Macroeconomics

9-1

The Facts About the Business Cycle

Before thinking about the theory of business cycles, let’s look at some of the facts

that describe short-run fluctuations in economic activity.

GDP and Its Components

The economy’s gross domestic product measures total income and total

expenditure in the economy. Because GDP is the broadest gauge of overall

economic conditions, it is the natural place to start in analyzing the business

cycle. Figure 9-1 shows the growth of real GDP from 1970 to early 2009. The

horizontal line shows the average growth rate of 3 percent per year over this

period. You can see that economic growth is not at all steady and that, occa-

sionally, it turns negative.

The shaded areas in the figure indicate periods of recession. The official

arbiter of when recessions begin and end is the National Bureau of Econom-

ic Research, a nonprofit economic research group. The NBER’s Business

Cycle Dating Committee (of which the author of this book was once a mem-

ber) chooses the starting date of each recession, called the business cycle peak,

and the ending date, called the business cycle trough.

What determines whether a downturn in the economy is sufficiently severe

to be deemed a recession? There is no simple answer. According to an old rule

of thumb, a recession is a period of at least two consecutive quarters of declin-

ing real GDP. This rule, however, does not always hold. In the most recently

revised data, for example, the recession of 2001 had two quarters of negative

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Business Cycle Theory: The Economy in the Short Run

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growth, but those quarters were not consecutive. In fact, the NBER’s Business

Cycle Dating Committee does not follow any fixed rule but, instead, looks at

a variety of economic time series and uses its judgment when picking the

starting and ending dates of recessions. As this book was going to press, the

economy was in the midst of the recession of 2008–2009, the ending date of

which was still to be determined.

1

Figure 9-2 shows the growth in two major components of GDP—

consumption in panel (a) and investment in panel (b). Growth in both of

these variables declines during recessions. Take note, however, of the scales

for the vertical axes. Investment is far more volatile than consumption over

the business cycle. When the economy heads into a recession, households

respond to the fall in their incomes by consuming less, but the decline in

spending on business equipment, structures, new housing, and inventories is

even more substantial.

C H A P T E R   9

Introduction to Economic Fluctuations

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