THE PARTHENON GROUP

THE PARTHENON GROUP200 STATE STREET

BOSTON, MA 02109

909cdreb16-ppt 1

US Business Cycles

Lecture 20

909cdreb16-ppt 2

What Forces Create Major Business Cycles in the United States?

• Following the lead of the bond market, the Federal Reserve has raised interest rates. Does this portend a US recession?

• Generally, do recessions emanate from government policies or private sector decisions?

US Business Cycles

909cdreb16-ppt 3

The Forces Creating Macroeconomic CyclesOil Price Shocks Are The Most

Commonly Imagined:This Illustration from The Economist is

Typical

0

1

2

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-0.75

-0.5

-0.25

0

0.25

0.5

0.75

1

1.25

1.5

1.75

2

Un

em

plo

yme

nt

Ra

te in

Pe

rce

nt

Re

al O

il Price

UNEMPLOYMENT RATEREAL OIL PRICE

909cdreb16-ppt 4

The Forces Creating Macroeconomic Cycles Can be

Totally Understood

(4.0%)

(2.0%)

0.0%

2.0%

4.0%

6.0%

8.0%19

76

1977

1978

1979

1980

1981

1982

1983

1984

1985

1986

1987

1988

1989

1990

1991

1992

1993

1994

1995

1996

1997

1998

Actual Growth

Sum of Factors

Pe

rce

nt

of

To

tal

Actual vs. Explained Real GDP Growth

909cdreb16-ppt 5

Wave Makers Affecting the Circular low of Income and

Production

Private Sector

Spending

GDP = U.S.

Output and

Income

Credit & Interest Rates

Sales Taxes

Imports

Exchange Rates

Exports

Government Spending

Income Taxes

Additive ForcesRestrictive Forces

909cdreb16-ppt 6

The Core Model

Reduced Form Model Derived from Structural Model

C=C ( G, T, i, GNPW )I = I ( G, T, i, GNPW ) M = M ( G, T, i, GNPW )X = X ( G, T, i, GNPW )GNP = C+I+X-M +G

= GNP ( G, T, i, GNPW )

Structural or Behavioral ModelC=C0 + C1 * (GDP - T) - C2 * i

I= I0 + I1 * (GDP- GDP(-1)) + I2 * IM = M0 + M1 * Y + M2 * I

X = X0 + X1 * GNPW + X2 * IG=G

GDP=C+I+G+X-M

Substitute to eliminate all endogenous variables from left-side of each equation

909cdreb16-ppt 7

The Forces Creating U.S. Macroeconomic Cycle

Systematic Patterns, 1976 - 1998

Wave Makers Quantitative MeasuresImpact on Real GDP

GrowthDemographic Core labor force Annual growth 1% 0.7%

Oil Shocks Price per Barrel

Iraq War

Current InflationPrior Year Inflation1991 Shock

10%10%

one time

(0.8%)(0.4%)(5.1%)

Financial 10-Year Bond Rate

Stock Market Wealth

Prior Year ActualPrior Year – Expected InflationPrice Growth - Inflation

1%1%

10%

(0.5%)(0.2%)(0.4%)

FederalBudget

Taxes

Federal Purchases

Prior year Change in AdjustedTax Rate (Taxes / GDP)Current Growth - Inflation

1%

1%

(1.8%)

0.6%

International ExportsExchange Rate

Current Growth – InflationPrior Year Growth

1%1%

0.1%(0.1%)

909cdreb16-ppt 8

The Forces Creating Macroeconomic Cycles

Oil Shocks

(6.0%)

(4.0%)

(2.0%)

0.0%

2.0%

4.0%

6.0%

8.0%

19

76

19

78

19

80

19

82

19

84

19

86

19

88

19

90

19

92

19

94

19

96

19

98

20

00

20

02

20

04

Real GDP GrowthOil PricesIraq War

Pe

rce

nt

of

To

tal

909cdreb16-ppt 9

The Forces Creating Macroeconomic Cycles

Demographic Forces

(4.0%)

(2.0%)

0.0%

2.0%

4.0%

6.0%

8.0%19

76

1977

1978

1979

1980

1981

1982

1983

1984

1985

1986

1987

1988

1989

1990

1991

1992

1993

1994

1995

1996

1997

1998

1999

2000

2001

2002

2003

2004

2005

Real GDP Growth

Core Labor Force Growth

Pe

rce

nt

of

To

tal

909cdreb16-ppt 10

The Forces Creating Macroeconomic Cycles

Finance Factors

(4.0%)

(2.0%)

0.0%

2.0%

4.0%

6.0%

8.0%19

76

1977

1978

1979

1980

1981

1982

1983

1984

1985

1986

1987

1988

1989

1990

1991

1992

1993

1994

1995

1996

1997

1998

1999

2000

2001

2002

2003

2004

2005

Real GDP Growth

Sum

Stock Market

Bond Rates

Pe

rce

nt

of

To

tal

909cdreb16-ppt 11

The Forces Creating Macroeconomic Cycles

International Trade Factors

-4%

-2%

0%

2%

4%

6%

8%19

76

1977

1978

1979

1980

1981

1982

1983

1984

1985

1986

1987

1988

1989

1990

1991

1992

1993

1994

1995

1996

1997

1998

1999

2000

2001

2002

2003

2004

2005

Real GDP GrowthSumExportsExchange Rate

Pe

rce

nt

of

To

tal

909cdreb16-ppt 12

The Forces Creating Macroeconomic Cycles

Federal Government Roles

(6.0%)

(4.0%)

(2.0%)

0.0%

2.0%

4.0%

6.0%

8.0%

1976

1977

1978

1979

1980

1981

1982

1983

1984

1985

1986

1987

1988

1989

1990

1991

1992

1993

1994

1995

1996

1997

1998

1999

2000

2001

2002

2003

2004

2005

Real GDP Growth

Tax Reform & Budget Shock

Sum

Tax Rate Changes

Federal Purchases

Pe

rce

nt

of

To

tal

909cdreb16-ppt 13

The Forces Creating Macroeconomic Cycles

Federal Policy Summary

-6%

-4%

-2%

0%

2%

4%

6%

8%19

76

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1978

1979

1980

1981

1982

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1985

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1987

1988

1989

1990

1991

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1994

1995

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1997

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2001

2002

2003

2004

2005

Real GDP GrowthTotal FederalFiscalFinancial

Pe

rce

nt

of

To

tal

909cdreb16-ppt 14

The Forces Creating Macroeconomic Cycles

Some observers think the business cycle is dead

It’s not dead, just fitfully sleeping

The “nirvana” or “goldilocks” economy of recent years is due to:

– Unusually stable federal government and Federal Reserve policies

– A serendipitous balance of international forces

– The private sector follows the wave-makers; it does not lead or cause the cycles

Whenever the “wave makers” once again create coincident forces, a major business cycle will re-appear

909cdreb16-ppt 15

The Forces Creating Macroeconomic Cycles

The Wave Makers are Either Benign or

Offsetting, For Now

-6%

-4%

-2%

0%

2%

4%

6%

8%

1976

1977

1978

1979

1980

1981

1982

1983

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1985

1986

1987

1988

1989

1990

1991

1992

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2004

2005

Real GDP GrowthOil ShocksFiscalForeignFinancialCore Labor

Pe

rce

nt

of

To

tal