ESRI forecasts for 2010 allow me to update the internal/external balance plot first used by Brendan Walsh and myself to describe the lengthy cycle 1975-2001.

The first chart, with data up to 2006, shows the previous big counterclockwise cycle: first the balance of payments goes into deficit (1975-1979); then the correction begins and unemployment rises (1980-85), the balance of payments deficit contracts (1981-87) and moves into surplus (1991-93); finally unemployment comes down again (1993-2000).

Looks like the Irish hare is taking a shorter and sharper curve this time. The balance of payments blow-out (2003-2008) has been much smaller in amplitude and shorter in duration than in the 1970s and 1980s. The rise in unemployment (2007-2010) is much faster than in 1981-86. Sooner or later we’ll get back to the bottom centre of the graph with low unemployment and zero balance of payments.

The first chart shows data up to 2006, the second one joins the dots for 2007-2010 according the the ESRI forecasts published this morning.

(PS: For those who like two-dimensional business cycle graphs, there is a very nice one (plotting rate of change of GDP against its level) for the US in a recent issue of the New York Times. Wish I had a copy of their animation software!)

*Related*

What a lovely type of graph! Although the graph itself doesn’t leave one with lovely feelings.

Patrick, this is indeed a very informative visual presentation.

I’m sure you’re right that ‘”sooner or later we’ll get back to the bottom centre of the graph with low unemployment,” but I worry it could be a long time coming. Central to this how much of the increase is structural. Based on the the IMF’s new estimates/projections for the output gap and real GDP growth, it is interesting to work out the underlying time series for potential and actual real GDP from 2005 to 2014. A striking feature of the resulting graph is that the post-bubble Irish economy is only just returning to potential about now (although a substantial negative output gap will open up during this year and next).

If we make the standard assumption that unemployment is at its “natural rate” when output is at potential then this suggests that the current unemployment structural. Of course, given how difficult it is to measure potential output in a turbulent environment, I wouldn’t push this too far. But it is sobering nonetheless.

Patrick, this is indeed a very informative visual presentation.

I’m sure you’re right that ‘”sooner or later we’ll get back to the bottom centre of the graph with low unemployment,” but I worry it could be a long time coming. Central to this is how much of the increase is structural. Based on the the IMF’s new estimates/projections for the output gap and real GDP growth, it is interesting to work out the underlying time series for potential and actual real GDP from 2005 to 2014. A striking feature of the resulting graph is that the post-bubble Irish economy is just returning to potential about now (although a substantial negative output gap will open up during the remainder of year and next).

If we make the standard assumption that unemployment is at the natural rate when real output is at potential then this suggests that the current unemployment structural. Of course, given how difficult it is to measure potential output in a turbulent environment, I wouldn’t push this too far. But it is sobering nonetheless.

Patrick, very interesting and informative graph. But I find it incredible that the balance of payments deficit will be reversed so soon. We are likely going to be much closer to the 86 data point than the 93 data point, at least in 2010.

“Looks like the Irish hare is taking a shorter and sharper curve this time. The balance of payments blow-out (2003-2008) has been much smaller in amplitude and shorter in duration than in the 1970s and 1980s. The rise in unemployment (2007-2010) is much faster than in 1981-86. Sooner or later we’ll get back to the bottom centre of the graph with low unemployment and zero balance of payments. ”

Pretty much what one would have expected, all other things being equal, as part of a large monetary union?

Was there a fall in the real effective exchange rate in the 1980s compared to this cycle? The exchange rate rigity this time around should produce larger domestic output responses and nullify the aforementioned J-curve effects.

Call me cynical, but I don’t actually believe we will ever get back to full employment. Not because we can’t, not because its that difficult, but because many employers and their far-right political and academic allies won’t want to. Therefore, I don’t think we can predict on the basis of past models.

During previous periods of high unemployment, a much higher proportion of the workforce was unionised, there was greater protection of employees’ rights and there were no immigrants. So, even in recessions wages rose. Since the mid 90s, these new factors have come into play, but employees retained a certain degree of bargaining power because there was full employment and a shortage of labour. This is the first time since these new factors came into play that there has actually been a large pool of unemployed. And, boy, are the employers taking advantage of it.

Look at how employers are reaping the benefits of the current increase in unemployment. They are able to slash wages right across the board. They are loving it. Alan Ahearne openly boasts about how easy it is to cut wages in Ireland (Irish Times, July 6). He contrasts that with how difficult it is in other countries. According to yesterday’s ESRI report, wages in Ireland are down 3 per cent in 2009 compared with 2008, and apparently the target for the year is 8%. In every other EU country, wages are rising by 4% to 5% annually, up to 10% in eastern Europe. The reason they can get away with it is the increase in unemployment. And that’s just with unemployment at 10%. Wait until its at 15%. We’ve only seen the beginning of this process of wage reduction. Does anyone seriously think they could get away with it if the unemployment rate was still under 5%. The employers and their far-right allies will never allow the 1995 to 2007 era to be repeated. To them, its a dark period in our history when the boot was on the other foot, and they didn’t have 200 people applying for every job they offerred. They will never allow it to return.

This graph is an example of a Phase Plane diagram, which is a plot

of two time-varying functions x(t) and y(t), t = 0,1,2, …

For each value of t we plot a point [x(t),y(t)] in the x-y plane.

These points are then joined by straight lines and we get the

resulting curve. As the time increment gets smaller the curve

becomes smoother.

For example, a phase plane diagram of [sin(t), cos(t)] for t = 0..2*pi

will give a circle. [sin(t), 2*cos(t)] will give an ellipse.

A search for “Phase Plane” under Google Images gives many examples.

The book below has examples of phase-plane diagrams, especially Chapter 10. It also has exercises and answers (using MS Word and Excel) which may be downloaded from the Cambridge site.

Ronald Shone: An Introduction to Economic Dynamics,

Cambridge University Press, 2001

http://cambridge.org/uk/catalogue/catalogue.asp?isbn=9780521800341

Contents

Preface; 1. Introduction; 2. Demand and supply dynamics; 3. Simple Keynesian dynamics; 4. Constructing trajectories in the phase plane; 5. IS-LM dynamics; 6. Inflation-unemployment dynamics; 7. Dynamics of the firm; 8. Saddles and rational expectations; 9. Fiscal dynamics and the Maastricht Treaty; 10. A little bit of chaos; Brief answers to selected exercises; Further reading.

Software: Phase-plane diagrams may be easily plotted using Matlab, and can be animated with a little extra effort.

Hares: Phase-plane diagrams are often used to illustrate Predator-Prey dynamic models. A fox chasing a hare may be modelled by setting up differential equations for the positions of the fox and the hare at any time t. Calculating and plotting the fox and hare positions on a phase-plane diagram will show how the chase evolves over time.