economic booms

Introduction

An economic boom occurs when real GDP grows faster than the trend rate of economic growth (in the Uk, the trend rate is around 2.5% per year).

In a boom aggregate demand is high. Typically, businesses respond to this by increasing production and employment and they may also opt to widen profit margins by raising prices. The increase in output eventually puts pressure on scarce factor resources and can lead to demand-pull inflation. This depends on how much spare capacity is available to meet demand.

Main Characteristics of an Economic Boom:

• A strong and rising level of aggregate demand – nearly always driven by household consumption but government spending, fixed investment and exports can also add to final demand. Exports might be boosted by a more rapid growth of world trade or a fall in the exchange rate which increases the competitiveness of the UK traded goods sector

• Rising employment and real wages as the labour market “tightens” leading to falling unemployment and higher real incomes for those in work. The tightness of the labour market can be measured in various ways for example the rate of unemployment; the percentage of the labour force in work; the number of unfilled jab vacancies and surveys of labour shortages in specific industries and occupations. Real incomes for those people in work tend to rise quickly during a boom because of rising labour demand and the opportunity to boost earnings from overtime and productivity-related pay

• Increased demand for imported goods & services because of our high marginal propensity to import which can lead to a increase in the trade deficit (this has been true for the UK since the late 1990s)

• Government tax revenues will be rising quickly because employment and income rise leading to an improvement in government finances (the so-called “fiscal dividend” arising from a sustained expansion). This can lead to a budget surplus which might be used to reduce government debt, or finance an increase in government spending on public goods and services

• Company profits and investment increase – possibly financing a higher level of fixed capital investment - the link between the strength of demand and planned investment is often explained using the accelerator theory of investment. The extent to which a sustained expansion of national output leads to rising profits depends in part on what is happening to the exchange rate. For example when the exchange rate is falling, the profitability of exporting goods and services increases leading to a rise in profit margins and higher export orders and output at the same time

• Rising productivity – a cyclical boom is good for labour productivity because businesses are stretching to meet extra demand by using their existing labour resources more intensively

• A danger of demand-pull and cost-push inflation if AD exceeds SRAS over a prolonged period. The consumer boom of the late 1980s led to a build up of inflationary pressure (partly masked by a trade deficit) which eventually led to inflation in excess of ten per cent and nominal interest rates of 15% from 1988-89.