Fudan EMA Macroeconomics

Jia PanMar 1, 2010

Major Macroeconomic Variables: Output, Employment, Price and Interest Rate

Digest from “the Economist”, Dec 4th, 2008

Though it may end up as one of the longest recessions, if not the longest, of the post-war era, the current episode still seems to have more in common with the mild downturns of 1990-91 and 2001 than the more wrenching affairs that came before. As Robert Hall, an economist at Stanford University, notes, earlier recessions, like that of the early 1980s, were caused by the Fed raising interest rates sharply to squelch emerging inflation and holding them high even once the recession began. In the current and past two recessions, interest rates never got very high and the Fed actually began to lower them before the contraction began …

Mr. Hall is chairman of the committee of the National Bureau of Economic Research, an academic group that “officially” declares when recessions begin and end. He now says that the current episode fits the “modern recession” template not just in the lack of a significant monetary spark, but also in the divergence between employment and output. It used to be that full-time employment fell more slowly than output around recessions; since 1990 it has fallen as, or more, quickly. While employment has declined steadily since December, real GDP as of the third quarter was still above its level at the end of 2007.

Some Basic Issues: Output

GDP – a measure of output Definition: total value of output

produced in a country in a period regardless of ownership of resources

Nominal GDP versus Real GDP

0

2000

4000

6000

8000

10000

12000

14000

16000

1995

-03

1995

-09

1996

-03

1996

-09

1997

-03

1997

-09

1998

-03

1998

-09

1999

-03

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US real GDP US nomi nal GDP

0

50000

100000

150000

200000

250000

300000

1995

-03

1995

-12

1996

-09

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-06

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-03

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-12

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-09

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-06

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-12

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-09

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-03

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-12

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-09

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-06

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-03

2007

-12

Chi na nomi nal GDP Chi na real GDP

Rat i o of GDP of Chi na to GDP of US(assumi ng exchange rate to be 4 yuan : 1 dol l ar)

0

0. 05

0. 1

0. 15

0. 2

0. 25

0. 3

0. 35

0. 4

0. 45

1995

-03

1995

-09

1996

-03

1996

-09

1997

-03

1997

-09

1998

-03

1998

-09

1999

-03

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-09

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-09

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2003

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2004

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2006

-03

2006

-09

GDP deflator – the ratio of the current price to constant price value as a measure of the average price change

GDP priceConstant

GDP priceCurrent deflator GDP

Price

CPI versus GDP deflator

Digression: CPI

To measure the average pri ce of consumpti on, or equi val entl y, the cost of l i ving, macroeconomi sts l ook at another i ndex, the consumer pri ce i ndex (CPI). The CPI gi ves the cost i n dol l ars of a speci fi c l i st of goods and servi ces over t i me.

0002

02

01

01

0022

011

mm

mtm

tt

QPQPQP

QPQPQPCPI

US GDP defl ator and CPI

0. 00%

2. 00%

4. 00%

6. 00%

8. 00%

10. 00%

12. 00%

1980 1985 1990 1995 2000 2005

year

grow

th r

ate

defl ator CPI

Chi na' s GDP defl ator and CPI

- 5. 00%

0. 00%

5. 00%

10. 00%

15. 00%

20. 00%

25. 00%

30. 00%

1984 1989 1994 1999 2004

year

grow

th r

ate

defl ator CPI

Employment

Unemployment rate

ForceLabor

People d UnemployeofNumber RatentUnemployme

Definition of Labor Force: the number of people elder than 16 who are either employed or unemployed but actively looking for a job.

Digression: Labor Force Status Population over 16 Labor force Employment Unemployment Not in labor force

Students Housewife Retired Sick Others

Labor Force Status of the U.S. Adult Population, 1994

Unempl oyment Rate (%)

0

2

4

6

8

10

1219

90

1991

1992

1993

1994

1995

1996

1997

1998

1999

2000

2001

2002

2003

2004

2005

2006

US Euro Regi on Chi na

Interest Rate A measure of costs of financing.

Nominal versus Real interest rate.

So many interest rates around! Treasure bill rate, bank deposit/loan rates, bond rates etc.

The spread between T-bill and bond rates - risk premiums; the spread between bank deposit and loan rates – frictions in the bank sector.

3- Month T- Bi l l Rates

02468

1012

1994

-01

1994

-08

1995

-03

1995

-10

1996

-05

1996

-12

1997

-07

1998

-02

1998

-09

1999

-04

1999

-11

2000

-06

2001

-01

2001

-08

2002

-03

2002

-10

2003

-05

2003

-12

2004

-07

2005

-02

2005

-09

2006

-04

2006

-11

US Euro Regi on Chi na

i nterest rate spread i n Chi na

0

2

4

6

8

10

12

14

1996

-05

1996

-11

1997

-05

1997

-11

1998

-05

1998

-11

1999

-05

1999

-11

2000

-05

2000

-11

2001

-05

2001

-11

2002

-05

2002

-11

2003

-05

2003

-11

2004

-05

2004

-11

2005

-05

2005

-11

2006

-05

2006

-11

2007

-05

2007

-11

one year t i me deposi t one year l oan

OKun’s Law In most countries, there is a clear relation between

the change in unemployment and GDP growth. This relation is known as Okun’s Law.

Okun’s law shows that high output growth is typically associate

d with a decrease in the unemployment rate, and low output growth is associated with an increase in the unemployment rate. This makes sense: High output growth leads to high employment growth, as firms hire more workers to produce more. High employment growth leads to a decrease in unemployment.

US gdp growth versus unempl oymentannual data: f rom 1963 to 2006

-4

-2

0

2

4

6

8

10

2 3 4 5 6 7 8 9 10 11 12

Unempl oyment rate

GDP

grow

th r

ate

Chi na' s GDP growth versus unempl oymentannual data: f rom 1996 to 2007

0

2

4

6

8

10

12

14

16

2. 7 2. 9 3. 1 3. 3 3. 5 3. 7 3. 9 4. 1 4. 3 4. 5

unempl oyment rate

GDP

grow

th r

ate

Phillips curve There is a relation between inflation and either

output or unemployment, but it is far from mechanical - it varies across time and country.

Sometime, there is a negative relation between the unemployment rate and the change in inflation. When the unemployment rate is low, inflation tends to increase. When the unemployment rate is high, inflation tends to decrease. The negative relation is called the Phillips relation, and the curve that fits the set of points best is called Phillips curve.

US annual unempl oyment rate (X - axi s) and US quarter l y i nfl at i onrate, measured by CPI (annual data: 1981- 2006)

0. 00

2. 00

4. 00

6. 00

8. 00

10. 00

12. 00

3 4 5 6 7 8 9 10 11 12

unempl oyment rate

infl

atio

n

Chi na' s annual unempl oyment rate (X - axi s) and quarter l yi nfl at i on rate, measured by CPI (annual data: 1995- 2006)

- 5

0

5

10

15

20

2. 5 2. 7 2. 9 3. 1 3. 3 3. 5 3. 7 3. 9 4. 1 4. 3 4. 5

Real GDP growth rate (X) vs I nfl at i on Rate (Y)US Quarterl y Data: 1990- 1 to 2007- 2

- 1

- 0. 5

0

0. 5

1

1. 5

2

2. 5

3

- 1 - 0. 5 0 0. 5 1 1. 5 2

Real GDP growth rate (X) vs I nfl ati on Rate (Y)Chi na Quarterl y Data: 1995-2 to 2007-4

-5

0

5

10

15

20

-30 -20 -10 0 10 20 30 40

National Income and Product Accounting (NIPA)

Computing GDP Three (identical) ways of computing GDP.

First, adding together the value of final good and services produced in all different industries.

Second, adding together the spending on goods and services of all different sectors.

Third, adding together all the income that is generated from the production process.

Computing GDP through Production:Industries Value Added in % of GDP

US

1999

China 2007

Agriculture, Forestry, Fishing 1.3 12.5

Mining 1.2 5.6

Construction 4.5 5.5

Manufacturing 16.1 32.7

Transportation, Public Utilities 8.4 5.9

Wholesale Trade 6.9 7.4

Retail Trade 9.2 8.6

Finance, Insurance and Real Estate 19.3 7.9

Service 21.4 5.5

Government 12.5 8.4

Digress: Final Good and Services

A final good is a good that is destined for final consumption.

An intermediate good is a good used in the production of another good.

Question: consider an economy with a steel firm and a car producer. How to calculate GDP according to the following statement?

Steel company

Revenues from sales $100

Expenses(wages) $80

Profit $20

Car company

Revenues from sales $210

Expenses $170

wages $70

Steel purchases $100

Profit $40

Computing GDP through Spending

C = Consumption I = (Gross) Investment G = Government Purchases X = Exports M = Imports Y = Nominal GDP

MXGICY

Consumption (C) Consumption (C) is spending of households on

all goods, including durable goods like TV, cars and furniture, nondurable goods like food and clothes, and services like education, health care.

The only form of household spending that is not included in consumption is spending on new houses.

The annual shares of consumpt i on as a percentage of GDP f or USand Chi na

0

0. 1

0. 2

0. 3

0. 4

0. 5

0. 6

0. 7

0. 8

1980

1981

1982

1983

1984

1985

1986

1987

1988

1989

1990

1991

1992

1993

1994

1995

1996

1997

1998

1999

2000

2001

2002

2003

2004

2005

2006

chi na us

Gross Investment (I)

Gross Investment is the sum of all spending of firms on plant, equipment and inventories, and the spending of households on new houses. Three components are listed as follows.

1. Residential fixed investment (the spending of households on the construction of new houses)2. Nonresidential fixed investment (the spending of firms on buildings and equipment for business use) 3. Inventory investment (the change in inventories of firms)

Digression: Capital and Investment The capital stock (a stock variable) is the total amount of

physical capital, including all buildings and equipment. Part of the capital stock wears out every period in the production process, a process called depreciation.

Capital Stock at end of this period (or beginning of next period)= Capital Stock at end of last period (or beginning of this period)+ Gross Investment in this period – Depreciation in this period

Net Investment = Gross Investment – Depreciation = Capital Stock at end of this period – Capital Stock at end of last period

Then we can define the net investment.

The annual shares of i nvestment as a percentage of GDP f or US andChi na

0

0. 05

0. 1

0. 15

0. 2

0. 25

0. 3

0. 35

0. 4

0. 45

0. 5

1980

1981

1982

1983

1984

1985

1986

1987

1988

1989

1990

1991

1992

1993

1994

1995

1996

1997

1998

1999

2000

2001

2002

2003

2004

2005

2006

chi na us

Government Spending (G) Government spending (G) is the sum of federal,

state and local government purchases of goods and services, i.e. government consumption, government investment.

Attention! Government spending does not equal total government outlays: transfer payments to households or interest payments on public debt are part of government outlays, but not included in government spending.

Question: Why?

The annual shares of government spendi ng as a percentage of GDPf or US and Chi na

0

0. 02

0. 04

0. 06

0. 08

0. 1

0. 12

0. 14

0. 16

0. 18

0. 2

1984

1985

1986

1987

1988

1989

1990

1991

1992

1993

1994

1995

1996

1997

1998

1999

2000

2001

2002

2003

2004

2005

2006

chi na us

Net Exports (X-M)

Exports (E) are deliveries of domestic goods and services to the rest of the world, imports (M) are deliveries of goods and services from other countries of the world.

The quantity (X-M) is also referred to as the trade balance. We say that a country (such as China) has a trade surplus if exports exceed imports. A country has a trade deficit if X-M<0.

The annual shares of net export as a percentage of GDP f or US andChi na

- 0. 06

- 0. 04

- 0. 02

0

0. 02

0. 04

0. 06

0. 08

0. 1

1980

1982

1984

1986

1988

1990

1992

1994

1996

1998

2000

2002

2004

chi na us

US - 1997 China - 1997

Consumption 67.4% 45.2%

Durable Goods 8.2%

Nondurable Goods 19.8%

Services 39.3%

Gross Investment 17.7% 36.7%

Nonresidential 12.9%

Residential 4.3%

Changes in Inventory 0.5%

Government Purchases 17.6% 13.7%

Federal Government 6.3%

State and Local Government 11.5%

Net Export -2.7% 4.3%

Export 10.6%

Import 13.4%

The Composition of Nominal GDP through Spending

Computing GDP through Income

The production of goods and services generates income like wages and profits, providing a third way of computing nominal GDP.

The total incomes of all Chinese is called national income.

Some people in this country are not Chinese. Although they contribute to China GDP, their income is not part of national income.

There are Chinese who produce goods and services abroad. They don’t contribute to China GDP, but their income is part of national income.

National Income vs. GDP National income is closely related, but

not equal to nominal GDP. GDP + Factor Income from abroad – Factor Income to abroad= GNP (Gross National Product) – Depreciation = Net National Product – Indirect Taxes (sales and excise taxes) – Other Adjustments= National Income

Five Components of National Income

1. Compensation of Employees: wages, salaries and fringe benefits earned by workers

2. Proprietors’ Income: income of non-corporate business, such as small farms and law partnerships

3. Rental Income: income that landlords receive from renting, including the “imputed rent” that homeowners pay themselves, less expenses on the house, such as depreciation

4. Corporate Profits: income of corporations after payments to their workers and creditors

5. Net interest: interest paid by domestic businesses plus interest earned from foreigners

Labor and Capital Shares

The first component is called labor income, components from 2 to 5 together are called capital income.

Income National

IncomeLabor ShareLabor

Income National

Income Capital Share Capital

Shares of National IncomeUS - 1999 China

Compensation of Employees 71%

Proprietors’ Income 8.9%

Rental Income 1.9%

Corporate Profits 11.5%

Net Interest 6.8%

Decomposing GDP by Income

US – 2000 (1960)

China – 2003

Labor Income 65%(66%)

<50%

Capital Income 28%(26%)

Indirect Taxes 7%(8%)

Identities Implied by the equivalence of GDP measured by spending and income

Assume G=X=M=0. Saving (S) is defined as income minus consumption, or S = Y – C.

The spending side of GDP shows that Y = C + I. Substituting for Y establishes S = Y – C = C + I – C = I, which is an accounting identity.

An Extension: Flow of Funds Identity

Define T as government revenues. Sum of sector financial balances (net lending or borrowing) must equal zero

MXGTIS )(

Private sector balance + Public sector balance = Current account balance

Assignment

Find data on S, I, T, G, X and M for US and China.

Check if the above identity holds for these two countries.

Recapitulate: Output = Expenditure = Income

Value added (or Final Good and Services) = sales less purchases of materials

Final Expenditures by households, firms and government (not intermediate expenditures)

Factor incomes (wages, rents, profits) earned from production (not transfer incomes)