The Goals of the Business Cycle

The 1946 law committed the Federal
Government to
◦ Maximize Employment and Economic Growth
◦ Maintain a stable price level
Humphrey Hawkins in 1978 went further and
committed the government to
◦ Reach an unemployment rate of 4 percent
◦ To stabilize the price level with a target inflation rate
of 0%
◦ To maintain steady economic growth
The Employment Act of 1946
Full Employment and Balanced Growth
Act of 1978 (Humphrey-Hawkins Act)
Alternating rises and declines in the level of
economic activity, sometimes extending over
several years.
Peak – business activity has reached a
temporary maximum
◦ The economy is near or at full employment
◦ The level of real output is at or very close to the
economy’s capacity
◦ The price level is likely to rise during this phase
Contraction/Recession – A period of decline
in total output, income, employment and
Recession last 6 months or more, is marked
by the widespread contraction of business
activity in many sectors of the economy
The price level is likely to fall only if the
recession is severe and prolonged.
Trough – Output and employment “bottoms
◦ Output and employment are at its lowest levels
◦ This phase may be either short-lived or quite long.
Recovery/Expansion – output and
employment rise toward full employment
◦ As recovery intensifies, price level may begin to rise
before full employment and full-capacity production
The basic economic cost of unemployment is
forgone output
Potential production of goods and services is
irretrievable lost when there aren’t enough
jobs created for all who are able and willing
to work
GDP Gap – actual GDP – Potential GDP
Arthur Okun was the first to quantify the
relationship between the unemployment rate
and the GDP Gap.
For every 1percentage point by which the
actual unemployment rate exceeds the
natural rate, a negative GDP gap of about 2%