Economic Fluctuations New
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Transcript of Economic Fluctuations New
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ECONOMIC FLUCTUATIONS:
THE BUSINESS CYCLE
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Business Cycle
A central concern of macroeconomics is the upswings and downswings inthe level of real output or economic fluctuations called the business cycle.
There are expansions and contractions
Aggregate economic activity declines in a contractionor recessionuntil it reachesa trough
Then activity increases in an expansionor boomuntil it reaches apeak
A particularly severe recession is called a depression
The sequence from one peak to the next, or from one trough to the next, is a
business cyclePeaks and troughs are turning points
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-2.00
-1.50
-1.00
-0.50
0.00
0.50
1.00
1.50
2.00
2000-I 2002-I 2004-I
recession
Expansion
Peak
Trough
A Complete Business Cycle consists of an expansion and a contraction
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The business cycle is recurrent, but notperiodic
Recurrent means the pattern ofcontraction-trough-expansion-peakoccursagain and again
Not being periodic means that it doesn'toccur at regular, predictable intervals
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Business cycle is the fluctuation in the level of economicactivity alternating between periods of depression andboom conditions. It is the economic conditionalternating between periods of economic growth andcontraction.
Business cycles are innate to market economies.
Business cycle
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Key indicator of cycles is the rise
and fall in real GDP, whichmirrors changes in employment
and the price levels.
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Peak or boom
Recession
Trough
Recovery
Four Phases of Business
Cycle
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peak- a phase where business activities are in their temporary maximum.
the economy at this phase is at full employment and the level of output is
at its full capacity
recession- a phase in business cycle that is characterized by a decline in
total output , income and employment.
trough/depression- it is the turning point of recession or when economic
activity is at its lowest. (unemployment is so severe)
recovery- in this phase, there is a recovery in the economy wherein
income, output, interest rate, wage and employment are rising.
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FISCAL POLICY
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Fiscal policy is the use of governmentspending and taxes to influence the nationsspending, employment and price level.(Tucker 2008 p.527)
It is the manipulation of the nationalgovernment budget to attain price stability,
relatively full employment, and a satisfactoryrate of economic growth (Slavin 2005 p. 275)
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Fiscal policy is reflected through the governmentsspending, taxation, and borrowing policies. It is one of themajor tools that government utilizes in order to helppromote the goals of full employment, price stability, andrapid economic growth.
When the supply of money is constant, governmentexpenditures must be financed with either: (1) taxes andother revenues derived from the sale of services (i.e fees
and charges) or assets (such as privatization ofgovernment owned and controlled corporations andselling of government assets) or (2)) borrowings (eitherdomestic or foreign)
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When government revenue from taxes is equal togovernment expenditure, the government has
achieved a balanced budget.
budget deficit- total government spending exceeds
total government revenue
budget surplus- government revenue's exceed its
total expenditure
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Changes in the size of the deficitorsurplusare often usedto gauge whether fiscal policy is stimulating or restrainingdemand.
Changes in the size of the budget deficit orsurplus may arise from either:
1. A change in the state of the economy, or,
2. A change in discretionary fiscal policy.
The natinal budget is the primary tool of fiscal policy.
Discretionary changes infiscal policy: deliberatechanges in government spending and/or taxes designed toaffect the size of the budget deficit or surplus.
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Keynesian view to fiscal policy
Government budget should be used
to promote a level of aggregate
demand consistent with full
employment rate of output
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When an economy is operating below itspotential output, the Keynesian modelsuggests that the government should instituteexpansionary fiscal policy,by:
increasing the governments purchasesof goods & services, and/or,
cutting taxes.
expansionary policiesGovernment policy actions that lead toincreases in aggregate demand.
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When inflation is a potential problem,Keynesian analysis suggests a shift toward amore contractionaryfiscal policy by:
reducing government spending, and/or,raising taxes.
contractionary policiesGovernment policy actions that leadto decreases in aggregate demand.
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MONETARY POLICY
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Monetary policy is a macroeconomicpolicy which involves the regulation ofthe money supply, credit and interestrates in order to control the level ofspending in the economy.
It is the measure or action undertaken by
central banks to influence the generalprice level and the level of liquidity in theeconomy.
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During the 1950s and 1960s, most Keynesianargued that monetary policy could be used to
control inflation, but that was often ineffectiveas a means of stimulating aggregate demand. Itwas popular to draw an analogy betweenmonetary policy and the workings of a string.
Like a string, monetary policy could be used topull ( hold back) price increases and therebycontrol. However, just as one cannot push witha string, according to this popular view,
monetary policy could not be used to push(stimulate) aggregate demand.
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Money supply
increases
Interest rate falls
Investment increases
Aggregate demand
increases
Aggregate outputincreases by the increase
in investment
Price level rises
Expansionary Monetary
Policy
Problem: Recession andUnemployment
Measures:1.Central bank buys
securities through
open market
operations
2.CB lowers bank rate.
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Refers to a monetary policy
setting that intends to increasethe level of which could alsoresult in a relatively higher
inflation path for the economy.
Expansionary monetary policy
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Is a monetary policy setting thatintends to decrease the level of
liquidity/money supply in theeconomy and which could also resultin a relatively lower inflation path
for the economy.
Contractionary monetary
policy
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Money supply decreases
Interest rate rises
Investment decreases
Aggregate demand
declines
Aggregate output decrease
by the decrease in investment
Price level fallss
Restrictive or Tight
Monetary Policy
Problem: Inflation
Measures:
1.Central bank sellssecurities through
open market
operations
2.It rises bank rate.
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Economists define money supply (Ms) as anything that
is generally accepted as payment for goods or services
or in the repayment of debts (Mishkin, 2003)
The term money is also being used to describe income
It may also refer to generally accepted in payment for
goods and services or in repayment of debts anddistinct from income and wealth.
What is Money Supply (Ms)?
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1.As a medium of exchange
2.As a unit of account3.As a store of value
Functions of Money
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1. M1 or Narrow Money- consists of currency incirculation (or currency outside depositorycorporations) and peso demand deposits.
2. M2 or Broad Money- consists of M1 plus peso
savings and time deposits.3. M3 or Broad Money Liabilities- consists of M2 pluspeso deposit substitutes, such as promissory notesand commercial papers
4. M4- consists of M3 plus transferrable and otherdeposits in foreign currency.
Measuring Money Supply (Ms)
F Whi h I h
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1. A reduction in the interest rate.2. A rise in the demand for consumer spending.3. A rise in uncertainty about the future and future
opportunities.4. A rise in transaction costs to buy and sell stocks
and bonds.5. A rise in inflation causes a rise in the nominal
money demand but real money demand staysconstant.
Factors Which Increases the
Demand for Money
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6. A rise in the demand for a countrys goodabroad.
7. A rise in the demand fro domestic
investment by foreigners.8. 8. A rise in the belief of the future value of
the currency.
9. A rise in the demand for a currency bycentral banks (both domestic and foreign).
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