MACROECONOMIC MEASURESWHAT THEY ARE & HOW TO USE THEM

Chapter 21, 22, 26

The Age of Macro Link

Outline• GDP• Comparing GDP across Time• Inflation• Real Interest Rates• Balance of Payments

Gross Domestic Product

Quantity Aggregates• To understand the macroeconomy, we need to measure it.

Chief measure of economy is the level of production: GDP• We need to combine the many goods produced or consumed in an economy into one measure.

++

++

=?

Gross Domestic Product (GDP)

• GDP is the sum of the value of new, final goods produced within the domestic borders of an economy.

All goods sold in an economy share a common unit of measure: the price at which they are sold.

Final goods are goods sold to their end-users

Sum up the value of goods

• Accounts are created by national statistical agencies • UN System of National Accounts is  the “internationally

agreed standard set of recommendations” used by most countries.

• Annual data for many countries available at the UN

Link

Link

Three Methods for Calculating GDP

1. Expenditure Method - The sum of the domestic spending on final goods (less domestic demand satisfied by imports).

2. Production Method - The value added created in all the sectors of the economy.

3. Income Method – The Wage, Rent, Interest and Profit Income generated by the domestic economy.

Income=Expenditure=Value Added

• Value of final good expenditure is equal to value added at each stage of production. (Expenditure = Value Added)

• Value Added would be paid to workers, creditors, or kept as profits.

(Income = Value Added)

Expenditure Approach

Purchase of Final goods by end users are divided into two categories:

1. Consumption: A. Personal Consumption Expenditure (durables,

nondurables & services); B. Government Consumption Expenditure

(nondurables & services); 2. Investment:

A. Gross Fixed Capital Formation (structures & equipment both public & private)

B. Change in Inventories

GDP = Consumption + Investment + Exports – Imports

Some Asian Expenditure Shares: 2010

Source: United Nations Main Aggregates Database Source: United Nations Main Aggregates Database

1 2 3

123

-10

0

10

20

30

40

50

60

70

80

90

0

0.1

0.2

0.3

0.4

0.5

0.6

0.7

0.8

0.9

1

Household consumption expenditure General government final consumption expenditureGross fixed capital formation Changes in inventoriesSeries5

People’s Republic of China

Reconciliation

GDP = Consumption + Investment + Exports – ImportsExports – Imports = Net Exports <> 0

GDP Exports of goods (f.o.b.)

1,935,195 3,411,364Private consumption expenditure Exports of services

1,237,872 952,336Government consumption expenditure Imports of goods (f.o.b.)

167,729 3,848,200Gross domestic fixed capital formation Imports of services

435,511 438,449Changes in inventories Net Export

17,032 77,051

Hong Kong Census and Statistics

13%

12%

22%

53%

Hong Kong Consumer Spending (by Category) 2011

Food Durables Non Durables Services

Hong Kong Census and Statistics

Food & Non-alcoholic Beverages

13%

Alcoholic Beverages 1%

Tobacco 0%

Clothing, Footwear & Other Personal Effects

16%

Rent, Rates, Water & Housing Maintenance

14%Fuel & Light

1%Furniture, Furnishings & Household Equipment

7%Household Operation

2%

Personal Care 4%

Medical Care & Health Expenses

4%

Transport & Communica-tions 8%

Recreation & Enter-tainment

7%

Education 2%

Other Services 20%

PCE by Category Hong Kong 2011

Hong Kong Census and Statistics

Compensation of Employees 57%

Purchases of Goods & Services 33%

Sales by Non Trading Govt Dept 10%

GCE by Category 2011

Hong Kong Census and Statistics

Building and Construc-tion: Private

23%

Building and Construction: Public 14%

Costs of Ownership Transfer

8%

Machinery, Equipment and Computer Software: : Private

50%

Machinery, Equipment and Computer Software: Public

4%

GFCF by Category 2011

Hong Kong Census and Statistics

Production Method• At the plant level, Value added = Sales + Change in inventories

- materials, intermediate inputs and energy costs.

• GDP is the sum of VA across establishments. • The value of a final good is equal to the value added at each stage of production.

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1970

20100

10

20

30

40

50

60HK:

VA

by

Sector

Source: United Nations Main Aggregates Database

2011 p

94431,09533,33664,527

1,771,154484,338

Import and export trade N.A.Wholesale and retail trades N.A.

68,598119,576

Transportation and storage N.A.Postal and courier services N.A.

63,078314,446213,864

Real estate N.A.Professional and business services N.A.

310,752196,502

1,901,05669,656

-1.81,935,195

Statistical discrepancy (%) @GDP at current market prices

Real estate, professional and business services

Public administration, social and personal servicesOwnership of premises

GDP at basic pricesTaxes on products

ConstructionServices

Import/export, wholesale and retail trades

Accommodation and food services ^Transportation, storage, postal and courier services

Information and communicationsFinancing and insurance

HK$ MnEconomic ActivityAgriculture, fishing, mining and quarryingManufacturingElectricity, gas and water supply, and waste management

Table 035

Income Approach to Measuring GDP

Value Added distributed as income to Employees, Owner/Creditors, & Gov’t1. Compensation of employees (Wages, Benefits)2. Net operating surplus (Profits, Net Interest, Rental

Income)3. Taxes on Production

20

52%47%

2%

Value Added 2010 1.58 Trillion HK$Compensation of employees Gross operating surplusTaxes on production

Value Added 1,606,092Compensation of employees 828,139Gross operating surplus 753,171Taxes on production 24,782

Comparing GDP levels across time

• GDP measures the value of the goods produced by an economy by using the market price of each good to assign it a value.

• Problem: Prices of goods in terms of money are changing overtime making comparisons in overall value difficult. • Bias: Money prices are growing over time as money supply grows.

• Solution: Choose a Base Year’s prices as a fixed yardstick of value for different goods.

Real GDP: Yt

•GDP aka Nominal GDP aka Current Dollar GDP is the weighted sum of the number of goods produced using their current prices as the weight.

•Real GDP aka Constant Dollar GDP aka GDP adjusted for inflation is the weighted sum of the number of goods produces using the Base Year prices as yardsticks.

Calculating Real GDP• Divide GDP into k = 1….K categories. • Survey dollar value of goods produced at time t for each of k categories

• Survey average prices of goods of type k relative

to a base year.• Divide value of each good by the relative price k

k k kBaset t Base tkk k

t

PY v P qP

k k kt t tv P q

kt

kBASE

PP

Solved ProblemReal GDP: 2010 (2009 Base Year)

2010 2009P q P q

Kitkat 8 150 6 135

M&Ms 10 150 4 135Nominal GDPReal GDP

Real GDP vs. Nominal GDP

1970

1974

1978

1982

1986

1990

1994

1998

2002

2006

2010

$0

$200,000,000,000

$400,000,000,000

$600,000,000,000

$800,000,000,000

$1,000,000,000,000

$1,200,000,000,000

$1,400,000,000,000

$1,600,000,000,000

$1,800,000,000,000

$2,000,000,000,000HK GDP

Constant 2005 Prices Current Prices

Source: United Nations Main Aggregates Database

Inflation

Price Indices: Pt

• Two most commonly used price indices are GDP Deflator and Consumer Price Index (CPI)

• The GDP deflator is the ratio of nominal GDP to Real GDP (multiplied by 100).

100

100

Nominal GDPP GDP DeflatorReal GDP

GDPPY

Consumer Price Index• The CPI is the price of a representative market

basket of goods relative to the price of that same basket during a benchmark/base year (multiplied by 100).

100tCost of Market Basket in year tCPI

Cost of Market Basket in Base year

0.0

20.0

40.0

60.0

80.0

100.0

120.0

140.0

1975 1978 1981 1984 1987 1990 1993 1996 1999 2002 2005

CPI

GDP Deflator

Hong Kong’s History of Prices

Q: What is Inflation?A: The Growth Rate of Price Level

1

1

% 100%t tt

t

P PInflation Rate xP

• What is the CPI inflation rate in Candyland in 2010 using 2009 as the base year?

• Inflation: prices are growing• Disinflation: inflation is slowing down but still positive• Deflation: inflation is negative and prices are actually

dropping.

Hong Kong CPI

-6-4-202468

101214

1982

1984

1986

1988

1990

1992

1994

1996

1998

2000

2002

2004

2006

2008

%

http://www.imfstatistics.org/imf/

Inflation

Disinflation

Deflation

Adjusting for Inflation

$r rt t

t

PN NP

• We can use price indices to “adjust for inflation” - converting values measured in money into values measured in terms purchasing power of some reference year, r.

• Measured in $, observed at time t: Nt

• Price level at time t: Pt

• Price level in reference year: Pr

• Measure adjusted for inflation – r$tN

Housing Price: Hong Kong Island• Compare the price of housing in HK average price of an apartment on HK Island with an area between 100m2 and 160m2 • in June 2013 : HK$242,500 /m2

• in June 1982: HK$15,078/m2

• How much did an apartment cost back then when expressed in today’s dollars?

Housing Price: Hong Kong Island

• The Hong Kong CPI (2010=100) was 32.3 in June 1982 and 115.2 in June 2013.

• Calculate:

• In purchasing power terms, luxury housing in 2013 is almost 5 times as expensive as in 1982!

$ 115.2$15,078 $53,776.6432.3

r rt t

t

CPIN NCPI

Link Hong Kong Department of Census and Statistics.

ADJUSTING INTEREST RATES FOR INFLATION

Interest Rates • Hong Kong HKMA

• HIBOR• Exchange Fund Bill &

Note Yields• Best Lending Rate• Government Bond Rates

• USD FRED • LIBOR• T-Bills• Prime• Treasury Constant

Maturity• Corporate Bonds

Adjusting Interest Rates for Inflation• Nominal rate represents how much money you will receive after 1 year for giving up 1 dollar of money today

• Real rate represents how many goods you can buy if you give up the opportunity to buy 1 good today.

• Nominal interest rate is money interest rate. Real interest rate is goods interest rate.

• The real interest rate on the loan is defined as the future goods received relative to current goods foregone

Real Interest Rate

11

$1 $11 $1

11

1

t+1t

t+1t t

tt t t t

t

i iP 1r PP P

ir r i

Looking Backward

1/1991 7/1992 1/1994 7/1995 1/1997 7/1998 1/2000 7/2001 1/2003 7/2004 1/2006 7/2007 1/2009 7/2010

-10

-5

0

5

10

15

20

25

HK Interest Rates

Ex Post Real 12 Month HIBOR (CPI Adjusted) 12 Month HIBOR

%

HKMA, Hong Kong Department of Census and Statistics.

Looking Forward• Borrowing and lending decisions must be based on forecast of future inflation: Ex Ante Real Rate

Forecasts• Ibond Yields• Consensus Forecasts• Central Bank Forecasts

2010 2011 2012 2013 20140

1

2

3

4

5

6

IMF World Economic Outlook Forecast

Hong Kong SARKoreaSingaporeTaiwan Province of China%

BALANCE OF PAYMENTS

National Income vs. Domestic Income

• Net Factor Income [NFI] is income earned on overseas work or investments minus income generated domestically but paid to foreigners.

GNI GDIGross National Income Gross Domestic Income

= income earned by national residents

= income created within domestic borders.

GNI = GDI +NFI

1970

1972

1974

1976

1978

1980

1982

1984

1986

1988

1990

1992

1994

1996

1998

2000

2002

2004

2006

2008

2010

-4.00%

-3.00%

-2.00%

-1.00%

0.00%

1.00%

2.00%

3.00%

4.00%

5.00%

Hong Kong Net Factor Income

NFI (% of GDP)

Source: United Nations Main Aggregates Database

Compare Macau and the Philippines GDP or GNP

• Macau produces a lot of profits paid to overseas owners of casinos.

• Philippines workers earn a lot of income overseas.

• Which is larger Philippines’ GDP or Philippines GNP?

• Does Macau have greater GDP or GNP?

NFI Across Countries

NFI/GDP 2009UN Main AggregatesChad -42.68%Russian Federation -3.23%China: Hong Kong SAR3.12%Liberia -20.14%China, People's Republic of -2.04%Switzerland 4.15%Ireland -16.94%Brazil -2.04%Haiti 9.62%Cambodia -15.64%India -0.13%Bangladesh 11.00%Angola -13.95%United States 0.28%Philippines 14.73%Chile -9.69% Bermuda 23.62%Panama -8.97% Lesotho 35.17%China: Macao SAR-6.03%Australia -4.65%

Source: United Nations Main Aggregates Database

Current Account Balance

• Current Account: NX +NFI• NFI = Primary Income (Overseas Wage & Investment Income) + Secondary Income (Transfers)

Current Account (CA) (Hong Kong) 110,086 Current Account: Credit (Hong Kong) 5,199,130 Current Account: Debit (Hong Kong) -5,089,044 Goods (Hong Kong) -71,087 Goods: Credit (Hong Kong) 3,411,260 Goods: Debit (Hong Kong) -3,482,347 Services (Hong Kong) 148,138 Services: Credit (Hong Kong) 721,661 Services: Debit (Hong Kong) -573,523 Primary Income (PInc) (Hong Kong) 52,826 Investment: Credit (Hong Kong) 1,056,615 Investment: Debit (Hong Kong) -1,002,210 Compensation of Employees: Credit (Hong Kong) 2,737 Compensation of Employees: Debit (Hong Kong) -4,315 Secondary Income (SInc) (Hong Kong) -19,791

Census and Statistics Department

Global Imbalances Link

World Current Account equals zero!

International Capital Flows

• Capital Outflows: domestic acquisition of foreign assets.

• Capital Inflows: foreign acquisition of domestic assetsNet Capital Outflows = Capital Outflows – Capital Inflows

Money is an asset. Most international financial transaction are swaps of one asset for another and have zero net effect on capital flows. Only net trade of foreign assets for goods or services creates opportunity for net capital flows. Current Account = Net Capital Outflows

Savings & Current Account• Gross National Savings: GNS• GNS = GNI – Consumption (PCE + GCE)• GNI = GDP + NFI• GDP = Consumption + Gross Capital Formation + Net

Exports (Exports – Imports)• GNS – GCF = NX + NFI = Current Account

Capital & Financial Account• Current Account is net capital outflows (i.e. national

savings less national investment).• Capital & Financial Account measures the allocation of net

inflows.• Capital Account: Transfer of Real Assets• Financial Account: Transfer of Financial Assets

• Non-reserve Assets• Direct Investment: (Taking Controlling Stakes in Foreign Entities)• Portfolio Investment: (Stocks, Bonds)• Financial Derivatives (Futures, Swaps)• Other (Mostly Bank Loans and Deposits)

Capital & Financial Account 2011Increases in financial assets, and decreases in liabilities should be shown as debits.Decreases in financial assets,and increases in liabilities should be shown as credits.

Capital & Financial Account (CFA) (Hong Kong) -113,242Capital Account (Hong Kong) -2,021Financial Account (FA) (Hong Kong) -111,220 Financial Non Reserve Assets (Hong Kong) -24,437 Direct Investment (DI) (Hong Kong) 1,868 Assets (AS) (Hong Kong) -746,372 Liabilities (LB) (Hong Kong) 748,240 Portfolio Investment (PI) (Hong Kong) -10,979 Assets (AS) (Hong Kong) -155,818 Liabilities (LB) (Hong Kong) 144,839 Financial Derivatives (FD) (Hong Kong) 20,884 Assets (Hong Kong) 359,707 Liabilities (Hong Kong) -338,823 Other investment (OI) (Hong Kong) -36,210 Assets (Hong Kong) -780,960 Liabilities (Hong Kong) 744,749 Reserve Assets (Hong Kong) -86,783Net Errors and Omissions (Hong Kong) 3,156Overall Balance (Hong Kong) 86,783

Salient Feature of Balance of Payments

Balance of PaymentsForeign Currency Received (Credit)

Foreign Currency Paid (Debit)

Exports (+)Income Receipts (+){Non reserve} Capital Inflows (+)

Imports (-)Income Payments (-){Non reserve} Capital Outflows (-)

Overall Balance = Current Account + Capital & Financial Account

Credits – Debits = Increase in Reserves

Link

Learning OutcomesStudents should be able to:• Explain the different methods of calculating GDP• Calculate simple real aggregates like real GDP.• Use price indices to calculate inflation rates.• Adjust nominal series for inflation.• Define and calculate real ex post and ex ante real interest rates. • Define the elements of the Balance of Payments Tables