Understanding Business Cycles: Indicators, Models, and Controversies

1. Outline W6B Cycles 1) What are they? Are they getting smaller? 2) Indicators: Conference Board , CFNAI, NBER dating 3) Keynesians in the SR vs LR and the CBO model 4) Keynesian vs RBC vs Monetarist patterns

2. Figure 8.01 A business cycle • A Cycle is • Aggregate • Has peaks and troughs • Co-movements of Series • Rucurrent not periodic • Some persistence • (persistence vs permanence) Figure 8.01 A business cycle

3. NBER/Conf. Board The Conference Board http://www.conference-board.org/ Authoritative Compilation of Leading, Coincident and Lagging Indicators NBER National Bureau of Economic Research http://www.nber.org/ Authoritative Dating of Recessions, often appearing as shaded areas in graphs Historical table appears in chapter eight Same roots Mitchel and Burns 1920’s Look for turning points in individual series. Clustering of turning points defines (subjectively) the cycle. Look for Leading/Coincident/Lagging

4. Figure 8.A The Index of Leading Indicators http://www.conference-board.org/ For the latest report and its components.

5. CFNAI discussed in Chapter 8 Chicago Fed National Activity Index The CFNAI is a weighted average of 85 monthly indicators of national economic activity. It is constructed to have an average value of zero and a standard deviation of one. -0.7 indicates a recession has with likelihood begun See recent report (look at pages one and two) at: http://www.chicagofed.org/webpages/publications/cfnai/index.cfm

6. NBER Memos • They look for turning points in • Employment • Personal income less transfers • Volume of sales • Industrial production Historical Table http://www.nber.org/cycles/cyclesmain.html Note Memo on Recession http://www.nber.org/cycles/recessions.html

7. Was the Cycle Worse?Pre vs Post WWII C. Romer, No because early data is only industrial and Industrial output is more volatile. R. Gordon, Yes when we add transport and retail data It was more volatile.

8. 2 Labor Market Impact

9. Figure 8.04 Cyclical behavior of civilian employment

10. Figure 8.05 Cyclical behavior of the unemployment rate

11. St. Lois FRB Tracking the Economy Compares recent performance of economies with past recessions and expansions in the post war period . http://research.stlouisfed.org/economy/ Look at the recent performance of US employment as contrasted with the average recovery and expansion. Contrast The US and UK with respect to re-attainment of peak level of output.

12. 3 What Causes the Cycle? Despite careful data collection we have contending Keynesian/Monetarist and Real Business Cycle views. Why doesn’t looking at the data for the leading causes of cycles resolve the controversy? Leading may not be causal because: Anticipation Data suggests X causes Y, but X jumps only because Y is expected to. Third factors Data suggest X causes Y, but X and Y were really driven by z. Some graphs follow from: Stock and Watson NBER working paper #6528 All NBER papers accessible via DePaul Library’s “databases”.

13. Filtered GDP

14. Keynesians: unstable investment and durable consumption.

15. Figure 8.03 Cyclical behavior of consumption and investment

16. GDP components 48-04 Shows NBER recessions. Volatility down I is prominent in downturns

17. C contribution to GDP -2.5 to -5 contribution in downturns

18. I contribution to GDP -5 to -10 contribution in downturns

19. NX contribution to GDP Not a consistent contributor to downturns

20. G contribution to GDP Not a consistent contributor to downturns

21. GDP and Components 48-60 C,NX, G 0 Y I NX, 0 C, G I Y G 0 NX, C, I Y

22. GDP and components 60-80 C,NX, G 0 Y I C, NX 0 G,Y I C, NX 0 Y I

23. GDP and components 75-90

24. GDP and components 85-04

25. Classical or RBC elements?

26. RBC In marked contrast to the Keynesian view which emphasizes demand shocks, the New Classical or Real Business Cycle Tradition sees the economy as subject to a large number of repeated supply shocks. The economy’s response to these shocks is close to optimal. There is little room for government intervention.

27. Figure 8.06 Cyclical behavior of average labor productivity and the real wage

28. Figure Box 8.1 Permanent components of the business cycle Figure Box 8.1 Permanent components of the business cycle

29. Monetarist Elements?

30. Figure 8.07 Cyclical behavior of nominal money growth and inflation

31. The Neo Classical Compromise The Neo Classical-Keynesian Compromise: Graft A Keynesian Short Term Model Onto A Neoclassical Long Run Model. Samuelson, Solow, Dornbush, Klein Early MPS model (MIT, PENN, Social Science Research Council) The current Congressional Budget Office models are of this stripe.

32. CBO SR/MR/LR Congressional Budget Office produces the budget and economic forecasts reported in the press. They go out 10 years and assume unchanged taxes and spending (current proposals may not pass). 2 yr short run: trends of GDP components + judgment 8 yr medium run: economy moves close to potential Long run: potential output historically calculated and projected ten years out. Used for Cyclical vs. Structural budget analysis

33. CBO SR 1 Not a formal model, rather eclectic bottom up and top down trend following, generally along the lines used to estimate current GDP before it can be estimated by Commerce Dept. returns.

34. CBO SR 2 “Near-Term Forecast. CBO analysts look at many economic indicators to develop a view about the near-term growth prospects of the economy. That analysis includes examining data on retail sales, disposable income, employment, consumer confidence, orders for and shipments of new capital equipment, new housing starts, sales of existing homes, net exports, foreign growth and inflation, governmental receipts and spending, interest rates on government and corporate securities, stock prices, commodity prices, inflation rates, exchange rates, the growth of the money supply, and overall credit conditions.” CBO: DESCRIPTION OF ECONOMIC MODELS, November 1998

35. CBO SR 3 “CBO also uses statistical methods to better understand recent economic developments. When new data on monthly retail sales are released, CBO analysts use that information to predict the likely path for the growth of overall consumption during the quarter. Monthly data on shipments of capital goods are used to predict the current quarter's investment. Monthly data on average hourly wages and total hours worked are used to forecast private wages and salaries. CBO then reconciles those "bottom-up" projections of individual components with "top-down" assumptions about overall economic growth through a framework of accounting identities …”

36. CBO SR 4 “CBO also looks at developments on the economic horizon that have not yet affected the economy but are expected to come into play in the near future. For example, the crisis in Asia became apparent in the summer of 1997, but its effects on the United States at that time were primarily limited to the foreign exchange markets. In its January 1998 report, CBO's projections incorporated the view that the Asian crisis would reduce U.S. net exports and would slow the growth of the economy. Those estimates were based on a statistical analysis of historical relationships between exchange rates, foreign growth, and net exports, as well as a judgment about the specific nature of the crisis.”

37. CBO SR-MR “An important part of CBO's forecast involves assumptions about the policy reactions of the Federal Reserve. When GDP is above potential output, underlying inflationary pressures are building. In that situation, CBO assumes that unless GDP growth slows enough on its own to eliminate the excess demand for goods and services, the Federal Reserve will take steps to restrain growth by raising interest rates. Conversely, when the economy is operating below its potential and the labor force is underemployed, CBO assumes that the Federal Reserve will provide sufficient economic stimulus so that GDP will eventually climb back to its potential level.” (my emphasis) Note that this contrasts with our text which assumes that price changes bring the economy back to potential.

38. CBO MR-LR “Although CBO does not forecast cyclical movements in the economy for the medium term, its methodology allows for the possibility of a recession. In particular, CBO assumes that GDP will be 0.2 percent less than potential GDP after 2001, which is the average gap between actual and potential GDP observed over time.” So after 2 years the CBO forecast is driven by the estimate of potential output and the assumption that the FRB will guide the economy close to its potential output.

39. CBO LR 1

40. CBO LR 2 Cyclically adjusted labor input and productivity. The labor force (from BLS survey) is de-trended over each cycle. Average hours per week are de-trended. An estimate of NAIRU is subtracted. Productivity is de-trended because it rises in expansions. Log(Qnfb*)= Log(Anfb*)+ 0.7 Log(Lnfb*)+ Log(Knfb)

41. Potential Labor

42. Productivity

43. CBO • See the most recent • Budget and Economic Outlook: An Update • From • http://www.cbo.gov/budget/budget.cfm • The charts are available in a separate file.

44. The CBO had forecast a faster recovery to potential output CBO The GDP Gap, 1965 to 2015 Produced March 2009 http://www.cbo.gov/ftpdocs/100xx/doc10014/Chapter2.6.1.shtml

45. NAIRU: What will it be?

46. GDP Report • http://condor.depaul.edu/~jberdell/ • To http://www.bea.doc.gov/ • GDP highlights • Tables from the news release