Economic Cycle
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Economic Cycle = one complete movement
from peak to peak (or trough to trough)
Peak = height of economic prosperity.
Contraction = downturn in the economy.
Expansion = period of positive economic
growth.
Recession = period when national economic
growth is negative for 2 or more consecutive
quarters.
Trough = lowest point in the cycle.
Economic Cycle
Peak
% Nat. Econ Growth
4
3
2
Expansion
Contraction
1
0
-1
Recession
-2
-3
-4
Trough
Time ===>
Four Stages of an Economic Cycle
Unemployment
Rate
Inflation Rate &
Interest Rate
Peak
low
rising
Contraction
rising
Hit the high point early in the
contraction, and then falling
Trough
high
falling
Expansion
falling
Hit the low point early in the
expansion, and then rising
Examples of historical cycles (trough to trough):
1959-1969, 1969-1975, 1975-1980, 1980-1989, 1989-1991,
1991-2001
Long-Term and Short-Term
Interest Rates
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What is “short term” and what is “long
term?”
Short Term: U.S. T-Bills (8/20/12)
3-month
0.09
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6-month
1-year
0.13
0.18
Long-Term and Short-Term
Interest Rates
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Longer-Term Investments: U.S.
Treasury Bonds...
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Time Period
Rate
5-year
 10-year
 30-year
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08/20/2012 Interest
.79
1.81
2.93
Interest rates on long-term investments
can be thought of as the average of future
short-term rates expected by investors.
The Spread - The difference between longterm and short-term interest rates.
10
8
Fed. Res. Funds
Rate
T-Bills (10yr) Rate
6
4
Spread
2
19
88
19
89
19
90
19
91
19
92
19
93
19
94
19
95
19
96
19
98
0
-2
Source: Board of Governors of the Federal Reserve.
What does the difference between long-term
and short-term interest rates tell us?
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Large positive difference (i.e., longterm r minus short-term r is positive
and large)
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investors think that interest rates will rise
in the future
short-term interest rates will rise at a
faster pace than long-term interest rates
What does the difference between long-term
and short-term interest rates tell us?

Large negative difference (i.e., longterm r minus short-term r is negative
and large)
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investors think that interest rates will fall
in the future
short-term interest rates will fall at a
faster pace than long-term interest rates
fall
Since 1975...
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In all instances where the spread was
negative, interest rates subsequently
fell.
The more negative the spread, the
bigger the decline in interest rates
that occurred.
In instances where there were large
positive spreads, interest rates
subsequently rose.
Other info the difference between long-term and
short-term interest rates gives us...
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The spread tells us something about
what is likely to happen to national
economic growth in the near future.
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Important information regarding forecast
for future employment
Important information regarding what is
likely to happen to financial markets and
interest rates
Important information regarding future
inflation
Making Economic Forecasts
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Why do families and households care
about economic forecasts?
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Implications for the costs of borrowing
Implications for the benefits of saving
Implications for the mix of human,
physical, and financial capital families
should hold
Implications for risk management
What indicators can/do help
families make accurate forecasts?
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Business cycle information - i.e., what
is happening to real national economic
growth. Where have we been
recently?
Recent rates of inflation (look to CPI)
The spread between long- and shortterm interest rates (comparison
between 10-yr bonds and 3-6 month
T-bills)