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 enrollment 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.

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 sales, building permits, consumer confidence) and reason why they move before general activity.

Describe how these three variables normally behave during an expansion and during a recession: unemployment, inflation, and companies' profits. Justify each answer in one sentence.

Meridia's GDP level over seven consecutive years was: $100$, $104$, $106$, $104$, $101$, $103$ and $107$ (index, year 1 $= 100$).

1. a) Calculate the rate of change of GDP for each year relative to the previous one.
2. b) Identify in which year the peak of the cycle is reached and in which the trough.
3. c) How many years did the recession last? Explain the difference between the rate of change being negative and its becoming positive again.

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 housing 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 layoff (furlough) programs) and with what aim.

Cycles repeat themselves, but no cycle is the same as the previous one. Explain why economic history is said to "not repeat itself, but rhyme": what do different crises have in common and how do they differ (triggering cause, duration, sectors affected)?

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 stabilizers" 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 dollars. The construction companies hire workers, who spend their wages in local stores, and these, in turn, place new orders with their suppliers.

1. a) Explain how an initial government 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 federal government 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.