Lecture Notes for Chapter 5 of MACROECONOMICS:
An Introduction
Growth & Recession
in the U.S. Economy
Copyright © 1999 by Charles R. Nelson
4/22/99
In this chapter we will discuss:
GDP - Nominal and Real
Recession and expansion
Anatomy of the "business cycle"
unemployment
inflation
interest rates
profits
stock market
U.S. Dept of Commerce announces GDP quarterly.
Broadest indicator of economic activity
Value of everything produced in the U.S.
Announced 4th week of next quarter.
Expressed at an annual rate.
Seasonally adjusted.
It is a statistical estimate, subject to revision.
Nominal GDP
Nearly 8 trillion $
$32 billion per day!
Ten-fold increase
Partly due to inflation,
partly real growth.
Need to measure REAL GDP.
Nominal and Real GDP
Components deflated,
add up to get real GDP
Re-based each year,
called "chaining"
Real GDP expressed in dollars of 1992
Real GDP dips called recessions.
Rule of thumb: recession when real GDP declines 2 quarters.
High point before recession is peak
Low point is trough.
Date recessions from peak to trough.
intervals are expansions.
Last recession:
July 1990 - March 1991.
Real GDP has tripled since 1960 despite recessions.
Average increase produces
long term economic growth.
Over many decades the growth rate of real GDP has averaged about 3% per year.
At that rate real GDP doubles roughly every 20 years!
But growth rate fluctuates widely around that average.
Real GDP Growth Quarterly
Quarterly at annual rate.
Very noisy!
3% average is reliable over long periods
Recent years below par
Can’t predict next quarter
Can expect 3% long term
Implicit Price Deflator for GDP
Divide nominal GDP by real GDP
A price index for everything!
Base year 1992
Chaining has reduced biases
Rapid inflation in 70s.
The Business "Cycle"
Are recession, expansion, recession,
like cycles in nature?
Time between recessions highly variable,
not a fixed frequency
Prefer term "business fluctuations"
Which are the key "cyclical" variables?
The Unemployment Rate
Who is unemployed?
If normally employed, looking for a job.
Normally employed are the labor force,
divided between employed and unemployed.
Unemployment and recession go together,
employers lay off workers they do not need.
Unemployment rate is % of labor force.
The Unemployment Rate
Increases in recession, declines in expansions.
Demographic factors:
More young workers in the 1970s,
higher unemployment
More experienced workers in the 1990s,
lower unemployment
What rate is "full employment"?
Always "frictional" unemployment.
Some have health or social problems.
Also "voluntary unemployment"
quit to look for better work, to move
"Natural" rate of unemployment about 5%.
Above 5%, economy is too slow,
below 5% is "inflationary"
Disfunctional people not counted!
The Rate of Inflation - CPI
Declines in recessions,
accelerates in expansions.
Law of supply & demand
But lags business cycle:
high in 90-91 recession,
fell sharply in 1992,
remains very low now.
Why doesn't inflation respond more quickly to recession?
Many prices and wages fixed by contract
Union contracts cover 3 year period.
Frequent changes upset customers
"Menu costs"
Regulations - less important today.
The Treasury Bill Rate
Falls during recessions,
rises during expansions
Why?
Inflation expectations
rise and fall with cycle
Real rate affected by:
Fed policy
loan demand
both cyclical
Real Disposable Income Per Capita
Personal income,
minus taxes.
Deflated by CPI,
divided by population
About $21,000 per year.
Doubled since 1960!
Dips during recessions.
Impact on Presidential Elections
Carter defeated incumbent Ford in 1976
Reagan unseated Carter in 1980
Clinton unseated Bush in 1992
All dips in real disposable income.
Recession in 90-91 spelled trouble for Pres Bush.
Clinton made his campaign motto:
"It's the economy, stupid!"
Expenditure Components of Real GDP
Note that:
Components vary in responsiveness to recession
Most sensitive is investment,
new plant and equipment.
Consumption spending declines only modestly
Government purchases little affected
Imports affected, reflect demand in the U.S.
What about exports?
The Investment Accelerator
If sales only levels off,
firm needs no new plant and equipment.
Investment goods dive during a recession
Some replacement demand
Capital goods makers called "cyclical".
Examples: Boeing, Caterpillar, Paccar.
Effect may be moderated by export demand.
Corporate Profits & Recessions
Strongly pro-cyclical
Many costs are fixed
Early 80s, GDP fell 3%, profits 45%.
Profits stagnated in 70s, took off in 90s,
so did stock market!
Not surprising.
Standard and Poor's Index of 500 stocks - nominal and real
Note the difference!
Stock market troughs before the economy.
also peaks before the economy.
Stock market is a leading indicator of the business cycle.
Why?
The Efficient Markets Hypothesis:
Stock market reflects investors’ best collective forecast of future profits
Many sources of information come together
In the midst of recession,
stock market sees signs of recovery
Lesson: you can’t beat the market!
The End!