Week 1
Lectures 1 & 2
Measuring Macroeconomic Performance: Output and Prices Reference: Bernanke, Olekalns and Frank (BOF) Chapter 1 Key Issues Indicators of macroeconomic performance Measuring output (GDP) Measuring prices and inflation
Evaluating Macroeconomic Performance 1. Rising Living Standards – economic growth Tendency for the level of output (i.e. quantity and quality of goods and services) to increase over time. Output divided by population = output per capita May also care about the distribution of living standards
2
Dec-2014
Sep-2013
Jun-2012
Mar-2011
Dec-2009
Sep-2008
Jun-2007
Mar-2006
Dec-2004
Sep-2003
Jun-2002
Mar-2001
Dec-1999
Sep-1998
Jun-1997
Mar-1996
Dec-1994
Sep-1993
Jun-1992
Mar-1991
Dec-1989
Sep-1988
Jun-1987
Mar-1986
Dec-1984
Sep-1983
Jun-1982
Mar-1981
Dec-1979
Sep-1978
Jun-1977
Mar-1976
Dec-1974
Sep-1973
$, cvm
Real Quarterly GDP per-capita – Australia (1973-2015) 18000
16000
14000
12000
10000
8000
6000
4000
2000
0
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2. Stable Business Cycle – low volatility in fluctuations of actual output around its trend or potential output. Australia’s Real Quarterly GDP Growth Rates – Decade Averages 1960s 1970s 1980s 1990s 2000s 2010s Mean 1.25 0.83 0.84 0.84 0.77 0.63 Standard 1.50 1.42 1.09 0.79 0.52 0.38 Deviation Ratio 0.83 0.58 0.77 1.06 1.48 1.66 Mid-1980s Great Moderation – large fall in volatility of real output – why?
4
Australia’s Growth Rate vs. Volatility: Decade Averages 1.40
60s 1.20
Mean growth per qtr
1.00
80s
90s
0.80
70s
2000s 2010s
0.60
0.40
0.20
0.00
0.00
0.20
0.40
0.60
0.80
1.00
1.20
1.40
1.60
Std of quarterly growth
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3. Relatively Stable Price Level – low (positive) rate of inflation Inflation has been concern for most developed countries over the last half century. Japan is an exception and has experienced deflation over the last decade.
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10.0
5.0 Year-ended percentage change
Australian Inflation - Consumer Price Index Measure 20.0
15.0
0.0
Mar-2014 Mar-2011 Mar-2008 Mar-2005 Mar-2002 Mar-1999 Mar-1996 Mar-1993 Mar-1990 Mar-1987 Mar-1984 Mar-1981 Mar-1978 Mar-1975 Mar-1972 Mar-1969
Mar-1966 Mar-1963 Mar-1960 -5.0
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4. Sustainable Levels of Public and National Debt Public debt – borrowing by public sector from private sector Influenced by government budget deficits/surpluses Foreign debt – borrowing by domestic residents from foreign countries Influenced by an economy’s current account deficits/surpluses
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5 Percent of GDP
Budget Balance and Net Government Debt for Australia 20
15
10
0
2017-18 2016-17 2015-16 2014-15 2013-14 2012-13 2011-12 2010-11
Net Debt Budget Deficit (underlying)
2009-10 2008-09 2007-08
2006-07 2005-06 2004-05 2003-04 2002-03 2001-02 2000-01 -5
-10
9
30 Percent
Australia’s Net External Liabilities (% of nominal GDP) 70
60
50
40
20
10
0
Mar-2014 Sep-2012 Mar-2011
Sep-2009 Mar-2008 Sep-2006 Mar-2005 Sep-2003 Mar-2002
Total Equity Debt
Sep-2000 Mar-1999
Sep-1997 Mar-1996 Sep-1994 Mar-1993 Sep-1991 Mar-1990 Sep-1988 -10
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5. Balance between Current and Future Consumption How much should an economy save/invest?
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I/Y Mar-2015
Dec-2013
Sep-2012
Jun-2011
Mar-2010
Dec-2008
Sep-2007
Jun-2006
Mar-2005
Dec-2003
Sep-2002
Jun-2001
Mar-2000
Dec-1998
Sep-1997
Jun-1996
Mar-1995
Dec-1993
Sep-1992
Jun-1991
Mar-1990
Dec-1988
Sep-1987
Jun-1986
Mar-1985
Dec-1983
Sep-1982
Jun-1981
Mar-1980
Dec-1978
Sep-1977
Jun-1976
Mar-1975
Dec-1973
Sep-1972
Jun-1971
Mar-1970
Share of GDP
Australian Investment and National Saving 0.40
0.35
0.30
0.25
0.20
0.15
0.10
0.05
0.00
NS/Y
12
6. Full Employment Provision of employment for all individuals seeking work
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Feb-2015
Feb-2014
Feb-2013
Feb-2012
Feb-2011
Feb-2010
Feb-2009
Feb-2008
Feb-2007
Feb-2006
Feb-2005
Feb-2004
Feb-2003
Feb-2002
Feb-2001
Feb-2000
Feb-1999
Feb-1998
Feb-1997
Feb-1996
Feb-1995
Feb-1994
Feb-1993
Feb-1992
Feb-1991
Feb-1990
Feb-1989
Feb-1988
Feb-1987
Feb-1986
Feb-1985
Feb-1984
Feb-1983
Feb-1982
Feb-1981
Feb-1980
Feb-1979
Feb-1978
Percent
Australian Unemployment Rate – Monthly 12.0
10.0
8.0
6.0
4.0
2.0
0.0
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Measuring National or Aggregate Output GDP = Gross Domestic Product
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Which of the following is the correct definition of GDP? (a)Value of all goods and services bought and sold during a year (b) Value of all new goods and services produced during a year (c) Value of all final goods and services purchased during a year (d) None of the above
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GDP = Gross Domestic Product Definition: The market value of final goods and services produced in a country during a given period.
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The market value of final goods and services produced in a country during a given period. GDP is a flow variable – measured over a period of time. Quarter – March, June, September, December Australian GDP in March 2015 = $403.5 billion Year – just add-up GDP over 4 quarters Calendar – Mar-09 + Jun-09 + Sep-09 + Dec-09 Financial – Sep-09 + Dec-09 + Mar-10 + Jun-10
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The market value of final goods and services produced in a country during a given period. Excludes goods and services that are produced in other countries (but might be consumed in Australia) Imports Excludes goods and services that were produced in some earlier period, but are re-sold in the current period – second-hand goods
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The market value of final goods and services produced in a country during a given period. GDP is measure of aggregate production or output Use market prices to value (or weight) quantities of various goods and services Example:
Quantity 10 cars 100 apples
Market Price $20,000 per car $1 per apple
GDP = $200,000 + $100 = $200,100
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What about goods and services with no observed market price? Some are included in GDP: National defense – use costs of provision (costs of buying equipment, wages of soldiers, etc.) Roads Some are excluded from GDP Unpaid housework (Household production)
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The market value of final goods and services produced in a country during a given period. GDP excludes intermediate goods and services. These goods are used-up in the production process. Example: In the production of a loaf of bread, the flour used is an intermediate input and is not (double) counted in GDP. Concept of Value Added: The market value of a firm’s production less the cost of inputs purchased from other firms
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Value Added in Computer Sales: Chapter 1, Problem 2 (Textbook) Firm Added Intel Incorp Macro Soft Bell PC Charlie’s
Sales
Cost of inputs
20,000 5,000 80,000 100,000
0 0 25,000 80,000
Value 20,000 5,000 55,000 20,000
PC Charlie’s final sales = $100,000 Sum of Value Added = $100,000
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The Verge Café offers a big breakfast of bacon, eggs, tomato and toast for $10. What is the best measure of the value added of a big breakfast? (a)$10 (b)$10 less the cost of the bacon, eggs, tomato and toast (c)$10 plus the cost of the bacon, eggs, tomato and toast (d)the cost to Verge Café of purchasing the bacon, eggs, tomato and toast (e)$10 less the cost of the bacon eggs, tomato, toast and the labour cost (waiter and cook) required to produce the big breakfast 24
(a)$10 (contribution to GDP, not value added of big breakfast at Verge Café) (b)$10 less the cost of the bacon, eggs, tomato and toast (Yes, price less cost of intermediate inputs) (c)$10 plus the cost of the bacon, eggs, tomato and toast (d) the cost to Verge Café of purchasing the bacon, eggs, tomato and toast (cost of intermediate inputs) (e)$10 less the cost of the bacon eggs, tomato, toast and the labour cost (waiter and cook) required to produce the big breakfast (Labour cost is not intermediate input)
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3 Equivalent Ways to Measure GDP 1. Production Method 2. Expenditure Method 3. Income Method
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Expenditure Method Accounting Identity Expenditure on goods and services by final users must equal the value of their production. Components of Expenditure Consumption (C) – purchases by Households Investment (I) – purchases by Firms Government (G) – Government purchases Net Exports (NX ) – net purchases by foreign sector NX = Exports (X) – Imports (M) 27
National Income Accounting Identity GDP=Expenditure Y = C + I + G + NX Y=C+I+G+X–M Y+M=C+I+G+X Supply of G & S = Demand for G & S
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Australian GDP March Quarter 2015 Expenditure Approach $billion Household Consumption 229.4 Private Investment 88.0 Government (Public) Spending 89.7 Change in Inventories 0.2 Exports 82.6 Less Imports 86.3 Total 403.6 Statistical discrepancy -0.1 GDP 403.5 http://www.abs.gov.au/AUSSTATS/
[email protected]/DetailsPa ge/5206.0Mar%202015?OpenDocument 29
Income Method GDP also equals the aggregate incomes paid to Labour (L) Capital (K) in the production of goods and services.
GDP = Labour Income + Capital Income
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Australian GDP March Quarter 2015 Income Approach $billion Compensation of Employees 192.7 Gross Operating Surplus 137.5 Gross Mixed Income 33.7 Total Factor Income 363.9 Taxes – Subsidies 41.2 Total 405.1 Statistical discrepancy -1.5 GDP (Market Prices) 403.5 http://www.abs.gov.au/AUSSTATS/
[email protected]/DetailsPa ge/5206.0Mar%202015?OpenDocument 31
Which of the following is the correct definition of GDP? (a)Value of all goods and services bought and sold during a year (This would include second-hand goods) (b) Value of all new goods and services produced during a year (This would include intermediate goods) (c) Value of all final goods and services purchased during a year (Option says purchased (not produced) so includes imported goods and services) (d) None of the above (Correct choice)
32
Nominal vs. Real GDP Nominal values quantities of goods and services produced at current year prices
Real (or constant price or chain volume measure) values quantities of goods and services produced at base year prices – measure of the actual physical volume of production
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Example No. of Cars Price of Cars No. of Apples Price of Apples Nominal GDP
2007 10 $20,000 100 $1 $200,100
Real GDP 2007 prices 2008 prices
$200,100 $400,200
2008 % Change 10 0 $40,000 100 100 0 $2 100 $400,200 100
$200,100 $400,200
0 0
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Choice of Base Year (Bit Technical) In the above example whether we use 2007 or 2008 as base year prices gives the same answer for the growth rate of real GDP This is not the case in general, particularly if you are comparing real GDP over a 5-10 year period. Using initial prices (i.e. 2007) is known as a Laspeyres index Using final prices (i.e. 2008) is known as a Paasche index
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Chain Weighting For any two consecutive years compute the growth rates of real GDP implied by both the Laspeyres and the Paasche indexes. Then take the average of the two growth rates and this is the chain-weighted growth rate. This can be used to compute a real chained-weighted GDP. Finally to compute a change index over a long period, the above approach is applied on a year-by-year basis.
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Example No. of Cars Price of Cars No. of Apples Price of Apples Nominal GDP
2007 10 $20,000 100 $10 $200,100
Real GDP 2007 prices 2008 prices
$200,100 $402,500
2008 % Change 10 0 $40,000 100 1000 900 $25 150 $425,000 112
$210,000 $425,000
4.9 5.6
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Chain-weighted measure of Real GDP Take average of growth rates implied by 2007 and 2008 prices. 5.25 = (4.9 + 5.6)/2 Choose either 2007 or 2008 as the base-year (nominal=real GDP). Let’s pick 2007 2007 Nominal GDP 200,100 Real GDP 200,100
2008 425,000 210,605 (200,100×1.0525)
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Chain Volume Measures of GDP and Components RBA Website http://www.rba.gov.au/statistics/tables/index.html#prices _inflation ABS Website http://www.abs.gov.au/websitedbs/d3310114.nsf/Home/ Home?OpenDocument
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Is GDP A Good Measure of Economic Wellbeing? GDP per capita = GDP/Pop (see slides 2 and 3) Omissions from GDP that might matter for economic welfare Leisure Time (extra week of holidays) Household production (cook at home) Environmental Degradation Quality of Life (happiness) Economic Inequality (distribution of income)
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Is GDP positively correlated with economic welfare? Yes: medical care No:
Income distribution over last 20 years
Maybe: Income and measures of Happiness
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Alternatives (complements) to GDP 1. Direct measures of Happiness - Survey-based measures (ask people how happy they are on a scale of 1 to 10. http://www1.eur.nl/fsw/happiness/index.html
2. Indexes of variables that might affect welfare http://www.smh.com.au/national/wellbeing-index-showsimpact-of-jobless-on-society-20140606-39okt.html 42
Measures of the Price Level Want to measure the average level of prices in the economy. Main Measures Consumer Price Index (CPI) GDP Deflator/Price Index CPI – For a given period, measures the cost in that period of a given basket of goods and services relative to their cost in a fixed year – called a base year.
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Construct a CPI Choose a basket of goods and services Basket 2000 (base) Rent (2 bedroom flat) $500 Hamburgers (60) $150 Books (2) $30 Total Expenditure $680
2015 $630 $150 $70 $850
CPI = Cost of base-year basket of goods and services in current year Cost of base-year basket of goods and services in base year CPI = $850/$680 = 1.25 44
Cost of living is 25 percent higher in 2015 than it was in 2000 Average prices are 25 percent higher in 2015 than in 2000 Australian CPI Published quarterly by ABS Household Expenditure Survey used to determine typical basket Base year changes every 5 years
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Was Charles Dickens the Taylor Swift of the 19th Century? According to a recent biography of the 19th century novelist Charles Dickens, in 1862 he could earn 190 pounds per night for giving a reading from his novels. According to The Richest (website) Taylor Swift earns revenue of about US $1.2 million from a concert. What information would you need to be able to calculate what Dickens’ earnings are in current UK pounds? http://www.measuringworth.com/calculators/ppoweruk/ 46
Inflation (and Deflation) Inflation is measured by the percentage change in the CPI over a given period. Inflation rate
CPI CPI (1) = [ CPI (1) ] *100
Inflation rate = 0 implies prices are constant Inflation rate > 0 implies prices are rising Inflation rate < 0 implies prices are falling – Deflation
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Limitations with CPI Quality Adjustment and New Goods Bias Quality improvements may show up as higher prices for goods and services New goods are often not included until CPI is rebased Substitution Bias Use of a fixed basket means that no allowance is made for consumers’ substitution toward relatively less expensive goods. CPI tends to overstate the rate of inflation. 48
Costs of Inflation Important to distinguish between relative price change and a change in the general price level Shoe-leather costs – inflation reduces the real purchasing power of a given amount of money Menu costs – real costs of changing prices Introduces noise into the price mechanism Distorts tax systems (if not indexed to inflation) Unexpected re-distributions of wealth
49
Inflation and Interest Rates Nominal Interest Rates – percentage increase in the nominal (or dollar) value of a financial asset. Real Interest Rate – percentage increase in the real purchasing power of a financial asset.
r i r = real interest rate i = nominal interest rate π = inflation rate
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Fisher Effect Nominal interest rate = real rate + (expected) inflation rate
i r
e
51
8.0 Percent
Inflation and Nominal Interest Rate 18.0
16.0
14.0
12.0
10.0
6.0
4.0
2.0
0.0
Sep-2014 Mar-2013 Sep-2011 Mar-2010 Sep-2008 Mar-2007 Sep-2005
Mar-2004 Sep-2002 Mar-2001 Sep-1999 Mar-1998
Sep-1996
Inflation rate (year-ended) 10 year bond rate
Mar-1995 Sep-1993 Mar-1992 Sep-1990
Mar-1989 Sep-1987 Mar-1986 Sep-1984 Mar-1983
Sep-1981 Mar-1980 -2.0
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The nominal interest rate on a one year government bond is 8 percent per annum. Investors require an annual real return of 3 percent. What is the expected rate of inflation? (i) (ii) (iii) (iv) (v)
11 percent 8 percent 5 percent 3 percent Insufficient information to calculate
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The nominal interest rate on a one year government bond is 8 percent per annum. Investors require an annual real return of 3 percent. What is the expected rate of inflation? (i) 11 percent (ii) 8 percent (iii) 5 percent (iv) 3 percent (v) Insufficient information to calculate Use Fisher effect
𝑖 = 𝑟 + 𝜋𝑒 𝜋𝑒 = 𝑖 − 𝑟 = 8 − 3 54
