Download Economic Instability - Federal Reserve Bank of Dallas

Session 10
Economic Instability
Disclaimer: The views expressed are those of the presenters and do not necessarily reflect those
of the Federal Reserve Bank of Dallas or the Federal Reserve System.
TEKS
(10) Economics. The student understands key economic
measurements. The student is expected to:
(A) interpret economic data, including unemployment rate,
gross domestic product, gross domestic product per
capita as a measure of national wealth, and rate of
inflation; and
(B) analyze business cycles using key economic indicators.
Teaching the Terms
•
•
•
•
•
•
•
•
•
•
Unemployment
Recession
Frictional
Structural
Cyclical
Inflation
Deflation
Price index
Indexing
Hyperinflation
Macroeconomic Issues
•
•
•
•
Recessions
Unemployment
Inflation
Distribution
Business Cycle
Long-Run
Growth Trend
Real
GDP
Peak
Expansion
Recession
Trough
Time
Recession
A recession is a significant decline in economic
activity spread across the economy, lasting
more than a few months, normally visible in
production, employment, real income, and
other indicators.
http://www.nber.org/dec2008.pdf
Federal Reserve Bank of
2011
2007
2003
1999
1996
1992
1988
1984
1980
1976
1972
1968
1964
1960
1956
1952
1949
1945
1941
1937
1933
1929
1925
1921
1917
1913
1909
1905
1902
1898
1894
1890
1886
1882
1878
1874
1870
1866
1862
1858
1855
An Economic Bar Code?
Federal Reserve Bank of
2011
2007
2003
1999
1996
1992
1988
1984
1980
1976
1972
1968
1964
1960
1956
1952
1949
1945
1941
1937
1933
1929
1925
1921
1917
1913
1909
1905
1902
1898
1894
1890
1886
1882
1878
1874
1870
1866
1862
1858
1855
U.S. Business Cycle
Black = Months in Contraction (Recession)
Labor Force
Employed
Population
Civilians over
16 and not
institutionalized
Labor Force
Unemployed
Not in labor
force
Unemployment
• Every person who is 16 years old or older (the
working-age population) and not institutionalized
falls into one of three categories
– Employed – a person who has worked full- or part-time
during the past week or is on vacation/sick leave
– Unemployed – a person who did not work in the past week
but sought work in the past four weeks
– Out of the labor force – did not work or seek employment
Unemployment
• Labor force = Employed + Unemployed
• Unemployment rate = Unemployed ÷ Labor
Force
• Participation rate = Labor force ÷ Working Age
(16+) Population
Criticisms of Measurement
•
•
•
•
Discouraged workers
Involuntary part-time workers
Underemployed
Types of employment
Unemployment
Frictional
Structural
Cyclical
Total
Unemployment
Types of Unemployment: Frictional
• Short-term unemployment associated with
matching workers with jobs
• Costs are small (may even be negative)
Types of Unemployment: Structural
• Long-term and chronic unemployment that
exists when an economy is producing at a
normal rate
• Mismatch of unemployed workers and
available jobs
• Very high costs related to its long-term nature
Types of Unemployment: Cyclical
• Occurs during a period of recession (unusually
low production)
• High costs both to worker and to society
– Lost production (output)
– Lost income for unemployed workers
– Lost tax revenue and increased government
support
Natural Rate of Unemployment
Frictional
Natural Rate of
Unemployment
Structural
• Full employment ≠ zero unemployment
• Full employment = no cyclical unemployment
Inflation
• Inflation is an increase in the overall level of
prices.
• Inflation is not an increase in the price of a
specific good or service relative to the prices
of other goods and services.
Measuring Inflation
• Use a price index that measures the cost of a
fixed market basket of goods relative to the
cost of the same basket in a base year
• Examples
– Consumer Price Index (CPI) – BLS
– GDP Deflator – BEA
– Personal Consumption Expenditures Price Index –
BEA
Computing a Price Index
•
•
•
•
Select a market basket
Compute the price of the basket in each year
Select a base year
Current year price ÷ Base year price = Price index
• Simulation – Candy Price Index
– Denise Hazlett
athttp://people.whitman.edu/~hazlett/econ/
Simulation: Step 1
• Individually
– Select a mix of candy that costs 30¢ for each of
the periods
• As a group
– Agree to a market basket that is representative
Simulation: Step 2
Period 1
Item
2 Kisses
3 Reese’s
1 Lifesaver
Item
Price
Total
Price
5¢
10¢
10¢
30¢
5¢
5¢
Price of basket
45¢
• Calculate the total price
of a market basket in
each period, using a
basket of:
– 2 Kisses
– 3 Reese's
– 1 Lifesaver
Simulation Instructions
• Calculate the Candy Price Index for each
period
– CPI = (Price current / Price base ) * 100
– For Period 1: CPI = (45¢ / 30¢) * 100= 150
• Calculate the inflation rate between each
period.
– Inflation rate = (CPI2 – CPI1) / CPI1
– Inflation between period 1 and 2 = (117 – 150) /
150 = -22%
Results with 2K, 3R and 1L
Period
Base
1
2
3
4
5
6
CPI
Inflation Rate
100
150
117
133
150
167
183
NA
50%
-22%
14%
13%
11%
10%
Results with 2K, 2R and 2L
Period
Base
1
2
3
4
5
6
CPI
Inflation Rate
100
133
133
133
167
167
167
NA
33%
0
0
25%
0
0
Issues with Market Baskets
• Substitution bias – a fixed basket ignores
consumers’ ability to substitute away from items
that have become relatively more expensive
• New product bias – a fixed basket does not
account for the value to consumers of newly
available goods and services
• Quality bias – a fixed basket does not adequately
account for change in the quality of goods and
services
Constructing a Market Basket
• Questions
– What is the scope of the market basket?
– How often is the market basket updated?
• Different baskets
– CPI – the purchases of a typical urban consumer
– GDP Deflator – the entire production of the
economy
– PCE – personal consumption expenditures
Computing the Indexes
• CPI – a historic basket at current prices
How much does it cost to buy the old basket this
year?
• GDP – a current basket at historic prices
How much would it have cost to buy this year’s
GDP at some point in the past?
• PCE – combines both measurement
techniques and takes an average of the two
Comparing Indexes
• The fixed basket used by CPI might not account for
– Improvements in the quality of goods and services
– The ability of consumers to substitute cheaper goods and
services for more expensive ones
• The changing basket of GDP might not reflect the loss of
welfare from substitutions
• PCE price index is a blend of the fixed basket and the
changing basket
PCE Price Index
• Since 2000, PCE has been the Fed’s preferred
inflation measure
• Advantages
– Bigger “basket” of goods & services than CPI
– Expenditure weights updated monthly (CPI
updates every 2 years)
• Disadvantages
– Slower to release than CPI
– Subject to data revisions
Using a Price Index
• Deflate nominal value
• Index values to reflect changing price level
• Calculate the rate of inflation
Nominal vs. Real Variables
• Nominal variables are measured using current
prices
• Real variables have been adjusted for inflation
by using prices from a base year
• Examples
– Real wages
– Real GDP
– Real interest rate
Deflating a Nominal Value
• Convert a nominal value to a real value to
remove the effect of inflated prices – allows
values to be compared over time.
• Real = Nominal ÷ (Price Index/100)
• Handout: Inflation at the Movies
Box Office Winners (and Losers)
Revenue
(in millions)
Movie Title
Year
Released
CPI
1983=100
Real
Revenue
1983=100
Rank
$260
Jaws
1975
54.0
$481.5
1
$400
E.T. The Extra-Terrestrial
1982
97.5
$410.3
2
$162
Close Encounters of the Third Kind
1977
61.0
$265.6
3
$242
Raiders of the Lost Ark
1981
91.6
$264.2
4
$357
Jurassic Park
1993
144.4
$247.2
5
$77
The Terminal
2004
188.9
$40.8
17
$44
Always
1990
130.7
$33.7
18
$44
Amistad
1998
163.2
$27.0
19
$47
Munich
2005
195.3
$24.1
20
$22
Empire of the Sun
1987
113.6
$19.4
21
Indexing
• Converts a real value to a nominal value by
increasing a nominal quantity by an amount
equal to the percentage increase in a price index
• Allows an employer or government to maintain
purchasing power of salaries and benefits
• Examples
– Candy consumption
– Indexed labor contracts (COLAs)
– Social Security payments
Rate of Inflation
• Shows the rate of change of prices over time
• Rate of inflation is the percentage rate of
change in a price index
• Rate of inflation = (PI2 – PI1) / PI1
Costs of Unexpected Inflation
• Redistributions of wealth
Creditors / Debtors and Employees (on contract) / Employers
• Interference with long-term planning
Future purchasing power is uncertain
• “Noise” in the price system
Information conveyed by prices becomes difficult to interpret
• Shoe leather costs
Time and effort spent to minimize the effect of inflation
• Distortions of the tax system
“Bracket creep” and future value of depreciation allowances
Hyperinflation
• Excessive monetary growth → hyperinflation
• Examples
– Nicaragua (1988) – 33,000% inflation
– Germany (1923) – 102 million% inflation
– Hungary (1945) – 3.8 * 1027% inflation
• Harm of inflation is magnified.
Causes of Inflation
• Long-run
– Too much money chasing too few goods
– “Inflation is always and everywhere a monetary
phenomenon…” (Milton Friedman)
• Short-run
– Expectations
– Excess demand
– Supply shocks
Distribution of Income
• Lorenz curve is a curve showing how the
actual distribution of income differs from an
equal distribution of income in a nation
Questions?