Economic cycles

Explain what a business cycle is and name its four phases, describing in one sentence what happens to economic activity in each one.

The figure shows the evolution of a country's GDP over time: the dashed line represents the long-term growth trend and the curve represents the actual path of activity. A point on the curve is marked with a question mark.

1. a) Which phase of the cycle does the marked point correspond to? Justify your answer.
2. b) Describe what happens to employment and investment in this phase and in the one that follows it.

Explain the difference between an economy's long-run growth trend (its potential GDP) and the swings of the business cycle around it. What is the output gap and what does it mean for it to be negative?

Explain the difference between a recession and an economic depression. State what simple rule economists use to speak of a technical recession, and give an example of each that you know of (one recession and one depression).

Explain what leading indicators of the business cycle are and what they are for. Comment on three examples (new car registrations, building permits, consumer confidence) and reason why they move before general activity.

The annual percentage change in Arta's GDP over seven consecutive years was: $+3\ \%$, $+2,5\ \%$, $+1\ \%$, $-1\ \%$, $-2\ \%$, $+0,5\ \%$ and $+2\ \%$.

1. a) Identify in which year the recession begins and in which year it bottoms out.
2. b) Place the expansion, recession, and recovery phases in the series and explain what happens to the level of GDP during the years with negative rates.

Classify each news item as a supply or demand shock and explain its effect on economic activity: a global drought that makes food more expensive, a collapse in consumer confidence following a financial crisis, and a new technology that makes battery production cheaper.

In Meridia, during the last expansion, inflation hovered around $3\ \%$; when the economy entered recession, it fell to $0,5\ \%$.

1. a) Explain why inflation usually rises during expansions and falls during recessions (relate it to demand).
2. b) Explain what stagflation is and why a supply shock (such as a sudden rise in the cost of energy) can produce inflation and recession at the same time.

Compare these two crises: the 2008 one, which began with the bursting of a property bubble and a financial crisis, and the 2020 one, caused by a pandemic that forced entire sectors to close.

1. a) Classify each crisis as a demand shock, a supply shock or a mixed one, and justify your answer.
2. b) Explain why the pandemic crisis was harder to treat with the usual demand-stimulus policies.
3. c) Comment on what specific measures were put in place in 2020 (direct aid, temporary lay-off (furlough) schemes) and with what aim.

During a recession, a country's unemployment increases by $200.000$ people.

1. a) Explain what automatically happens to government tax revenues and to its expenditure on unemployment benefits.
2. b) Reason why these "automatic stabilisers" cushion the recession: what happens to household disposable income and to demand?

In the middle of a recession, Briga's government builds a hospital for $500$ million euros. The construction companies hire workers, who spend their wages in local shops, and these, in turn, place new orders with their suppliers.

1. a) Explain how an initial public outlay ends up generating more activity than it costs (the multiplier effect).
2. b) Reason why that effect is more powerful in a recession, with idle resources, than in an economy at full employment.

Examine the budgetary record of the country of Briga during the last economic cycle:

• Expansion phase (years 1 to 4): Average GDP growth of 3,8 % per year; average budget balance with a deficit of 2,5 % of GDP; public debt increased from 70 % to 82 % of GDP.

• Recession phase (year 5): GDP drop of 3,2 %; the Government cut public spending by 12 % and froze hiring to «clean up public finances in the face of falling revenues».

1. a) Technically justify why the actions of Briga's Government in both phases qualify as a procyclical fiscal policy and predict the impact that the spending cuts in year 5 had on the severity and duration of the recession.
2. b) A Government representative argues: «If families tighten their belts during a crisis because their income drops, the State has a moral and economic duty to do exactly the same». Refute this analogy by explaining how automatic stabilizers work and the macroeconomic difference between an individual agent and the public sector.
3. c) Design a fiscal rule for Briga that compels its leaders to act countercyclically in the next cycle, and identify two real-world dilemmas (political, institutional, or time-lag related) that would hinder its strict implementation.