Understanding Business Cycle

Based on typical labor utilization patterns across the business cycle, productivity (output per hours worked) is most likely to be highest:

• At the peak of a boom

• Into a maturing expansion

• At the bottom of a recession

Answer explanation

At the end of a recession, firms will run “lean production” to generate maximum output with the fewest number of workers.

As the expansion phase of the business cycle advances from early stage to late stage, businesses most likely experience a decrease in:

• Labor costs

• Capital investment

• Availability of qualified workers

Answer explanation

When an economy’s expansion is well established, businesses often have difficulty finding qualified workers.

An analyst writes in an economic report that the current phase of the business cycle is characterized by accelerating inflationary pressures and borrowing by companies. The analyst is most likely referring to the:

• Peak of the business cycle

• Contraction phase of the business cycle

• Early expansion phase of the business cycle

Answer explanation

Accelerating inflation and rapidly expanding capital expenditures typically characterize the peak of the business cycle. During such times, many businesses finance their capital expenditures with debt to expand their production capacity.

The indicator indexes created by various organizations or research agencies:

• Include only leading indicators to compute their value

• Are highly reliable signals on the phase of business cycles

• Evolve over time in terms of composition and computation formula

Answer explanation

The indicator indexes are constantly updated for their composition and methodology based on the accumulation of empirical knowledge, and they can certainly include more than just leading indicators.

Which one of the following trends in various economic indicators is most consistent with a recovery from a recession?

• A declining inventory-sales ratio and stable industrial production index

• A rising broad stock market index and unit labor costs turning from increasing to decreasing

• A decrease in average weekly initial claims for unemployment insurance and an increase in aggregate real personal income

Answer explanation

The improving leading indicator, average weekly initial claims for unemployment insurance, and the improving coincident indicator, aggregate real personal income, are most consistent with an economic recovery. Even though a declining inventory-to-sales ratio, a lagging indicator, is consistent with an early recovery, the coincident indicator, the stable industrial production index, does not support that conclusion. Although a rising stock market index can signal eco- nomic expansion, the lagging indicator, the unit labor costs, has peaked, which is more consistent with a recession.

Which of the following statements gives the best description of nowcasting?

• This method is used to forecast future trends in economic variables based on their past and current values

• This method is used for real-time monitoring of economic and financial variables to continuously assess current conditions and provide an estimate of the current state

• This method is used to study past relationships between variables to determine which ones have explained the path of a particular variable of interest

Answer explanation

Nowcasting involves the use of techniques to estimate the present state. A is incorrect because nowcasting aims to estimate the present, not fore- cast the future. C is incorrect because the focus of nowcasting is to estimate the current, present value of a variable, such as GDP.

Which of the following statements is the best description of the characteristics of economic indicators?

• Leading indicators are important because they track the entire economy

• Lagging indicators, in measuring past conditions, do not require revisions

• A combination of leading and coincident indicators can offer effective forecasts

Answer explanation

Although no single indicator is definitive, a mix of them—which can be affected by various economic determinants—can offer the strongest signal of performance.

When the spread between 10-year US Treasury yields and the short-term federal funds rate narrows and at the same time the prime rate stays unchanged, this mix of indicators most likely forecasts future economic:

• Growth

• Decline

• Stability

Answer explanation

The narrowing spread of this leading indicator foretells a drop in short-term rates and a fall in economic activity. The prime rate is a lagging indicator and typically moves after the economy turns

Current economic statistics indicating little change in services inflation, rising residential building permits, and increasing average duration of unemployment are best interpreted as:

• Conflicting evidence about the direction of the economy

• Evidence that a cyclical upturn is expected to occur in the future

• Evidence that a cyclical downturn is expected to occur in the future

Answer explanation

Rising building permits—a leading indicator—indicate that an upturn is expected to occur or continue. Increasing average duration of un- employment—a lagging indicator—indicates that a downturn has occurred, whereas the lack of any change in services inflation—also a lagging indicator—is neither negative nor positive for the direction of the economy. Taken together, these statistics indicate that a cyclical upturn may be expected to occur

If relative to prior values of their respective indicators, the inventory-sales ratio has risen, unit labor cost is stable, and real personal income has decreased, it is most likely that a peak in the business cycle:

• Has occurred

• Is just about to occur

• Will occur sometime in the future

Answer explanation

Both inventory—sales and unit labor costs are lagging indicators that decline somewhat after a peak. Real personal income is a coincident indicator that, by its decline, shows a slowdown in business activity.