The Boom and Bust of Business Cycles

I'm Malaya.
Betsy justin this week's episode feels personal for me, and
I think for a lot of people my age more generally.
Yeah, Nas, didn't you graduate in the two thousand and
eight financial crisis.
I feel like for a lot of us, our careers
never really took off, and but we never really recovered,
and now we've been hit with another recession. But none
of us feel like we got over the first recession
in the first place.
And and as people who were looking to launch their careers
amidst the coronavirus recession, they really feel your pain too.
Research shows that when you graduate into a recession like
you did, it can have long lasting negative effects. So
you were quite unlucky, just like the people who graduated
in twenty twenty are quite unlucky. You know, people who
graduated a few years after you, Naz, don't have as
much of a long lasting negative impact from that financial
crisis as you have.
Recessions can have such a big impact on both our
individual lives and on society as a whole. Overall, the
economy eventually recovers, but some people get left behind, and
it takes some time to get out of a recession
and back into an economic expansion.
Economists call these periods of booms and bus business cycles,
and that's our topic on this week's episode of Think
Like an Economist with Me Betty Stevenson.
And I'm just a Wuphas. We're teaching you there's super
tools of economics that can transform your life and hopefully
help you navigate a recession or two. Nestra and Tabercoli
fires with us.
Intuitively, we all know what a recession is. It's a
period in which people can't find work.
It's also a period in which everyone's really fearful of
being laid off. So most people aren't actually going to
lose their job during a recession, but a lot of
people are going to be fearful that they might because
their employer seems to be struggling. Businesses just aren't selling
as much as they once were, and that often means
they have to cut their costs by cutting hours or
even laying off workers.
So, in personal terms, a recession can mean that it's
hard to find work and that economic turmoil creates a
lot more uncertainty.
A recession is a period of declining economic activity. It's
that period when the economy is actually getting smaller.
By smaller, we literally mean that GDP is shrinking, so
that we're producing less, we're consuming less, we're earning less
than we were before. On average, the pandemic's the most
dramatic recession we've ever had. Usually, recessions start when something
goes wrong, and then they snowball as people keep cutting back,
which means people byless. So business is produced less, so
people earnless, so people byless, and so it goes on.
The coronavirus recession was incredibly rapid and dramatic. We just
put the brakes on the economy. A lot of people
think that that's because government shut things down, but it wasn't.
Actually just that. Research shows that people started to withdraw
due to fear. People were fearful of getting sick, so
they stopped going out spending money, and they're fearful of
losing their income, so they cut back on spending just
in case.
Most people cut back in a whole bunch of different ways,
and so on. Aggregate, it led to a dramatic decline
in spending in early and mid twenty twenty in just
about every country. One way you might think about this
is the virus was like a tax on every face
to face interaction. Of course, it wasn't attack of paid
in dollars and cents. It was attack you paid in
terms of risk to your health.
Prior to the virus, the economy was humming along and
then bam, the virus really brought the economy to its knees.
For years, people had been asking me in interviews if
the economic expansion could keep going, as the economy had
been really going pretty steadily for a decade, and the
answer is always that booms don't die of old age,
they get murdered. And in our recent case, our last
boom was murdered by COVID.
That's pretty traumatic imagery. Betsy, Let's go back for a minute,
because to understand all this, she needs to know what
an economic expansion is, and expansions the opposite of a recession.
It's the period in which GDP is growing or getting larger.
Now here's the tricky bit, noticing that definition of a
recession when an economy is shrinking or an expansion when
it resumes growth. Again, those definitions are all about the
change in the size of the economy. So neither the
words recession nor expansion tell us much about whether we're
in economic good times or bad times, which would be
statements that are more about the levels of income and employment.
So, the coronavirus pandemic happened, and there were recessions in
countries all over the world. But towards the end of
twenty twenty a lot of countries started recovering and there
were expansions. However, in the US there were still ten
million fewer jobs than right before the pandemic. That still
sounds pretty bad.
It is badns And the point is that an expansion
doesn't mean that things are great, or even that we're
returned to a previous level. It's simply a period of
increasing economic activity.
So can we ever.
Fully recover That's one question? Can we get back to
where we were? For? Another way to think about it
is to compare how much we're producing relative to how
much we could sustainably produce.
So compared to where we could be. I feel like
you're hinting out the output gap right.
The output gap is the difference between our actual level
of output and a guess as to a sustainable level
of output, which is an idea that economists call potential output.
Potential output is what a country can produce when all
its resources are being used fully, but they're not being
overused or stretched too thin, or creating a sort of
bottlenecks that might lead to inflation.
Figuring out potential output is a little tricky, and we're
all guessing a bit about what's sustainable. But we know
the factors that determine potential output. There are things like
how many workers we have, what kind of skills they have,
what kind of capital and equipment and technological know how
we have available to us. The same factors that determine
a country's long run growth trajectory, which we talked about
in our episode on economic growth, also determine its potential output.
So long run economic growth is determined by fundamental factors
like how many workers and machines we have. But business
cycles are like the ups and downs and other deviations
from that long term trend.
That's how a lot of economists think about it. It's
a useful way to frame things because it gives us
a distinction between the long run, which is about those
fundamental factors in the short run, in which business cycles
can cause these sometimes violent changes in the state of
the economy. I'm not sure you could always fully separate
the short run in the long run, because things like
the pandemic might cause some longer run damage as well.
But it's a useful intellectual starting point.
And business cycles are called cycles because sometimes we are
below potential and sometimes above it, and so people see
like a sine wave around potential output. But they're not
really cycles at all.
There's no rule that says that the economy will rise
or fall every five or seven or ten years. The
truth is expansions just keep going until they end, and
that could be a year, three years, five years, ten years,
or in Australia the last expansion lasted thirty years. So
business cycles aren't really cycles because.
We don't know when either a recession or an expansion
will end. We've just had the business cycles aren't regular,
But do they have any common characteristics?
Yes, there are some common characteristics. I mean, no two
business cycles are the same, but they have some certain similarities.
You know, Recessions tend to be short and sharp, expansions
tend to be long and gradual. Since World War Two,
the average recession has lasted only a year, whereas expansions
have lasted five years on average. Some are shorter summer
a lot longer.
Remember that Bitsy said pretty graphically that expansions get murdered. Well,
there are lots of things that can bring the good
times to an end and bring on a recession. Naz,
you graduated into a sudden financial crisis. Oil price hikes,
stock market bubbles bursting can end the good times. A
sharp shift in productivity growth, or big changes in interest
rates have also initiated recessions.
The other common future of business cycles is that expansions
and recessions affect many parts of the economy.
Nearly every industry suffers in a recession, but there are
some differences in that some sectors get hit harder, and
that can vary across recessions.
I think we really saw that in twenty twenty because
it was our first ever service sector led recession. And
that's actually one reason the twenty twenty recession was so
hard on women and then so many jobs lost or
lost among women, because women are disproportionately likely to work
in the service sector.
By contrast, in two thousand and eight, the financial crisis
caused the financial sector to create it. Now you might
think that's part of the service sector, but that credit
crunch led the goods producing sector to really fall apart.
Yeah, that's why people called it a man session in
two thousand and eight, because financial sector plus goods producing
sector equals a lot of men losing their jobs.
Flolks without jobs.
Is there one statistic you can look at to assess
how the economy is doing.
By one piece of advices? There is not one statistic.
There are many. You could say there's thousands. We think
there's at least ten, or at least I can try
to help you herenas and get the list down to ten.
The most important answer to your question is don't look
at just one indicator if you want to understand how
the economy is doing.
Okay, to start, people talk about confidence data being a
leading indicator. What do we mean by leading indicators?
A leading indicator is something that tends to move in
advance of the rest of the economy. So business confidence
and consumer confidence tell you whether business owners is likely
to hire and where the consumers are likely to spend.
If you tell someone tonight that you're really worried about
the state of the economy and what that might mean
for your job, probably not going to go out next
week on a big spending spree.
Leading indicators tend to be real time data that tells
us what's happening right now are likely to happen in
the near future. Lagging indicators tend to follow business cycle
movements with some delay. So when businesses are telling us
that they're worried, they might not have yet let anyone
go or stopped hiring, but their worry means that they
might soon, so then we might see unemployment start to rise.
Unemployment typically follows declines in sales. In other words, it
lags those declines in sales.
Yeah, that makes sense, because I'd like to think that
if I ran a business, I'd be reluctant to fire
people unless I knew for sure that business was bad.
Now you talked about indicators, Let's go through the ten
that you follow.
Yeah, so real GDP is clearly the big thing to
look at. A recessions a period of declining GDP, So
in some sense that's the only thing you need. But
it's a really lagging indicator, at least in how we
measure it. Remember that real GDP measures total production, total spending,
and total output across the whole economy, and by real
we mean adjusted for price changes related to inflation. But
here's the thing, it's really hard to measure it. In fact,
it can take five years to get a precise, good measure,
and two thousand and eight, lots of people were confused
why unemployment was so high given the measured decline in GDP.
We got the answer years later. GDP had declined more
than we realized.
Because it's really hard to measure output, particularly when there's
a lot of changes going on, you might want to
look at a different way of measuring GDP. Remember GDP
is total spending, but it's also total income. So there's
a measure called gross domestic income, which measures GDP by
adding up people's incomes.
How is gross domestic income different from what GDP measures?
Conceptually they're the same thing, but it relies on different
data sources and there can be some discrepancies. Early reports
of what's going on with income can actually be more
reliable than the data we get on spending, which is
why it can be useful to look at GDI.
Employment and unemployment gives us a more timely look at
what's happening. There are a lot of different ways that
we can measure employment and unemployment. One way is to
actually count how many jobs people have, and in the
US we call that the non farms payrolls jobs and
that number gets released every month.
And why do we focus on non farm payrolls.
Because the ups and downs of what happens on the
farm has a lot to do with droughts and floods,
and so it doesn't tell us much about the broader
business cycle.
Okay, that's interesting, and we have indicated number four.
Next, that's the unemployment rate. If you remember we talked
about unemployment in an earlier episode. The unemployment rate tells
us the share of the labor force who don't have jobs,
but who want a job and are actively looking for one.
So the unemployment rate is an indicator of excess capacity
or workers that we're not using.
Our next indicator is related to unemployment, and that's initial
unemployment claims.
Yeah, these tell you something about how many people have
just lost their jobs. And it's a really handy indicators.
The data is released weekly, so you can see those
trends pretty quickly.
We're under indicated number six and it's one I mentioned before,
business confidence. We can measure this from surveys that just
ask managers about their plans over the next few months.
About whether they're going to change production or hire more
people stuff like that.
The other important confidence indicator is consumer confidence. Those surveys
that ask people how optimistic they are about the economy.
That gives us that really useful indicator about what their
spending patterns might be looking like over the next few months.
Another indicator is the inflation rate.
And why inflation. I gave the sense that so far
in these micro episodes, we're trying to get inflation out
of the picture when we deal with data.
Yeah, but here we're thinking about what the inflation rate
can tell us beyond just the fact that prices a rising.
If you run a business and sales are booming and
you can't produce more to meet demand, it's likely that
you'll go ahead and raise your prices.
Which in turn raises the inflation rate.
That's right. Think about it this way. Rising inflation indicates
the economy might be producing above its potential. By contrast
to falling inflation rates suggests the opposite, that we're not
using all of our resources.
Another way to think about whether prices are rising is
to take a look at the employment cost index, which
tells us how expensive workers are getting. In other words,
how fast wages and benefits are rising.
We're under our tenth and final indicator, the stock market.
Am I right in predicting that this has something to
do with expectations?
Of course, stock prices tell us a lot about what
shareholders expect a company's future profits to be. A strong
stock market suggests that traders are optimistic about how much
profits businesses are going to make in the future.
So you could say the store market is a bit like.
A vote of confidence exactly, but be careful because the
stock market can be a bit flighty. One famous economist
joke that the stock market has predicted nine of the
last five recessions.
And so, now that we have these ten indicators, where
can we find them? I want to start looking at
some graphs and charts and tables and see where the
economy is heading.
In a lot of countries, the central Bank collects that data,
like in the United States, you can go to the
Saint Louis Fed's website and they're going to give you
easy access to a lot of these indicators. The OECD
also collects a lot of these indicators for most countries,
and so you could head over to the OECD's website
and start looking up these data.
Betsy Justin, this is really handy. I'm definitely going to
start tracking some of these numbers before we go. Are
there any tips or things we should bear in mind?
Remember the big tip, which is track a lot of indicators,
not just one too. We've given you our favorite ten.
You could think about whether you want to add a few,
but remember you need a lot. In reality, the FAT
and other economic forecasters literally track thousands of indicators. A
country's economy is large and complex, so you want to
get as full of picture as you can.
It's also best to focus on broad indicators, and by
that I mean indicators that account for a really big
share of the economy. It turns out it's really easy
to measure the output of factories, so we have tons
of measures of manufacturing, even though it's only a small
share of the economy. If you really want to understand
what's going on with people's lives, you're going to need
to look at the entire economy. At the same time, you.
Also just want to pay attention to indicators that come
out frequently and quickly, as that's what's going to keep
you on top of where the economy is headed.
And you want to realize that economic data are noisy.
They can be all over the shop, and so it
can be hard to figure out the signal or the
underlying pattern. That's why it's often going to be helpful
to average over a bunch of indicators or a bunch
of months to see the underlay trends.
Once you've been looking at indicators for a while, you're
going to start to form some expectations about how you
think the economy is doing. You know. That's why when
you hear new data being released, it's often compared to expectations.
Those are expectations of professional forecasters. When you're following data,
you're going to come up with your own expectations.
And so what you want to do is compare the
numbers to your current expectations.
So if the data come in stronger than what you
were expecting.
It's time to admit maybe you weren't right, maybe the
economy is doing better than your thought, and update update
your expectations.
That's the real trick at the end of thinking about
how to use indicators is you have to use the indicators,
form some expectations, update your expectations as new data come in,
and you will become great at understanding where the economy
is going.
Now you've learned how to think like an economist.
Betsy Justin, I'm gonna go off and check out some
of these indicators.
Now, I think business cycles seems like such a dry subject.
Of course, this is like the heart of people's lives.
I mean, we started this episode by talking about how
you got hammered by graduating into a recession, and that's
gonna shape your entire life, just like people who graduate
into twenty twenty. It's going to shape their entire life.
So we study these business cycles so we can do
what we can to moderate them because they do tend
to hurt people. Thanks for listening.
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