real business cycles supply side economics. the real economy neoclassical (supply side) economics...
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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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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
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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
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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
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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
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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
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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)
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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
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Example: A Negative supply shock
00.10.20.30.40.50.60.70.80.9
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EmploymentOutputWagesInvestmentCapital
Example: A Negative supply shock
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-1
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0 1st Qtr
EmploymentOutputWagesInvestmentCapital
Example: A Negative supply shock
-9
-8
-7
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-2
-1
0
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EmploymentOutputWagesInvestmentCapital
Example: A Negative supply shock
-9
-8
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-4
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-2
-1
0
0 1st Qtr 2nd Qtr 3rd Qtr
EmploymentOutputWagesInvestmentCapital
Example: A Negative supply shock
-12
-10
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-6
-4
-2
0
0 1st Qtr 2nd Qtr 3rd Qtr 4th Qtr
EmploymentOutputWagesInvestmentCapital
Example: A Negative supply shock
-12
-10
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-6
-4
-2
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0 1st Qtr 2nd Qtr 3rd Qtr 4th Qtr 5th Qtr
EmploymentOutputWagesInvestmentCapital
Example: A Negative supply shock
-14
-12
-10
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-6
-4
-2
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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
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5thQtr
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EmploymentOutputWagesInvestmentCapital
Example: A Negative supply shock
-14-12-10-8-6-4-202468
0 1stQtr
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4thQtr
5thQtr
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EmploymentOutputWagesInvestmentCapital
Example: A Negative supply shock
-14-12-10-8-6-4-202468
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EmploymentOutputWagesInvestmentCapital
Example: A negative supply shock
-14-12-10-8-6-4-202468
0 1stQtr
2ndQtr
3rdQtr
4thQtr
5thQtr
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EmploymentOutputWagesInvestmentCapital
The Recession of 2001
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-3
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12/1
/99
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/02
GDPConsumptionProductivity
The Recession of 2001
-10
-5
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15
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25
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99
May
-99
Sep-
99
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00
May
-00
Sep-
00
Jan-
01
May
-01
Sep-
01
Jan-
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May
-02
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Investment
The Recession of 2001
-2
-1.5
-1
-0.5
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5/1/
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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