Abstract
In this chapter, we lay the foundation for a business cycle approach to TAA which will be elaborated further in Chap. 9. Section 8.2 first outlines standard business cycle analysis and the dating of business cycles. We will then shift our attention to the concept of the output gap and its evolution over time, giving rise to four separate phases for the economy. Section 8.3 discusses the relevance of this to monetary policy and examines how changes in policy rates are reflected in the yield curve.
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Notes
- 1.
- 2.
This, of course, does not imply that the Fed will ignore the cyclical impact of such policies. At the time of writing, a key question is whether the tax cuts implemented by the Trump administration will imply a boost to growth which might accelerate the path toward normalization of the Fed’s policy rates.
- 3.
As mentioned in Chap. 4, total factor productivity is associated with technological progress, improvements in efficiency and so on. Technically, it is the residual output which is not explained by the labor and capital input. The CBO estimates that labor and capital account for only about 60% of the growth in real non-farm business GDP since 1950. See further Shackleton (2018).
- 4.
See further Hodrick and Prescott (1997).
- 5.
In the words of former Fed Chair, Janet Yellen, “Expansions don’t die of old age”. See further https://www.federalreserve.gov/mediacenter/files/FOMCpresconf20151216.pdf
- 6.
Note that only these two reversals are technically possible. The economy can revert back to Phase IV from Phase I on a slowdown in growth. But it cannot move from Phase IV to Phase III without first having been in Phases I and II. Similarly, an increase in growth during a Phase III can move the economy back to Phase II, but it cannot move from Phase II to Phase I without first having been in Phases III and IV.
- 7.
To illustrate the mechanics of this, suppose that the number of potential workers is 100 and that 60 are currently employed while 5 are unemployed. The labor force (sum of employed and unemployed) is therefore 65 and the unemployment rate (unemployed as a percentage of the labor force) is 7.7%. If one person moves from being unemployed to being employed, the unemployment rate will drop from 7.7% to 6.1%. But if that person instead leaves the labor force, it will decrease from 65 to 64 but the unemployment rate will still fall, in this case from 7.7% to 6.3%, without any improvement in employment having taken place.
References
Hodrick, Robert J., and Edward C. Prescott. 1997. “Postwar U.S. Business Cycles: An Empirical Investigation”, Journal of Money, Credit and Banking, 29(1), 1–16.
Peach, Richard, Robert Rich, and Anna Cororaton. 2011. “How Does Slack Influence Inflation?”, Federal Reserve of New York, Current Issues in Economics and Finance, 17(3).
Shackleton, Robert. 2018. “Estimating and Projecting Potential Output Using CBO’s Forecasting Growth Model”, Congressional Budget Office, Working Paper 2018-03, February.
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Lumholdt, H. (2018). Tactical Macro-Drivers. In: Strategic and Tactical Asset Allocation. Palgrave Macmillan, Cham. https://doi.org/10.1007/978-3-319-89554-3_8
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