ECOS3021 Business Cycles and Asset Markets University of Sydney
2021 Semester 1
Tutorial #2
1. Study the business cycle facts reported for the image labeled “Table 9” (from Jorda, Schularick, and Taylor (2017), Macrofinancial History and the New Business Cycle Facts). In this table sd refers to the standard deviation of a variable, and corr refers to the correlation between two variables. Output=y; Consumption=c; Investment=i; Government expenditure=g; Net exports=nx. Statistics are reported for the United States and then all other countries (“Pooled”). The full sample period covers the years 1870-2013. There are also three sub-sample periods: pre-WWII (1870-1939), post-WWII (1939-2013), and the more recent period of floating exchange rates (1972-2013).
1.a) Over the full sample period, which variables are more volatile than GDP? Which variables are less volatile? Do these patterns vary across the United States and other countries?
1.b) For the United States, which variable experiences the largest decline in volatility over time? For the other countries, which variable experiences the largest decline in volatility over time?
1.c) Describe the correlation between government spending and GDP. Is this correlation consistent across time? Why might the Full Sample period provide a misleading picture of this correlation?
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2. Study the business cycle facts reported for the image labeled “Table 1” (from Aguiar and Gopinath (2007), Emerging Market Business Cycles: The Cycle Is the Trend). In this table σ refers to the standard deviation of a variable, and ρ refers to the correlation between two variables. Output=Y ; Consumption=C; Investment=I; Trade Balance=TB. Statistics are reported for emerging markets countries and developed markets countries (i.e. wealthy countries).
2.a) In which group of countries is output more volatile? In which group of countries is relative consumption more volatile? In which group of countries is consumption absolutely more volatile (justify your answer using simple mathematical relationships)?
2.b) Are trade balances pro-cyclical or counter-cyclical? This suggests that exports are -cyclical, and imports are -cyclical.
2.c) Suppose a fall in output causes a fall in consumption.1 If a recession results in a decline in output of 10%, how much do we expect consumption to decline? Provide an answer for each group of countries. Note: There is an easy way to answer the question (a good answer) and a hard way to answer the question (an excellent answer)!
1Note: this is not necessarily the case in reality!
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3. Consider a household choosing between consumption C and leisure L. They face the following decision problem:
max U(C,L)=CαL1−α C,L
s.t. L+N=1 C = wN
where N is labour hours and w is the wage.
3.a) Solve the household’s problem for the optimal choices of consumption, leisure, and labour.
3.b) What does the solution suggest about how the household allocates time between leisure and labour? How is this allocation affected by the parameter α? How is this allocation affected by the level of the wage, w?
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4. Consider a household choosing between consumption C and leisure L. They face the following decision problem:
max U(C,L)=logC+b×L C,L
s.t. L+N=1
C = wN + Π
where N is labour hours and w is the wage, and Π is non-labour earnings (e.g. dividends from firms that households own shares in).
4.a) Solve the household’s problem for the optimal choices of consumption, leisure, and labour.
4.b) Suppose Π = 0. How does an increase in the wage affect consumption, labour, and leisure?
4.c) Suppose there is an increase in profits Π. How does this affect consumption, labour, and leisure?
4.d) Suppose that profits are pro-cyclical, but that wages are sticky due to labour contracts agreed to between workers, unions, and firms. Now suppose that the economy is experiencing an expansion. In this economy, are consumption/labour/leisure: pro-cyclical, counter-cyclical, or acyclical? Can you provide economic intutition to explain these results?
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