Issues in Macroeconomics
5. Domestic economic fluctuations

As we have seen, inflation and unemployment rise and fall from year to year. And so does everything else in the economy. That's the third issue that commands the attention of macroeconomists. Fluctuations in the size of the domestic economy-the alternation of good times and bad times-is an important part of the biography of any economy.

Fluctuations show up in the volume of goods the economy produces - that is, its total output. Officially speaking, total output is referred to as Gross Domestic Product (GDP). (In the next chapter we will explain how GDP is determined.)

In short, Gross Domestic Product is the value of the total output of the economy.

There's more to it than that. But for now, focus on the bigger meaning. What matters is real GDP - that is, nominal GDP corrected for price changes.

In the last several decades the U.S. economy seems to have been rolling along with gentle ups and downs. There have been relatively good times, especially during the 1960s, and the second half of the 1990s; and, looked at from the point of view of real GDP, much of the 1980s weren't so bad, either. But there have also been dramatically bad times, as in the early 1930s, the late 1930s, and right after the Second World War. And there were some serious downward dips in the middle 1970s and early 1980s. Figure 20-6. Shows the percentage changes in U.S. Real GDP, in the period 1960-2005.

Figure 20-6. Percentage Changes in U.S. Real GDP, 1960-2005
Caption: U.S. real GDP has risen and fallen over the years. Recessions occur when real GDP dips below 0 percent into an area of negative growth.

Economists call successive ups and downs in total production "a business cycle." The term cycle is a bit misleading, because it suggests a regular predictable pattern.

The so-called business cycle is anything but predictable. One economist has remarked, "If the business cycle were predictable we would not have one." A stockbroker on the New York Stock Exchange would always buy low and sell high if he could tell exactly when the market would peak and when it would bottom out. A college student who knew what employment opportunities would be in three years time could adjust his or her plans for graduate school accordingly (the present authors have on this score a mixed record). And Mary and Carl, the unemployed steel workers, could have prepared themselves for the bad times by saving some money or by moving away.

Still, macroeconomists try to answer questions like these: Is the cycle simply an expression of erratic behavior on the part of consumers and business leaders? Might the government be responsible for certain fluctuations, good or ill? Or might sudden changes in technology or in the international economy be the cause? Research on these questions has been extensive, as we shall see in Chapter 31.

McCloskey: But don't expect too much. Remember: if economists could predict the next cycle, we'd all get rich speculating in the stock market. And we'd keep our secret to ourselves. Rich we are not, so our theory of the business cycle can't be too good. We'd do better if we paid attention to the long-term trends instead of following erratic short-term cycles. As we shall see, long-term growth in real GDP overwhelms the fluctuations.

Klamer: But the short-term fluctuations are real. And they hurt. Economists need to identify the reasons for economic fluctuations so that the government can do something to soften their impact.

Ziliak: True: recessions are especially hurtful to speculators and the least economically advantaged workers. But the government is sometimes the cause of the downturn, not the solution.

McCloskey: That is the big if controversial finding of Milton Friedman and Anna J. Schwartz concerning the causes of the Great Depression (***cite). The Federal Reserve Bank radically cut money supply, driving up interest rates and reducing consumption and investment, at exactly the time that the economy needed the opposite cure: looser money.

Ziliak: Economic historians such as Peter Temin and Barry Eichengreen have suggested, however differently, the Friedman-Schwartz hypothesis to be mistaken in timing and incomplete in explanation. Still, even neo-Keynesians such as Temin will admit that government can hurt as much as help the short-run fluctuations. Going off the gold standard turned out to be necessary though damaging, like amputation.

Klamer: This topic is important; but we have to postpone it for a few chapters.

Paul: Thank you-because I'm not sure what you're all talking about!