the widening gap between
well-educated and poorly
educated workers,
– declining unionism
– the changing structure of
the American family.
Antipoverty Programs
• Income assistance provides cash to people in need.
• General assistance provides noncash assistance,
such as food stamps, to people in need.
• Social service programs provide assistance with
family planning, job training, child abuse
prevention, and other problems affecting lowerincome people.
• The earned income tax credit provides federal tax
credits and/or cash to low-income workers.
Antipoverty Programs
• Enterprise zones provide jobs in poor
neighborhoods.
• Workfare programs require welfare
recipients to work in order to receive
benefits.
• A negative income tax would replace
welfare programs by providing cash to
people living below the poverty line.
Federal Reserve System
Organization of the FED
• Board of Governors
– 7 governors- appointed by the
Pres. and approved by the
Senate
– 14 year terms/4 year term
for the chairman
– Chairman – Ben
Bernanke
• Open Market Committee
– 7 governors and 5
presidents of district
banks
Organization of the FED
• Federal Advisory Council – offers advice
– 12 Commercial bankers – 1 from each district
• District Banks
– 1 regional bank in each of 12 geographic districts
What are the FED’s
responsibilities?
• Provide banking services for financial
institutions
• Hold deposit accounts for member banks
• Control and supply currency
• Process checks
• Make loans to member banks
• Transfer funds
• Approve bank mergers
• Set margin requirements
Responsibilities Cont.
• Serve as the federal
government’s bank
• Supervise and
regulate the nation’s
banking system
• Control monetary
policy
Monetary Policy
• Actions by the
FED to regulate
the money
supply and to
stabilize the
economy.
Fractional Reserve System
• System requiring
financial
institutions to set
aside a fraction of
their deposits in the
form of reserves
Excess Reserves
• Financial
institution’s cash,
currency, and
reserves not needed
to back existing
loans
• Potential source of
new loans
Easy Money/Expansionary
Policy
• The FED
expands the
money supply
when
spending is
too low
(recession)
Tight Money/Contractionary
Policy
• The FED
decreases the
money supply
when spending
is too high and
prices are rising
(inflation)
Tools of Monetary Policy
•
•
•
•
Reserve Requirement
Open Market Operations
Discount Rate
Moral Suasion
Reserve Requirement
• The % of deposits banks must keep on
reserve and not loan out.
• This creates required reserves and
excess reserves.
• Only excess reserves can be loaned
out
• Every time a deposit, and then a loan,
is made, the money supply is
increased.
Open Market Operations
• The FED buys and sells govt. securities
from member banks.
• By buying securities (writing a check to
a bank) the money supply is increased.
• By selling securities (a bank writes a
check to the Fed) the money supply is
decreased.
Discount Rate
• Interest rate the Fed
charges banks for
loans.
• This affects the prime
rate.
• Prime rate – interest
rate banks charge
customers
Moral Suasion
• The Fed tries to
direct the economy
by making
announcements,
speeches, testifying
before Congress,
etc.
• Unofficial tool
Tool (used by
the FED
unofficial)
Stimulate
Economy
(Recession)
Cool Off
Economy
(Inflation)
Reserve
Requirement
decrease
increase
Open Market
Operations
Buy
Sell
Discount Rate
Lower
Raise
How is money defined?
• M1 – transactional
components of the
money supply, or the
components of the
money supply that most
closely match money’s
role as a medium of
exchange. Ex: coins,
currency, traveler’s
checks
How is money defined?
• M2 – a measure of money
that includes those
components most closely
conforming to money’s role
as a store of value. Ex: time
deposits, savings deposits,
money market funds,
includes M1
Weaknesses of Monetary Policy
• Tight money policy works
better than a loose money
policy
• By enacting a loose money
policy, the Fed encourages
spending, but can’t
guarantee it
• Businesses don’t always
depend on credit
Strengths of Monetary Policy
• Changes take effect
quickly
• Members of the Fed are
not elected, so they feel
freer to make changes,
even though they may be
unpopular