(From Rein, to you, prepared with loving care, but with scant concern for accuracy)
The cycles from economic upswing (boom) to economic recession (Black et al., Ch 19.3) A business cycle may or may not consist of the following 4 cycles (Roux): (i) Recovery Phase / Upswing • Building up of inventories / stocks in reaction to sales • Investment in capital goods (machinery, equipment) to satisfy increasing demand • An increase in employment • Greater expenditure on durable goods • The current account increases • The above start occurring “exponentially” Boom Phase • Typified by a leveling off in the cycle • Generally, obstructions to the above appear • Shortages of (skilled) labour, raw materials • Production difficulties experienced in meeting growing demand • Production costs and consumer prices begin to increase • More goods need to be imported • Current account surplus decreases • Investment and consumer spending remain high, resulting in a rise in interest rates because the demand for credit exceeds the availability Recession / Downswing • Typified by the exponential decay in the cycle • Consumer spending (durable goods) starts to decrease • Investment loses momentum (drop in expected returns on investment) • Higher interest rates (to curb spending and demand for imports) • Production levels, income, living standards, employment and spending drop • Factories produce fewer goods or will carry too much stock • Profits fall, prices may drop and little investment occurs due to financial burdens on the businesses • Demand for imported goods decreases • The current account may improve eventually Depression • Typified by bottoming out of the economy (pessimism) • Dramatic unemployment • Fall in income and spending results in fall in demand • Severe case of Recession • Businesses experience difficulties and may close • Prices and profits fall
Note pages 32 and 33 (Roux) for a summary on the above cycles.
Note page 28 (Roux) on typical variables that rise and fall during this cycle (e.g. employment, interest rates, company profits, stocks, etc.), as well as variables that experience little impact during such cycles (e.g. wage increases, spending on food and medical or non-durable goods). A single indicator of the state of the economy is usually the Gross Domestic Product (GDP), which measures the level of total production in the economy. The textbook definition of a recession is when there are 2 successive quarterly declines in the GDP (Roux). This can then be compared to several indicators, such as new car sales, imports, employment or retail sales, and compared to the real GDP. By watching the leading indicators, it is possible to pick up an early indication of the state of the economy. The per capita GDP is calculated on the basis in which population changes are also taken into account (e.g. 10% increase in production accompanied with a 4% increase in population results in a per capita GDP increase of 6%). Leading Indicators: Indicators that move ahead of the business cycle
Coinciding indicators: Indicators that move in tandem with the business cycle Business/Consumer Confidence → Turning Point Indicators: • Politics • Acts of God • World Economy (Trade / Foreign Capital) • Crime (1 major crime may lead to loss of tourism) • “Arthur Andersen” Effect • Wealth Effect (how wealthy do you feel) • Oil Price • Gold Price (for SA) Of these, (i) (ii) Politics probably influences all others most World economy is the major driver of the economy (when politics in place)
A depression is typified by low confidence and expectations. The correct time for investment is at the end of a recession, going into a recovery period. ↓ ↓ ↓ ↓ ↓ Business confidence Capex Expenditure Employment Wages Bill Sales ↑ ↑ ↑ ↑ ↑
Free market economies that are inherently unstable because of the existence of contract and...