Business cycles: What does “above potential” mean?

Posted: August 22, 2013 in economy
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IN A column at Vox Antonio Fatas and Ilian Mihov describe an interesting new paper of theirs which posits a third phase of the business cycle. Expansions and contractions we all know and love, but that two-way division leaves out important dynamics, they reckon. Better to describe cycles in terms of a recession, in which output falls well below trend, a recovery, in which output returns to trend, and then an expansion, in which the economy grows more or less at trend. It’s a neat approach which allows them, among other things, to isolate the cost of recessions by computing the aggregate GDP loss relative to trend. The cost is big; they peg the loss from the current cycle at $3.4 trillion and counting. Strikingly, about three-fourths of that cost has accumulated during the ongoing “recovery” phase of the cycle, during which output has been growing but remains below trend.Paul Krugman uses the piece to reflect on the nature of business cycles:I’m very much in sympathy with their underlying view about the asymmetry between booms and busts…Here’s how I’d put it: Fatas and Mihov have an Anna Karenina view of booms and busts, in which all happy economies are alike, but each unhappy economy is unhappy in – well, not exactly its own way, but certainly to its own extent. Business cycle peaks are always times when the economy is operating at capacity; troughs are times when the …

via Economic Crisis


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