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Real Business Cycles. Supply Side Economics. Neoclassical (Supply Side) Economics suggests that business cycles are the result of random disturbances to productivity. The Real Economy. - PowerPoint PPT Presentation
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Real Business Cycles
Supply Side Economics
The Real Economy
• Neoclassical (Supply Side) Economics suggests that business cycles are the result of random disturbances to productivity.
The Real Economy
• Neoclassical (Supply Side) Economics suggests that business cycles are the result of random disturbances to productivity.
• The initial impact takes place in labor markets (employment/output)
The Real Economy
• Neoclassical (Supply Side) Economics suggests that business cycles are the result of random disturbances to productivity.
• The initial impact takes place in labor markets (employment/output)
• Capital markets determine the impact on future labor markets (Investment today affects the capital stock in the future)
Example: A negative supply shock
• Consider an unanticipated rise in oil prices (permanent enough to impact capital investment).
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4
8
12
16
20
24
28
0 100 200 300 400 500
Example: A negative supply shock
• Consider an unanticipated rise in oil prices (permanent enough to impact capital investment).
• This drop in productivity lowers labor demand resulting in lower wages, lower employment, and lower output 0
4
8
12
16
20
24
28
0 100 200 300 400 500
Example: A negative supply shock
• Now, moving to capital markets, the drop in productivity ( from lower employment as well as high oil prices) lowers investment demand
0
4
8
12
16
20
0 100 200 300 400 500
Example: A negative supply shock
• Now, moving to capital markets, the drop in productivity ( from lower employment as well as high oil prices) lowers investment demand
• Lower investment demand causes interest rates, investment, and savings to fall
0
4
8
12
16
20
0 100 200 300 400 500
Investment and the Capital Stock
• Recall that investment is defined as the purchase of new capital goods.
Investment and the Capital Stock
• Recall that investment is defined as the purchase of new capital goods.
• Capital goods are constantly wearing out (depreciation). Therefore, positive investment is needed to maintain the current capital stock.
Investment and the Capital Stock
• Recall that investment is defined as the purchase of new capital goods.
• Capital goods are constantly wearing out (depreciation). Therefore, positive investment is needed to maintain the current capital stock.
• The capital stock evolves according to
K (Future) = (1-dep)*K + I
Investment and the Capital Stock
• Recall that investment is defined as the purchase of new capital goods.
• Capital goods are constantly wearing out (depreciation). Therefore, positive investment is needed to maintain the current capital stock.
• The capital stock evolves according to
K (Future) = (1-dep)*K + I
• A large enough drop in current investment causes the capital stock to shrink.
Example: A negative supply shock
• With a lower capital stock, labor productivity drops (capital and labor are complements) causing another drop in labor demand
0
4
8
12
16
20
24
28
0 100 200 300 400 500
Example: A negative supply shock
• With a lower capital stock, labor productivity drops (capital and labor are complements) causing another drop in labor demand
• Therefore, wages, employment, and output continue to fall
0
4
8
12
16
20
24
28
0 100 200 300 400 500
Example: A negative supply shock
• Lower employment causes another drop in capital investment (not as big as the previous decline – the capital stock is lower than it was before)
0
4
8
12
16
20
0 100 200 300 400 500
Example: A negative supply shock
• Lower employment causes another drop in capital investment (not as big as the previous decline – the capital stock is lower than it was before)
• Interest rates and investment continue to fall
0
4
8
12
16
20
0 100 200 300 400 500
Example: A Negative supply shock
00.10.20.30.40.50.60.70.80.9
1
0
EmploymentOutputWagesInvestmentCapital
Example: A Negative supply shock
-7
-6
-5
-4
-3
-2
-1
0
0 1st Qtr
EmploymentOutputWagesInvestmentCapital
Example: A Negative supply shock
-9
-8
-7
-6
-5
-4
-3
-2
-1
0
0 1st Qtr 2nd Qtr
EmploymentOutputWagesInvestmentCapital
Example: A Negative supply shock
-9
-8
-7
-6
-5
-4
-3
-2
-1
0
0 1st Qtr 2nd Qtr 3rd Qtr
EmploymentOutputWagesInvestmentCapital
Example: A Negative supply shock
-12
-10
-8
-6
-4
-2
0
0 1st Qtr 2nd Qtr 3rd Qtr 4th Qtr
EmploymentOutputWagesInvestmentCapital
Example: A Negative supply shock
-12
-10
-8
-6
-4
-2
0
0 1st Qtr 2nd Qtr 3rd Qtr 4th Qtr 5th Qtr
EmploymentOutputWagesInvestmentCapital
Example: A Negative supply shock
-14
-12
-10
-8
-6
-4
-2
0
2
4
6
0 1st Qtr 2ndQtr
3rdQtr
4th Qtr 5th Qtr 6th QtrEmploymentOutputWagesInvestmentCapital
Example: A Negative supply shock
-14-12-10-8-6-4-202468
0 1stQtr
2ndQtr
3rdQtr
4thQtr
5thQtr
6thQtr
7thQtr
EmploymentOutputWagesInvestmentCapital
Example: A Negative supply shock
-14-12-10-8-6-4-202468
0 1stQtr
2ndQtr
3rdQtr
4thQtr
5thQtr
6thQtr
7thQtr
8thQtr
EmploymentOutputWagesInvestmentCapital
Example: A Negative supply shock
-14-12-10-8-6-4-202468
0 1stQtr
2ndQtr
3rdQtr
4thQtr
5thQtr
6thQtr
7thQtr
8thQtr
9thQtr
EmploymentOutputWagesInvestmentCapital
Example: A negative supply shock
-14-12-10-8-6-4-202468
0 1stQtr
2ndQtr
3rdQtr
4thQtr
5thQtr
6thQtr
7thQtr
8thQtr
9thQtr
10thQtr
EmploymentOutputWagesInvestmentCapital
The Recession of 2001
-4
-3
-2
-1
0
1
2
3
4/1/
99
8/1/
99
12/1
/99
4/1/
00
8/1/
00
12/1
/00
4/1/
01
8/1/
01
12/1
/01
4/1/
02
8/1/
02
12/1
/02
GDPConsumptionProductivity
The Recession of 2001
-10
-5
0
5
10
15
20
25
Jan-
99
May
-99
Sep-
99
Jan-
00
May
-00
Sep-
00
Jan-
01
May
-01
Sep-
01
Jan-
02
May
-02
Sep-
02
Jan-
03
Investment
The Recession of 2001
-2
-1.5
-1
-0.5
0
0.5
1
1.5
2
2.5
3
1/1/
99
5/1/
99
9/1/
99
1/1/
00
5/1/
00
9/1/
00
1/1/
01
5/1/
01
9/1/
01
1/1/
02
5/1/
02
9/1/
02
1/1/
03
5/1/
03
0
1
2
3
4
5
6
7
EmploymentInterest
What caused the 2001 recession?
What caused the current recession?
• Collapse of the stock market• The Dow dropped 30% from its Jan 14, 2000 high of $11,722
• The Nasdaq dropped 75% from its March 10, 2000 high of $5,132
• The S&P 500 dropped 45% from its July 17, 2000 high of $1,517
What caused the current recession?
• Collapse of the stock market• The Dow dropped 30% from its Jan 14, 2000 high of $11,722
• The Nasdaq dropped 75% from its March 10, 2000 high of $5,132
• The S&P 500 dropped 45% from its July 17, 2000 high of $1,517
• Y2K/Capital Overhang
What caused the current recession?
• Collapse of the stock market• The Dow dropped 30% from its Jan 14, 2000 high of $11,722
• The Nasdaq dropped 75% from its March 10, 2000 high of $5,132
• The S&P 500 dropped 45% from its July 17, 2000 high of $1,517
• Y2K/Capital Overhang
• A sharp rise in oil prices (oil prices doubled in late 1999)
What caused the current recession?
• Collapse of the stock market• The Dow dropped 30% from its Jan 14, 2000 high of $11,722
• The Nasdaq dropped 75% from its March 10, 2000 high of $5,132
• The S&P 500 dropped 45% from its July 17, 2000 high of $1,517
• Y2K/Capital Overhang
• A sharp rise in oil prices (oil prices doubled in late 1999)
• Enron/Accounting scandals
What caused the current recession?
• Collapse of the stock market• The Dow dropped 30% from its Jan 14, 2000 high of $11,722
• The Nasdaq dropped 75% from its March 10, 2000 high of $5,132
• The S&P 500 dropped 45% from its July 17, 2000 high of $1,517
• Y2K/Capital Overhang
• A sharp rise in oil prices (oil prices doubled in late 1999)
• Enron/Accounting scandals
• Terrorism/SARS