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Lesson 13: Why Changes in GDP ARE The Business Cycle!

Module 1: Macro Fundamental Analysis

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Video Transcript

So in this lesson we’re going to look at real GDP in relation to the business cycle so we’ve talked about the four stages of the business cycle previously and we’re going to look at what happens to GDP during those four stages of the business cycle so on the y-axis here we simply have real GDP in percentage change terms and on the x-axis we simply have time so months in this case so changes in real GDP over time now if we’re to take this data point here at say two percent in terms of real GDP growth we’re looking don’t forget at an annualized number we would be looking at this so this would be a two percent growth right here in real GDP terms from say q3 2019 to q3 2020 and in terms of the business cycle you can see that in the first phase of the business cycle when we have sustained economic expansion real GDP is increasing the rate at which real GDP growth is taking place is increasing one two three four five percent let’s say when GDP gets to a certain level we may actually because don’t forget from previous videos as we get economic growth if this growth is because of an increase in aggregate demand we’re going to start to see inflation as well and it may be the case that inflation is starting to get above the percent target or whatever the target is for that economy and so the central bank steps in and they start to raise interest rates and this slows economic growth we start to see a slowing and a peaking of economic growth and this puts us into phase two of the business cycle so from the transition from sustained expansion into slowing and peaking now you can see even if we start to go from five percent all the way down to one percent we still have economic growth because GDP is still increasing we still have economic growth but just at a slower rate so instead of five percent growth we have one percent we then enter the third phase of the business cycle so sustained contraction we start to see GDP in percentage change terms dropping below the zero percent and we start to have a contraction in GDP so not just a slowing of the growth rate but an actual contraction of GDP this is where recessions will take place possibly depressions depending on how long they last and how severe they are in general and at this point we might to see lots of job losses within the economy we may even start to see a bit of deflation if this contraction here is caused by a reduction let’s say in aggregate demand and so central banks in this stage of the business cycle may want to step in to stimulate growth we may see governments cutting tax in order to enforce fiscal policy measures which would be popular politically but also more importantly really to stimulate the economy back to economic growth and some inflation and those policy measures may actually start to push us into the fourth phase of the business cycle so a slowing of contraction and we may actually start to see in this area for example if we had minus two percent contraction over here again it is a slowing of negative contraction of GDP so we are not growing in this area we do not have economic growth we have economic contraction but at a slower rate than we did down here so we still have this negative output gap and then we may actually start to see the economy breaking back above into growth territory so instead of contracting we go into growth and this leads us back into the sustained economic expansion phase one and so begins again phase two maybe after a period of time let’s say eight years ten years who knows we start to see too much inflation in the economy because all of this aggregate demand that has been stimulated from a shift to the right of the aggregate demand curve why because in this area government spending increased consumption increased because of lower interest rates let’s say we have investment increasing et cetera so all of these policies enacted by central banks and governments have actually pushed the business cycle back into sustained economic expansion over time and once again we have too much inflation central banks need to step in raise interest rates perhaps the government actually cuts spending so it’s not going to start taking money out of the economy but it can actually reduce spending in this area this would be deflationary and this would slow down this would cool down the economy once again back into sustained contraction and then if we start to see a period of recession or a depression then the central banks and governments would step in once again to stimulate growth to stimulate inflation and they would do that by enacting policies which shift the aggregate demand curve to the right so increasing spending lowering taxes decreasing interest rates or even more recently we’ve seen some helicopter money so money being put straight into the bank accounts of citizens this is something which can be utilized if interest rates get too low and you can’t cut them anymore in a period of contraction it’s just another additional policy measure that can be enacted to stimulate economic growth to increase consumption because if you start to put money in people’s banks they will go out and spend it generally speaking and so as you can see that contractions and expansions in GDP are reflective of contractions and expansions in the business cycle itself