Exercises: 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.

Assign each headline to the phase of the cycle it best describes and justify your choice: "Record Social Security registration and companies cannot keep up with demand", "$300$ businesses closing per month and unemployment keeps rising", "The economy has been growing for two years and business investment is rebounding strongly".

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.

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.

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?

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 Briga's latest recession, GDP contracted by 2 %, but the unemployment rate rose sharply from 10 % to 15 %.

1. a) A government advisor argues that "it is impossible for unemployment to increase by 5 percentage points if output has only fallen by 2 %, so the employment statistics must be falsified." Refute his statement by analysing labor market duality (temporary versus permanent contracts) and apparent labor productivity.
2. b) If Briga's GDP grows by 2 % next year, recovering to its initial level, can it be predicted with certainty that the unemployment rate will automatically fall back to 10 %? Justify your answer using the concept of economic hysteresis or discouraged-worker effect.
3. c) Design a package of two short-term economic policy measures to curb job destruction in this scenario, under a key constraint: the country is running a high public deficit. Justify how you would ensure their effectiveness without triggering runaway debt.

During a televised debate on the national economy, a pundit states: "If households and firms were more prudent and decided to save more and invest less at the first signs of a crisis, the economy would be much more solid and we would avoid recessions."

1. a) Analytically refute the pundit's statement using the Aggregate Demand model and the paradox of thrift (or paradox of frugality). Explain what happens to national income and the total volume of saving in the economy when all agents attempt to increase their savings at the same time.
2. b) Suppose that the central bank responds by lowering the policy interest rate to 0 %, but households continue to postpone consumption and firms freeze hiring due to fear of the future. What is this situation called and why does conventional monetary policy lose traction?
3. c) Design a combined strategy (fiscal policy and management of expectations) to break this spiral of pessimism without compromising long-term budgetary stability. Justify the transmission channels through which your measures would restore confidence.

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.