Economic Fluctuations

• Economic fluctuations have three key features: co-movement, limited predictability, and persistence.
• Economic fluctuations occur because of technology shocks, changing sentiments, and monetary/financial factors.
• Economic shocks are amplified by downward wage rigidity and multipliers.
• Economic fluctuations are short -run changes in the growth of GDP.
• Many aggregate macroeconomic variables grow or contract together during booms and busts, exhibiting a positive or negative co-movement pattern.
• During booms and busts, variables such as real consumption, investment, and employment move positively (or together) with real GDP - pro-cyclical.
• During booms and busts, variables such as unemployment move negatively (or opposite) with real GDP - counter-cyclical.
• Even though the beginnings and ends of recessions are somewhat unpredictable, economic fluctuations are not random but persistent and are likely to continue into the next quarter.
• There are three different schools on the sources of economic fluctuations:

  • Real business cycle theory emphasises changes in productivity and technology
  • Keynesian theory focuses on business and consumer expectations of the future.
  • Financial and monetary theory looks at changes in prices and interest rates.
• Real business cycle theory emphasises changes in productivity and technology.

  • Technological advances and other productivity-enhancing innovations cause expansions.
  • An increase in input prices, like oil, causes recessions.
• Keynesian theory focuses on changes in the expectations of the future.

  • Animal spirits are psychological factors that cause changes in business and consumer mood or sentiment. They can lead to decreases in spending (recessions) or increases in spending (expansions).
  • Willingness to spend decreases and is not offset by increased spending in other parts of the economy.
  • The initial decrease in spending is amplified by further decreases in other people’s spending due to multipliers.
  • A self-fulfilling prophecy - the expectations induce actions that lead to the event.
• Monetary theory looks at changes in prices and interest rates.

  • A decrease in the money supply will cause the price level to fall, reducing employment because of downward wage rigidity.
  • A decrease in the money supply will also increase the real interest rate. Higher real interest rates will reduce firms' investment.
• Multipliers can amplify the effects of any economic shock, regardless of its source.