But over the last 15 years, many economists have turned their attention away from short-term cycles and focused instead on long-term growth trends. This new focus has been driven, in part, by the observation that even small differences in long-term growth rates lead to huge differences in standards of living over time, disparities that far exceed the impact of transitory cyclical change.
For example, Nobel Laureate Robert Lucas, a University of Chicago economist, has pointed out that while South Korea and the Philippines had similar per capita incomes in 1960, the superior growth of South Korea over the following 28 years (6.2 percent per year vs. 1.8 percent) resulted in Korean incomes being three times larger than the incomes in the Philippines by 1988. While this example is especially striking, a general observation from the growth literature is that differences in long-term growth rates have a much larger impact on the level of income over time than do typical business cycle fluctuations.
Defining business cycles
To compare Minnesota business cycles with national business cycles, as well as business cycles in other states, a measure of economic activity and a clear definition of business cycles are needed. The measure of economic activity used here is real earned income, which includes all wage and salary earnings, plus proprietor’s income. This is a broad measure of activity that encompasses all sectors of the economy. The data have been adjusted for inflation, and all variables are measured in 1996 dollars.
Following modern business cycle theory, business cycles are defined as the fluctuations in earned income around the long-run trend. Figure 1 illustrates the basic idea of this definition for the U.S. economy. The top panel shows U.S. earned income and a smooth trend line drawn through the data. The percent deviations between the actual data and the trend line are shown in the bottom panel, and are defined to be the business cycle. The same procedure is used to define the business cycle for each state economy.