Economics

Home > Economics > The global economy > The international business cycle

The international business cycle

This tutorial was written by Ken Edge
Head Teacher HSIE
Cardiff High School

Outcomes
Overview
Content
Review exercises
More

Outcomes

HSC topic: The Global Economy is covered in the Board of Studies NSW Stage 6 Economics Syllabus (1999) on pages 31-33. The specific outcomes for this tutorial are:

H1:	demonstrates understanding of economic terms, concepts and relationships.
H3:	explains the role of markets within the global economy.
H4:	analyses the impact of global markets on the Australian and global economies.
H8:	applies appropriate terminology, concepts and theories in contemporary and hypothetical economic contexts.

Overview

The tutorial describes the characteristics of the international business cycle and relates these to current World Output figures (Real GDP). Global economic events are analysed to explain some of the patterns and trends in the business cycle.

Being up to date and aware of contemporary issues

Students of Economics need to be aware of what is happening now and what has happened recently, in respect to the international business cycle.

After completing this tutorial you may wish to do some research on the current situation by visiting the websites listed under 'MORE' at the bottom of this page.

Access the OECD Business Cycle Clock at: http://stats.oecd.org/mei/bcc/default.html

This online business cycle clock provides a real time explanation of how the international business cycle affects the domestic economy. It is useful to compare Australia to other countries such as the United States. For example, Australia performed relatively well during the global recession of the early 2000s and did not experience recession as opposed to other countries/regions such as the US and the EU.

Content

A. The International Business Cycle

The global economy, like any economy, is affected by regular and recurring fluctuations in the levels of economic activity. If a country’s economy is experiencing a boom or recession its domestic demand for goods and services can be affected. The combined effects on the level of economic activity of individual countries will in turn affect the global economy.

The periodic and irregular expansions and contractions in world output can be measured by changes in real world GDP.

Characteristics of the phases in the business cycle:

An upswing in economic activity or recovery is usually associated with rising levels of GDP, consumption expenditure, investment expenditure and decreasing levels of unemployment. This may lead to a boom characterised by high levels of GDP with businesses operating at close to full capacity, inflation rising due to increasing costs, rising demand and interest rates at higher levels.
A recession is a downturn in economic activity and is associated with falling levels of GDP, consumption and investment expenditure. Inflation and interest rates are declining and unemployment is rising. A recession will have a trough at the lowest point. A trough occurs with GDP, consumption expenditure and investment expenditures at the lowest levels. Unemployment is high and inflation is low.

Historically there is a strong relationship between the business cycles of the world economies. To identify a global recession is a difficult task, even when they are occurring. This is why most recessions are not determined until after the economic event has taken place. Gross world product (GWP) tends to go through upswings, booms, downswings and troughs.

Graph 1

International Business Cycle

Graph of the International Business Cycle

Factors that can affect the level of global economic activity

investment flows: especially if one nation is experiencing higher levels of economic growth. An example is the Chinese economy which is expected to grow at a rate faster than most developed nations in the next five yearsforeseeable future (figures in Table 1 below, indicate this trend).
monetary conditions: variations in real interest rates and exchange rates may cause increased investment flows from to one country at the expense of another. The increases in interest rates by the US Federal Reserve (central bank) during 2000, to reduce domestic inflation, and bring back economic growth, and then the subsequent reductions during 2001 affected global investment flows and the value of the dollar in Australia. From 2001 the US Central Bank, called the Federal Reserve, introduced a low interestexpansionary monetary policy, of having with very low interest rates. This meant that it became very cheap to borrow funds and money. As a result many consumers bought assets such as shares and property, using borrowed funds and money. This forced up the prices of these assets and house prices and share prices increased rapidly. Because the cost of money in (interest rates) was low, this encouraged Â business and consumers to load up on debt and buy assets. Because As many businesses and consumers were borrowing more and more and increasing their debt, this continued to forced up the price of the assets they were buying very rapidly. As soon as the borrowing became difficult andWhen the sub-prime mortgage collapse occured in the USA, this led to athe global financial crisisGlobal Financial Crisis occurredspreading around the world, : the prices of assets fell very sharply , interest rates in on borrowing increased quickly and funds were harder and harder to borrow all over the world.
Market confidence: the Australian economy, like most world economies, is influenced by the economic conditions in the United States, Japan and Europe. Strengthening or weakening consumer and business confidence in these economies tends to influence economies in other parts of the world. For example, Australia sells raw materials to manufacturing nations to make manufactured goods, . If these nations such as Japan and China can not export goods to the United States then Australia's exports to China and Japan will fall, and export income will decline, economic growth will slow and Australia will have a reduced standard of living.

B. Global snapshots:

Global Economy 2001 The Dot Com Crash

During 2001 there was a slowdown in global growth from the very high rates of late 1999 and early 2000. By the end of 2000 global economic activity, particularly in the United States, had weakened and the Japanese economy was stalling in recovery.

This was partly due to the tightening of monetary policy in the USA to dampen the high rates of growth in late 1999. The Japanese economy also slowed, indicating weaker consumer confidence, slowing business investment and weakening export growth.

Other factors which may have led to a slow down in the growth of domestic demand and weakening consumer and business confidence in the global markets include:

higher energy prices when OPEC restricted supply to the world markets
the reassessment by many transnational corporations of their earning capacity
slowing growth in the world technology sector, e.g.evidenced by declines in the NASDAQ index in America and the failure of the One.Tel Company in Australia (June 2001)

The Global Financial Crisis is an example of how events in a region of the world can impact on the international business cycle.

The GFC commenced n 2007 with a financial crisis in the US housing market. Many financial institutions lent money to consumers for purchasing houses that the borrowers could not repay. These included people with low incomes, insecure employment and poor credit histories. The lenders made commission and fees from lending the money. The more money they lent these 'subprime' consumers and house buyers theÂ more commissions and fees they made. The risks were taken by the actual providers of the capital and funds for lending. The lenders at first were happy to lend the money to these subprime house buyers as the interest rates charged on the home mortgages were high. Everyone seemed to win. The financial firms lending earned significant fees and commissions. The lenders received a high rate of interest on the loans. The house buyers could be sure that the value of the house would increase and when they went to sell it they could pay off the loan.

In late 2007 the number of house buyers unable to pay their loans increased rapidly. This affected the mortgage lending market for in which the house mortgages were bought and sold. Very quickly lenders stopped lending for house purchases. The prices of houses started to fall as very new buyers entered the market, as they could not access home loans. Financial institutions began to make losses. This led to a panic as people withdrew their funds from financial institutions. A number of very large investment banks on wall Wall street Street failed. Lehmann Brothers, one of the largest investment banks, became bankrupt. In a short time the credit markets, where businesses borrow to fund investment and business expansion, seized up and it was difficult to borrow funds. Business could not raise loans for investment and working capital. Many businesses had also borrowed heavily and had great large debts (highly geared or leveraged). Many of these businesses also began to fail and unemployment began to rise rapidly. This rise in unemployment caused more and more consumers and mortgage holders to be unable to pay their house mortgages causing more consumer and personal bankruptcies and more 'subprime' mortgage losses. This impacted on financial institutions around the world. The subsequent downturn in the US economy, coupled with the wordwide ‘credit squeeze’, created the Global Financial Crisis (GFC) and the global recession, dubbed the ‘great recession’ by the head of the IMF, Dominic Strauss-Kahn, in March 2009.

To view an animation called ‘What’s a credit crunch?”, created in September 2008 that explains the impact of the credit crunch, go to: http://blogs.abcnews.com/theworldnewser/2008/09/whats-a-credit.html

Review exercises

Exercise 1

Table 1 GDP Growth by Region(annual percentage change, constant prices)

Region	2006	2007	2008	2009	2010	2011	2012	2013	2014
World	5.09	5.17	2.99	-1.06	3.10	4.19	4.44	4.56	4.54
Advanced Economies	2.99	2.72	0.56	-3.43	1.32	2.45	2.56	2.52	2.39
Emergining & Developing	7.93	8.31	5.99	1.69	5.08	6.06	6.38	6.58	6.59
China	11.61	13.01	9.01	8.50	9.03	9.73	9.84	9.77	9.51

(estimates start after 2008)
Source: IMF World Economic Outlook Database October 2009 edition

Using Table 1, construct a line graph of the International Business Cycle from 2006-2014. (You can update these figures – see the reference to the IMF’s database under the section ‘More)
Using the figures from Table 1 and your graph, write a paragraph describing movements in the international business cycle over that period, referring to changes in world GDP and making comparison with the different regions.

Exercise 2

Table 2 GDP Growth Selected Economies (annual % change, constant prices)

Country	2006	2007	2008	2009	2010	2011	2012	2013	2014
USA	2.67	2.141	0.44	-2.73	1.52	2.77	2.62	2.49	2.13
Japan	2.04	2.34	-0.71	-5.37	1.68	2.38	2.32	2.04	1.79
UK	2.85	2.56	0.74	-4.39	0.91	2.49	2.87	2.88	2.89
Germany	3.17	2.52	1.25	-5.23	0.34	1.47	1.74	1.83	1.85
Russia	7.7	8.1	5.6	-7.55	1.54	3.0	3.7	4.2	5.0
China	11.61	13.01	9.01	8.50	9.03	9.73	9.84	9.77	9.51
India	9.82	9.37	7.35	5.36	6.42	7.28	7.63	7.99	8.08
Australia	2.84	4.05	2.35	0.73	1.96	3.29	3.42	3.2	2.96

(estimates start after 2008)
Source: IMF World Economic Outlook Database October 2009 edition
(You can update these figures – see the reference to the IMF’s database under the section ‘More)

Task: Using the information in Table 2, write a page outlining the impacts of the GFC and global or ‘great’ recession on 4 of the countries listed (your choice), including reference to:

Changes in GDP over the period 2006-2009
Differences between GDP growth in these countries and possible reasons for those differences
Changes in GDP after 2009 and reasons for different rates of recovery in these countries

Note that figures after 2008 are estimates – you can update these figures by visiting the IMF’s World Economic Outlook (WEO) Database at:
http://www.imf.org/external/pubs/ft/weo/2009/02/weodata/index.aspx

The United States stock exchange technology index (NASDAQ ) has some interesting information on recent trends.

Various organisations post information on the internet on recent trends in the international business cycle and a Google search including the current year will bring several sites, including the following National Australia Bank Site which includes a www.wholesale.nabgroup.com