Trade Cycle Essay, Research Paper

MACRO ECONOMICS RESEARCH ASSIGNMENT

Economic “crises” occurred throughout the 19th century. By the latter part of the century, a number of observers had come to the conclusion that there was a regular, wavelike pattern to crises, and they called this pattern the business cycle. A cycle with its regular and periodic fluctuations needed an explanation. What caused the pattern? What forces determined the length and amplitude of the waves? Could the cycle be eliminated?

Business cycles are a type of fluctuation found in the aggregate economic activity of nations business cycles cover the economy as a whole (GDP).

These fluctuations in economic activity are characterized by periods of rising and falling economic health . During a business cycle, an economy grows, reaches a peak, and then begins a downturn followed by a period of negative growth (a recession), that ends in a trough before the next upturn. In duration business cycles vary from more than one year to ten or twelve years.

There are two different views of the business cycle.

a. New Classical economists.

Believe that the classical model with its market-clearing equilibrium assumptions can be extended to explain economic behavior in the short run.

b. Keynesian

Believe that short run fluctuations are most usefully viewed as periods in which the economy is in disequilibrium rather than equilibrium.

Indicators

These try to predict the economic ups and downs before they appear in the official data. The Australian Bureau of Statistics Experimental Composite Leading Indicator (XCLI) a major indicator. The XCLI summarises the business cycles present in a selection of economic indicators, which had typically shown turning points ahead of the business cycle in GDP from the early 1970s to the early 1990s.

ABS research found that because the evolution of each expansion and contraction in activity presents a unique combination of features, none of the individual indicators has had an unvarying or perfectly stable leading relationship with GDP.

But when a number of indicators are combined to form the XCLI, their performance is more stable, even though the lead-time of the XCLI with respect to the reference cycle still varies considerably. The ABS warns that the index can only provide early signals of turning points in the business cycle. It does not predict the level of GDP, nor signal recessions or recoveries.

Recession/contraction.

Definition: The period of time during which aggregate economic activity is falling.

Depression.

Definition: A particularly severe recession.

Expansion/boom.

Definition: The period of time during which aggregate economic activity grows.

Trough.

Definition: The low point of a contraction in economic activity.

Peak.

Definition: The high point of the expansion in economic activity.

Turning points.

Definition: Peaks and trough of the business cycle that indicate a change in the direction of measurement.

Reasons For The Movements in The Business Cycle

If we start just before the up swing of 1987, the economy is in a recession; at this point there are low prices for consumer goods and low interest rates. This induces a multiplier affect causing higher levels of consumer spending and therefore higher incomes. Economic activity rises on its upward path.

This upward path continues to its peak at about 1987 and six months, at this point there is a ‘boom , this is where there is an above average level of economic activity.

The boom can t last forever the economy reaches a point where it s at full economic capacity. At this point it s not possible to produce more output, leading indicators now start to cause low confidence; interest rates that were rising due to the boom start to discourage borrowing and spending. Now the economy start to turn, all the high incomes, output and spending level off, investment drops and it becomes obvious that the economy is about to take a turn for the worse. As you can see from the above diagram the downswing happens much quicker than the upswing because people pull out before their investments take a bad turn. The economy is now in a recession, (mid 1988). All the factors that made the economy great in the boom are now at a low in the recession. The boom slowly moves back into the upswing and the cycle starts again.

Does the business cycle exist?

In a paper written by Peter Downes, an RBA staff member, made the point that there is not really a business cycle because there is no regularity in economic fluctuations. Downes attacked the demand-side explanation for business fluctuations, saying that if we can forecast demand-driven movements in GDP in which economic activity and prices move in the same direction then why is it we cannot control these forces. The problem is the complications and continual changes that influence these forces. The basic explanation of business cycles, the Keynesian Theory, paid no attention to the role of aggregate supply. Instead, it assumed that all that mattered was the determinants of demand. Economists also paid no attention to inflation. The government is also trying to control the cycle and this is disrupting its natural fluctuations.

Bibliography.

+ Australian Bureau of Statistics, [Online]. (2001). Available WWW:Http://www.abs.gov.au/

+ Greenwald, D. (1994). Encyclopedia of Economics. Washington: R.R Donnelley & Sons.

+ Parry, G. Kemp, P. (2000). Exploring Macroeconomics. WA: Lamb Print.