Chapter 10: Economic Growth and Business Cycles 105
CHAPTER 10
Economic Growth and Business Cycles
TEACHING OBJECTIVES
Goals of Part 3: Macroeconomics
A. Introduce the basic ideas behind economic growth and business cycles
(Chapter 10), methods of modeling the use of money (Chapter 11), the
standard workhorse macroeconomic model of aggregate demand and
aggregate supply (Chapter 12), modern macroeconomic models (Chapter
13), and the interdependence between economies of di”erent countries
(Chapter 14).
B. Why so much macroeconomics in a textbook on money and banking?
Because to understand monetary policy, students need to understand
basic macroeconomic theory.
Goals of Chapter 10
A. Analyze both long-run and short-run movements of the economy’s
output.
B. Look at trend output growth, focusing on productivity and increases in
capital and labor as the variables that contribute most to the economy’s
overall growth.
C. Study the business cycle to analyze how the economy is deviating from
its long-run path.
D. Show how the economy’s growth rate a”ects a worker’s future income.
TEACHING NOTES
A. Introduction
1. We split the economy into two parts:
B. Measuring Economic Growth
1. Introduction
a) What causes economic growth?
b) The trend in output has changed over time (Figure 10.2)
c) The key variables a”ecting output are resources (labor and capital)
and productivity
Chapter 10: Economic Growth and Business Cycles 106
d) Poor measures of capital lead us to investigate productivity it two
ways: with good data on labor productivity and with 2awed data on
overall productivity
2. A View of Economic Growth Based on Labor Data
a) The growth of labor in the economy can be measured by looking at
the number of workers and the number of hours they work
d) Population is split into working-age population and others (too
young, in military, in institutions); working-age population = labor
force + not in labor force; labor force = employed + unemployed
(Figure 10.4); unemployment rate = unemployed ÷ labor force
(Figure 10.5)
e) Labor productivity = output ÷ number of hours worked (Figures
10.6 and 10.7)
f) Output growth = labor productivity growth + growth in hours
worked
g) Economic Lifto” is the period from 1950 to 1970; Reorganization is
the period from 1971 to 1982; Long Boom is the period from 1983
to 2007 (Table 10.1; Figure 10.8); what will be the e”ect of the
Bnancial crisis of 2008? Use Data Bank: Why Is the Economy More
Stable in the Long Boom?
3. A View of Economic Growth Using Data on Both Labor and Capital
a) Economy’s production function: production mainly depends on
capital and labor:
Y =F(K,L) (3)
b) A speciBc production function Bts the data well:
Y =A × Ka × L1−a (4)
Chapter 10: Economic Growth and Business Cycles 107
C. Data Bank: Why Is the Economy More Stable in the Long Boom?
1. Research by Stock and Watson suggests that the economy became
more stable at the start of the Long Boom (Figure 10.A)
2. Better monetary policy is responsible for just a fraction of the
increased stability; the rest may be just good luck
D. Business Cycles
1. What Is a Business Cycle?
a) A business cycle is the short-term movement of output and other
key economic variables (such as income and employment) around
their long-term trends; use Figure 10.9 to illustrate a hypothetical
business cycle
b) DeBne economic expansion and peak, recession and
depression, and trough
c) The NBER’s business cycle dating committee determines when
recessions and expansions begin and end (Figure 10.9 and Table
10.3)
d) A business cycle has two main characteristics (Figure 10.10):
(1)Many economic variables move together
(2)Many economic variables deviate from their long-term growth
trends for substantial periods
2. The Causes of Business Cycles
a) Erratic growth of the money supply
(1)Monetarists make this argument
b) Swings of optimism and pessimism that cause business investment
in capital goods to 2uctuate
(1)Some Keynesian economists support this view as the main
cause of business cycles
(2)But explaining the optimism or pessimism is diOcult
(3)Keynesians argue that shifts in aggregate demand occur,
causing the economy to deviate from equilibrium, thanks to
sticky wages and prices that do not restore equilibrium
immediately
Chapter 10: Economic Growth and Business Cycles 108
(4)Skeptics argue that wage and price stickiness seem unlikely to
be the main source of recessions
c) Sudden changes in productivity growth
(1)TFP 2uctuations lead to output 2uctuations, according the real
business cycle (RBC) theory
(2)Skeptics argue that RBC theory does not account for the
intensity with which Brms use their workers, so the RBC
researchers measure TFP 2uctuations badly
(3)Adherents of monetarism and RBC theories are called classical
economists
d) Changes in the prices of key factors of production, such as oil
(1)Hamilton argues that nearly every recession was preceded by a
signiBcant rise in oil prices
(2)But oil is not signiBcant enough in the economy to cause such a
dramatic e”ect
E. Application to Everyday Life: How Does Economic Growth A”ect Your
Future Income?
1. A comparison of labor productivity and workers’ compensation
shows a close relationship in the Economic Lifto” period, but little
relationship in the Long Boom; see Table 10.4
2. However, the level of compensation per hour of work was much
higher in the long boom period, thanks to earlier growth
F. Data Bank: The Anxious Index
1. The anxious index is the probability of a decline in real GDP in the
next quarter, as measured by the Survey of Professional Forecasters.
2. The index tends to rise just before recessions begin, especially when
the index exceeds 20 percent (Figure 10.B)