Approach Figure 1.1 Per Capita Real GNP (in 1996 dollars) for …€¦ · · 2014-04-28Copyright © Pearson Education, Inc. and Yunus Aksoy Slide 20 Understanding Recent and Current

1

Copyright © Pearson Education, Inc. and Yunus Aksoy Slide 1

Important Information

Assessment: Test (20%), Examination (80%) Test: Thursday February 16, 2006 (Lecture hour in the reading week) Lecture Slides on my site: http://www.econ.bbk.ac.uk/faculty/aksoy/


What is Macroeconomics?

Why are some countries rich, others so poor?Why are current generations richer than the older generations?Why do we observe recessions/expansions?Why do prices go up/down?How to avoid unemployment?Who is a policymaker and what should he do?


Approach

Theoretically: macroeconomics based on microfoundationsEmpirically: look first at “stylized facts”


Figure 1.1 Per Capita Real GNP (in 1996 dollars) for the United States, 1900--2002

2


What do you see?

Sustained growthMajor business cycle fluctuationsQuestions here..

What causes growth?Is it sustainable?What causes BCs?What can the policymaker do to affect growth and BCs?


Growth and Business Cycle Accounting

( )

1

1

1

1

l n ( 1 )

l n ( )

l n l n ( )

t tt

t

t t

tt

t

t t t

y ygy

o r a l t e r n a t i v e l y

g go r

y gy

o ry y g

−

−

−

−

−=

+ ≅

≅

− ≅


Business Cycle

1. Decompose ‘level’ data into itsBusiness Cycle component andTrend component

2. How?Define the linear or non-linear trendInterpret deviations from the trend as being the business cycle (sometimes it is called output gap)


Figure 1.3 Natural Logarithm of Per Capita Real GNP and Trend

3


Actual and trend GDP, UK, 1963-2002

Fig. 14.01 (a)

300

400

500

600

700

800

900

Q1/1963 Q1/1969 Q1/1975 Q1/1981 Q1/1987 Q1/1993 Q1/1999

Bill

ions

of 1

995

Pou

nds

GDP in 1995 prices Trend


Figure 1.4 Percentage Deviations from Trend in Per Capita Real GNP


Real GDP in the UK, deviation from trend (%)Fig. 14.01 (b)

Q1/1963 Q1/1969 Q1/1975 Q1/1981 Q1/1987 Q1/1993 Q1/1999-4.0

-3.0

-2.0

-1.0

0.0

1.0

2.0

3.0

4.0

5.0

6.0

Dev

iatio

n fro

m T

rend

(%)


Output Change (%)

-8%-6%-4%-2%0%2%4%6%8%

10%

1961

1964

1967

1970

1973

1976

1979

1982

1985

1988

1991

1994

1997

2000

USGermanyUKFrance

4


A typical macroeconomic model

A typical macroeconomic model containsFirms and consumersGoods to purchaseConsumer preferencesProduction technologyResources, (K,L,N)Sometimes policymakers


Microfoundations

Throughout the lectures we will take microfoundations of macroeconomics seriously

Approach up to 80’s ad hoc models

Rational expectations revolution

Lucas Critique


Figure 1.6 Total Taxes (black line) and Total Government Spending (colored line) in the United States, as Percentages of GDP


Figure 1.7 The Total Government Surplus in the United States\break as a Percentage of GDP

5


What is the implication of a Government Deficit?

Source of the deficit?Less taxes or more expenditures?If due to less taxes, the deficit will be paid off by higher taxes in the future

Ricardian equivalence: no free lunch!Intergenerational resource transfer

If due to government expendituresCrowding out of private activity


CPI

-10

-5

0

5

10

15

20

25

30

35

40

1961

1963

1965

1968

1970

1972

1974

1977

1979

1981

1983

1986

1988

1990

1992

1995

1997

1999

2001

US FranceGermanyUK


Inflation is costly Causes distortions in the economic activity, (investment, consumption, saving etc)Mainly due to irresponsible monetary policyBut what caused the disconnection after 80’s?


Understanding Recent and Current Macro-eventsInflation and Money Growth

6


Figure 1.8 The Nominal Interest Rate and the Inflation Rate


Interest Rates (%)

0

5

10

15

20

25

1961

1964

1967

1970

1973

1976

1979

1982

1985

1988

1991

1994

1997

2000

FranceGermanyUSUK

Copyright © Pearson Education, Inc. and Yunus Aksoy Slide 23will_macr_01_09

Figure 1.9 Real Interest Rate


Interest Rates

Key variable to make decision on investment, consumptionNominal interest rate obviously tracks inflation rateReal interest rate is a function of several variables

Policy variables (monetary, fiscal)Real (productivity, energy prices, demography etc)

7


To sum up

Very exciting areaChallenging questions ahead: inflation, output, unemployment, policy issues Modern macroeconomics takes microfoundations very seriously


Measurement:

Twin pillars: empirics and theoryMeasurement provides us with stylized facts Helps to build theoretical models to account for these

Key issue: how to measure key macroeconomic fundamentals?


Variables of interest

Introduce the key variables of macroeconomics, emphasising on GDP, GNP, and the CPI.


Overview:

1. Gross Domestic Product (GDP)2. Gross National Product (GNP)3. Components of Aggregate Expenditure

a. Consumptionb. Investmentc. Net Exportsd. Government Expenditures

4. Real GDP/Price indexes and inflation5. Saving, Wealth and Capital6. Labour Market Measurement

8


Gross Domestic Product (GDP)

GDP measures the total spending on final goods and services produced within a nation during a specified period of time.GDP measures the total income of everyone in the economy during a specified period of time.


The aggregate expenditure approach

GDP as the total spending on all final goods and services production in the economy

Total Expenditure= C+I+G+NX

(do not count spending on intermediate goods)


(b) The aggregate expenditure approach

GDP = Y = C + I + G + NXConsumption (C) : goods and services bought by householdsConsumption can be broken down into consumer durable goods such as TVs, computers etc., non-durable consumption goods such as foods and clothing, consumer services such as medical services and education.

Investment (I): goods bought for future use.Investment can be broken down into business fixed investment such as newly produced plant and equipment (capital goods), residential fixed investment such as houses, changes in business inventories.

Government expenditure (G): goods and services bought by government. Notice that not all government expenditures are part of GDP because not all government expenditures represent a demand for currently produced goods and services. For instance, government transfer payments to individuals (Social security payments) are not considered as part of GDP.

Net exports (NX) = Exports - ImportsCopyright © Pearson Education, Inc. and Yunus Aksoy Slide 32

Gross National Product (GNP):

GDP represents total income produced domestically. GNP is the total income earned by nationals whether or not the production takes place inside the countryGNP = GDP + Net factor payment from abroad (NFP) NFP = payments to domestically owned factors located abroad - payments to foreign factors located domestically

Example: Engineering revenue for a road built by a UK company in Belgium is part of UK GNP (built by a UK factor of production), not UK GDP; and is part of Belgian GDP (built in Belgium), not Belgian GNP.

9


Figure 2-1 GDP and GNP


What Does GDP leave out?

1. Welfare issues: Inaccurate measureIf we are interested in per capita income the use of GDP as a measure may be problematic

One person may own everything, income distribution problems will not be taken into account in the per capita GDPWork at home (GDP does not measure the value added when you cook at home)


What Does GDP leave out?

2. Aggregate Output: Inaccurate measureUnderground economyHow are government expenditures counted?

How do we value railways, bridges, policing?The solution in GDP accounting is to value them at their costs (factor payments)

May overvalue or undervalue the expenditureA railway to nowhere is overvaluedNHS maybe undervalued (or overvalued?)


Components of Aggregate Expenditure

ConsumptionInvestmentNet ExportsGovernment Expenditures

10


Consumption

Largest expenditure component of GDPConsists of durables, non-durables and servicesSometimes difficult to distinguish durables from non-durables (e.g. shoes may last as long as refrigerators!)


Investment

Def: Expenditures on goods that are produced but not consumed during the current period

Fixed Investment: production of capital (plant, equipment, housing etc)Inventory Investment

In general investment is small compared to consumption but matters a great deal for business cyclesHousing investments lead business cycles


Net Exports

Exports-Imports


Government Expenditures

Expenditures by government (can consists of federal, state, local depending on the constitution of the country)Transfers (unemployment insurance, child support, social security payments) are not included in the government expenditures

Redistribution vehicle

11


Table 2.9 Gross Domestic Product for 2002


Table 2-10


Nominal GDP in year 1$1.00x50+$0.80x100=130

Nominal GDP in year 2$1.25x80+$1.60x120=292Percentage change in GDP is %125


How much increase in nominal GDP is accounted for by inflation and how much by an increase in real quantity?

Choose a base year and calculate real GDP based on base yearIf year 1 is base year

RGDP in year 1=$130RGDP in year 2 at year 1 prices= $1,00x80+$0.8x120=$176percentage change in RGDP is %35

If year 2 is base yearPercentage change in RGDP is %31

12


Real GDP

Base year matters!Proposed solution: Chain weightingChain weighted ratio of real GDP in year 2 to real GDP in year 1 is:

According to this percentage change in RGDP is %33An in between solution, should be somewhat more accurate

1 2 1.354*1.312 1.333cg gg= = =


Figure 2.1 Nominal GDP (black line) and Chain-Weighted Real GDP(colored line) for the Period 1947–2003


Measures of the Price Level

a. Implicit GDP price deflator = (Nominal GDP/Real GDP)*100

GDP deflator measures the price of output relative to its price in the base year.


Figure 2.2 Inflation Rate Calculated from the CPI (blue line), and Calculated from the Implicit GDP Price Deflator (black line).

13


Differences between the GDP deflator and the CPI

GDP deflator takes into account all goods and services in the economyincludes only products produced domesticallyallows the basket of goods to change over timeCPI takes into account goods and services bought by a typical consumerinclude all products bought by the typical consumer (whether they are produced domestically or imported from abroad).uses a fixed basket of goods


Problems with Measuring Real GDP and the Price Level

1. relative prices change over time, thus introducing bias in how CPI measures inflation

2. Quality of goods change (cars are more expensive but much better now)If National Income Accounts do not take into account quality changes, real GDP is biased downward, inflation is biased upward

3. How to tackle new goods arriving into the market? (computers replacing calculators)


Measuring Savings, Wealth and Capital

Very important distinction: Flow variables and stock variables

Flow: a rate per unit time (such as GDP, C, S, I, G, NX)

Stock: the quantity in existence of some object at a point in time (e.g. capital stock, wealth)


Savings

Private disposable income

Private sector saving

Government saving

d

p d

g

g

Y Y NFP TR INT T

S Y C Y NFP TR INT T C

S T TR INT Gor D S T TR INT G

= + + + −

= − = + + + − −

= − − −

= − = − + + +

14


Saving (cont’d)

National saving

( )

e x p

. .

p g

c u r r e n t a c c o u n t s u r p l u s d e f i c i t

S S S Y N F P C Gf r o m i n c o m e e n d i t u r e i d e n t i t y

Y C I G N Xr e w r i t e SS C I G N X N F P C G

I N X N F P

i eS I C A

= + = + − −−

= + + +

= + + + + − −= + +

= +


Saving

National savings represent additions to nation’s wealthThrough I or CA

I: additions to nation’s capital stock (quantity of plants, housing, inventories)CA: surpluses in current account (flow variable) adds new claims on foreigners on the top of the existing ones (stock variable)

International wealth transfer


Labour Market Measurement

Employed: those who work full or part time in a specified periodUnemployed: those who are not employed but looking for a jobNot in the labour force: neither of those aboveUnemployment rate=number unemployed/labour forceParticipation rate=labour force/total working age population


Labour Market Measurement

labour market tightness: degree of difficulty firms face in hiring workersUse of UE as a measure of labour market tightnessmay be problematic:

Discouraged workers (in long recessions unemployment may fall just because some stop searching a job for a while, thus out of labour force)UE rate does not take into account intensity of job search

15


Employment/unemployment

Macroeconomic models tend to use employment level and growth instead of unemployment rate due to measurement problems


In sum

Accurate measurement of variables of concern is the key to establish some stylized facts


Business Cycle Measurement


What is a Business Cycle?

Fluctuations around the trend component in real GDPlargest negative deviations (recessions) troughsand largest positive deviations (booms/expansions) peaks from trend component. turning pointsAmplitude and frequencyPersistency of BCs

16


Figure 3-1 Stylized Business Cycles


Figure 3.2 Percentage Deviations from Trend in US Real GDP from 1947--2003


Comovements

Some macroeconomic variables fluctuate togetherStylized facts


Figure 3-3 Time Series Plots of x and y

17


Some useful concepts

Covariance

correlation

[( )( )][ , ]

1i x i yi

xy

x yCov x y

nμ μ

σ− −

= =−

∑

[ , ] x y

x y

x y

c o r x y ρ

σσ σ

=

=


Covariance and correlation

Sign of covariance will indicate the direction of covariation of X and YHowever its magnitude depends on the scales of measurementCorrelation coefficient is very useful to account for this magnitude..


Figure 3-4 Correlations Between Variables y and x


Some concepts

Important macroeconomic terms: A variable is said to be procyclical if its deviations from its trends component are positively correlated with the real GDP

countercyclical, acyclical

18


Procyclical: Imports and GDP


Procyclical: Scatter Plot of Imports and GDP


Leading vs. Lagging Variables

If a variable helps to predict the future real GDP leading variableIf the real GDP helps to predict the future value of a macro variable lagging variableCoincident variableLeading indicatorsStandard deviation of the percentage deviation from trend as a measure of cyclical variability


Figure 3-7 Leading and Lagging Variables

19


Percentage Deviations from Trend in Real GDP and the Index of Leading Economic Indicators for the Period 1959-1999


Components of Real GDP I: Percentage Deviations from Trend in Real Consumption and Real GDP


Components of Real GDP II: Percentage Deviations from Trend in Real Investment (black line) and Real GDP (colored line)


Nominal Variables: Scatter Plot for the Percentage Deviations from Trend in the Price Level and Real GDP

20


Price Level and GDP


Nominal Variables: Percentage Deviations from Trend in the Money Supply (black line) and Real GDP (colored line) for the Period 1947-1999


Labor Market Variables: Percentage Deviations from Trend in Employment (black line) and Real GDP


Descriptive statistics of business cycles1963-2002

Table 14.01

No. of Av. cycle length Maximum Minimum Av. Deviation completedcycles

peak to peak cycle length cycle length from midpoint(%)(quarters) (quarters) (quarters)

UK 4 21.5 25 19 4.2France 3 28.0 38 14 2.0Germany 5 19.0 27 11 3.8Italy 5 20.2 40 10 2.2Japan 2 46.5 73 20 4.0USA 4 31.3 42 17 3.4

Source: OECD Main Economic Indicators database, authors' calculations.

21


Summary of Comovements


Business cycle correlations of macroeconomicvariables with output

1968-2002

Table 14.02

Consumption InvestmentGovernment

spending Exports Imports Prices Inflation

EU 0.86 0.90 -0.15 0.85 0.94 -0.45 0.30Japan 0.71 0.89 -0.03 0.47 0.64 -0.15 0.18USA 0.88 0.95 0.04 0.32 0.75 -0.75 0.15

Source: OECD Main Economic Indicators database

* Correlation coefficient of seasonally adjusted and detrended values using the Hodrick-Prescott filter.


Variability* of key macro variables over the cycle1964-2002

Table 14.03

GDP(%)

Consumption Investment Government purchases

Exports Imports Prices (GDP deflator)

EU 0.95 0.86 2.52 0.53 2.44 3.07 0.94Japan 1.18 0.81 2.43 0.71 3.28 4.44 0.65USA 1.61 0.80 2.68 0.77 2.68 3.12 0.54

*Variability is measured as the stantard deviation of seasonally adjusted and detrended values using the Hodrick-Prescott filter.

Source: OECD Main Economic Indicators and National Accounts databases


Summary of Comovements II

22


Sum up

Measurement, thus generating stylized facts on business cycle is importantKeywords: Procyclical, countercyclical, acyclical, correlation, comovements

Documents

Approach Figure 1.1 Per Capita Real GNP (in 1996 dollars) for …€¦ · · 2014-04-28Copyright © Pearson Education, Inc. and Yunus Aksoy Slide 20 Understanding Recent and Current