Business Cycles - Chapter 17

Potential output

the level of output that occurs when all resources are fully employed.

• Represents sustainable production capacity

Business cycle

short-run fluctuations in economic activity.

• Deviations of actual output from potential output

• Includes expansions and recessions

seasonally adjusted data

data stripped of predictable seasonal patterns.

• Helps you see the underlying trends.

Okun’s Rule of thumb

For every percentage point that actual output falls below potential output, the unemployment rate is around one-third a percentage point higher.

• demonstrates how a rise/fall in unemployment is usually associated with a rise/fall in GDP

data revisions

Updates to earlier estimates

10 Economic Indicators

1. Real GDP

2. Export Data

3. Unemployment rates

4. Payroll

5. Building permits

6. Capacity utilization

7. Retail sales

8. Inflation rate

9. Labour cost index

10. Stock market

Actual Output

The real level of output currently produced in the economy

• measured by GDP

Output Gap

The difference between actual output and potential output (as a % of potential output)

• measures how far the economy is from full capacity

Negative Output Gap

when actual output is below potential output

indicates:

• recessionary conditions

• high unemployment

• idle resources

Positive Output Gap

When actual output is above potential output

indicates:

• economic boom

• inflationary pressure

• unsustainable production

Business cycle phases

peak, trough, recession, expansion

Peak

Highest point of economic activity before a downturn

Trough

Lowest point if economic activity before recovery

Recession

a period of declining economic activity

runs from peak → trough

Expansion

A period of increasing economic activity

• runs from trough → peak

Persistence

The tendency for economic conditions to continue in the same direction over time.

Co-movement

The tendency of many economic variables to move together over the business cycle.

ex: GDP, unemployment, investment all rising together

leading indicators

Variables that change before the overall economy changes.

• used to predict future economic activity

lagging indicators

Variables that change after the economy has already begun to follow a trend.

• Used to confirm trends

ex: unemployment

Okun’s Rule of Thumb

For every 1% decrease in output relative to potential, unemployment rises by about 0.33%.

• links output gap to unemployment

Seasonally Adjusted Data

Data that has had predictable seasonal patterns removed.

• Helps reveal underlying trends

Annualized Rate

A rate converted to show what it would be over a full year.

• Allows comparison across different time intervals

Real Variables

Economic variables adjusted for inflation.

• Reflect true changes in quantity, not prices

Nominal Variables

Economic variables measured in current prices (not adjusted for inflation).

Data Revisions

Updates to previously released economic data.

• Occur because initial estimates are based on incomplete information

5 Rules to Track the Economy

1. Track many indicators

2. Broad indicators beat narrow indicators

3. Seak just in time data + distinguish between leading and lagging indicators

4. Find the signal amid the noise → use averages

5. Adjust your outlook when data differs from expectations