The 3 different waves of a business cycle.

According to Lacy Hunt, chief economist at Hoisington Investment Management the “business cycle” is actually three different waves occurring in a specific order. They peak and trough in that sequence

1. Financial cycle – lose and tight monetary policy influence the movement
2. GDP cycle – monetary policy then impact inflation and risk-taking
3. Price/labour cycle – this later makes wages and prices rise

Source: Hoisington Investment Management

Can the US Fed stimulate growth?

Although central banks can control the money supply, the velocity that it moves in an economy is very important to the business cycle – creating more money has little effect if people don’t use it. Velocity in the US is now lower than it was in the great depression. This is a serious problem for the US Federal Reserve’s attempts to stimulate growth.

There is also the problem of Marginal revenue product of debt – this is the amount of GDP growth generated by each additional dollar of debt. That has been falling for years and is set to fall even more as higher rates divert a bigger part of the revenue from debt-funded projects to interest payments instead of more productive uses.

Source: Mauldin Economics: Thoughts from the front line – 6th May 2023

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Global GDP levels June 2019 – December 2020

A recent publication from the ANZ looked at the GDP in a range of economies. Useful for discussion in class if you are doing GDP and business cycles.

Note:

• China has rebounded well
• UK and Euro area had the more severe downturns
• New Zealand has the steepest rebound from a lockdown period
• Interesting to note that the bottom of the downturn in all countries is in June 2020 with the exception of China.

Global GDP levels (Q4 2019= 100)

Source: New Zealand Weekly Data – 19th March 2021.

Output Gap in Eastern European Countries

The Economist had a very good graphic showing the difference between the actual and potential GDP in central and eastern European countries. In Romania a 16% rise in the minimum wage is likely to lift domestic demand and inflation whilst the Ukraine and Bosnia have problems with big negative output gaps where their GDP is well below their potential GDP.

Remember to mention the output gap when doing an essay that involves the business cycle. The output gap is the difference between demand and the economy’s capacity to supply. This is the difference between the ‘actual’ level of output (GDP) and the economy’s ‘potential’ level of output (potential GDP).

• If the economy is running above capacity (GDP > potential GDP) the output gap is positive.
• If the economy is running below its full capacity (GDP < potential GDP) the output gap will be negative.
• There is a sweet spot which is where the level of output is consistent with stable inflation and full employment.

Remember that ‘potential’ output is not an upper limit on the level of output. Rather, think of potential GDP as the economy’s efficient level of output. Running the economy below potential GDP is inefficient because there are some resources that are not employed. Running the economy above potential GDP is also inefficient because resources are over-utilised (eg, machinery is being made to work too hard causing it to wear out too quickly).

While it is efficient to have the economy running at potential, quite often it does not. Resources can be over- or under-utilised, which will translate into inflationary or disinflationary pressure (over-utilisation will push future inflation up, while under-utilisation pushes future inflation down).

A2 Economics – Actual versus potential growth in national output

Remember to mention the output gap when doing an essay that involves the business cycle. The output gap is the difference between demand and the economy’s capacity to supply. This is the difference between the ‘actual’ level of output (GDP) and the economy’s ‘potential’ level of output (potential GDP).

If the economy is running above capacity (GDP > potential GDP) the output gap is positive. Conversely, if the economy is running below its full capacity (GDP < potential GDP) the output gap will be negative.

Remember that ‘potential’ output is not an upper limit on the level of output. Rather, think of potential GDP as the economy’s efficient level of output. Running the economy below potential GDP is inefficient because there are some resources that are not employed. Running the economy above potential GDP is also inefficient because resources are over-utilised (eg, machinery is being made to work too hard causing it to wear out too quickly).

While it is efficient to have the economy running at potential, quite often it does not. Resources can be over- or under-utilised, which will translate into inflationary or disinflationary pressure (over-utilisation will push future inflation up, while under-utilisation pushes future inflation down).